If you’ve read any real estate investing blogs, or browsed any forums, you’ve probably been given a whole list of numbers to look at when analyzing a rental property. There are different ratios, rates of return, and rules of thumb people like to use.
There is one problem that all of these numbers and calculations have, they only speak to a property’s history. You don’t make money on what a property did last year, last month, or even yesterday. You invest in real estate for what it’s going to do in the future.
One of the best ways to build wealth in real estate is to increase the value of the property. When it comes to investment real estate, that doesn’t just mean new countertops and light fixtures. The value of income producing real estate increases with the cash flow.
So what number do you look at to figure out how to increase the cash flow and the value of the asset? We talked to one of the most successful real estate investors in the world, who manages one of the largest private real estate funds in the world; Grant Cardone, CEO of Cardone Capital.
“Size matters in this game.”
Grant Cardone says the most important number in real estate is not the cap rate, cash flow, cost per unit, cost of leverage, debt service coverage ratio, or any of the other common terms we are all familiar with.
Instead, he says the most important number in real estate is the number of units purchased.
“Size matters in this game. If you own 2 units and raise the rents $100, it’s an increase of $200. If you own 300 units and raise the rents to $25 it’s an increase of $7,500, most of which will hit the bottom line.”
Cardone owns roughly 8,000 units in states where there is no rent control and he avoids investing where there is the type of government influence that may impose rent control.
Take those 8,000 units and multiply them by $25. That’s an increase of $200,000 a month, which is $2.4M of additional cash flow each year.
“Small doesn’t work in any business. Scaling in real estate is simply about the number of units.”
Building wealth in real estate is all about scaling. You can’t create generational wealth by taking 50 years to grow your portfolio one single family or 2-4 unit property at a time.
The ability to scale will determine your ability to grow in any type of business. Whether it’s cutting hair, or owning a bar or restaurant, it takes adding multiple units to grow. Even when it comes to selling products online, you need to have multiple products (units) to sell.
Cardone adds “Small doesn’t work in any business. Scaling in real estate is simply about the number of units.”
“If it’s easy to buy, it will be hard to sell.”
If you lose two tenants in your four-unit property, you are only 50% occupied. It’s not an unlikely scenario to be down two tenants at one time, either.
If you lose two tenants in a 40-unit property, you’re still at 95% occupancy. You can lose 10 tenants and still be in better shape than with the four-unit property.
The number of units in a property will make a huge difference when it comes time to sell. Not only were you able to force the appreciation on the property by increasing cash flow, but you’re working with a different buyer pool.
Cardone further explains “The first thing I look for when I am new in a market is how many units are available in that market. Then I Look for how many deals there are under 50 units, 50-100, 100-250, and then above 250 units. I want to be in a market where it’s hard to buy properties over 250 units. If it’s easy to buy, it will be hard to sell.”
Cardone explained that larger properties are more difficult to replace. Government controls, regulations, and the development costs make it difficult to build apartments with over 200 units. This is a benefit to the investor because there is more competition amongst buyers when it comes time to sell the property.
Cardone also went on to talk about the buyers you’ll be working with. “The people buying 4, 8, 16-unit deals are price sensitive. They’re looking for a deal; they don’t want to pay market price. The institutional investors and the private funds, buying the types of properties I invest in, have money they need to park somewhere. They’re willing to pay a premium price for quality real estate that will generate safe and consistent returns to their investors.”
“You don’t have to have a million dollars to invest in these kinds of deals”
Crowdfunding has become a way for investors to pool their money together to invest in larger assets, like the apartments Grant Cardone talks about. With most crowdfunding deals, a sponsor puts the deal together and finds multiple investors to help fund the deal. The investors simply contribute money, and the sponsor manages the investment.
Crowdfunding has become the easiest way for investors to participate in high quality real estate deals. Each deal is different, but most have a minimum investment between $25,000 – $100,000. These are mostly reserved for accredited investors as well.
An accredited investor is anyone with an annual income of at least $200,000, or a household income of $300,000 if the investor is married. Another way to be accredited is to have a net worth of at least $1 million, excluding their personal residence.
Cardone uses crowdfunding to raise capital and allow other investors to partner on his deals. A lot of his investors choose real estate to get a more consistent return than the stock market provides. Many others use it as a way to diversify their retirement portfolio. “You don’t have to have a million dollars to invest in these kinds of deals.” Cardone explains. “These deals aren’t reserved for the ultra wealthy anymore. Hedge funds and REITs aren’t the only ones that get to participate anymore.”
The bottom line
All of this isn’t to say that you should ignore the cap rates, the cash-on-cash returns, and the other common numbers. That’s just not where you should start your analysis. The first thing you want to look at when you’re jotting down numbers on the back of a napkin is how much more cash flow you’ll get if you increase the rent $25, $50, and $100 per month. If that number is enough to get you excited, then it’s time to dig into the rest.