An excerpt from The Doctors Guide to Real Estate Investing for Busy Professionals.
Cash flow is the only method I use to determine the value of the property to me and is my decision-making tool.
This is how I determine the price I’m willing to pay. This is the only way to fully evaluate the property as an investment, and it will take some of your time to compute. It also takes into consideration how the property is financed—which none of the other methods care about, but you certainly should.
When I buy an investment property, the idea is to make money. That’s the definition of an investment: a place to put your money so it will make you more money. There are two ways real estate makes money. One is appreciation, which I can’t predict well, and the other is cash flow, which is much more predictable.
In order for you to compute the cash flow, you will need two of the pieces of information already discussed: the income and expenses, which make up the NOI. The final piece of information is the financing terms, which I cover in the next chapter.
It is unlikely you will be buying your investment property with all cash. You will need to get a loan or mortgage on the property. It is very important that the money coming from the property, the NOI, can fully cover the mortgage payments.
This is the key to why it is OK to borrow money to make a real estate investment but not to buy a car. When you borrow to buy a car, you will personally need to earn the money to make those payments, and that means the car payments take away from your available cash flow. A car loan creates a negative cash flow.
With the investment property mortgage, the property is responsible for earning the money to make the payments. You can then put the leftovers in your pocket: a positive cash flow. So a property investment loan puts money into your pocket, and the car loan takes money out of your pocket.
Cory Fawcett is a general surgeon and can be reached at his self-titled site, Dr. Cory S. Fawcett. He is the author of The Doctors Guide to Real Estate Investing for Busy Professionals, The Doctors Guide to Starting Your Practice Right, The Doctors Guide to Eliminating Debt, and The Doctors Guide to Smart Career Alternatives and Retirement.
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