The first calculation you need to do BEFORE you start investing in real estate. - CWHO - Commonwealth Home Ownership
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The first calculation you need to do BEFORE you start investing in real estate.

As I am sure you’ve heard a million times before, real estate investing can be a great way to build wealth, provide financial security, retirement income and also generate passive income (I say passive with a hint of sarcasm as it tends to require a lot more work than what most would class as a ‘passive’ source of income). Even so, a question I would often ask new investors excited to get started with their investing journey is quite simply ‘why?’. I mean, what exactly would they like the real estate to do for them?

The response is typically based on owning a certain number of doors without any thought about ‘what for’? Don’t get me wrong, there is nothing wrong with being excited about becoming a real estate investor and owning a stack of doors, but before you throw a bunch of money into a property or a deal, it is worth establishing what your long term investment plan is and what you want it to do for you.

 

A good starting point is to work out your Quantifiable ONE Number. Basically, in short, how much income do you need to make while you sleep (yes, you read that correctly, while you sleep) to live life your way, on your terms, and essentially do what you want when you want without having to worry about your next paycheck or a mind-numbing nine-to-five.

 

Now, there are two fundamental factors that you’ll need to contemplate when calculating your ONE number; they are your ‘Needs’ and ‘Wants.’

 

Needs = Essential base living costs (a roof over your head)    

 

Wants = Everything non-essential (the good stuff)

 

Before you pull out the calculator, create a list of all the things you consider essential for the way you would like to live. Don’t forget you can do this exercise from two perspectives:

 

  1. Your expenses as they exist today
  2. Your expenses once you’ve retired

 

Below are some points to consider:

 

Needs include items such as:

 

  • Housing Costs: You’ll need to keep a roof over your head, so be sure to account for your mortgage, tax, insurance, utilities and maintenance. Even if you don’t have a mortgage, the other costs will still apply.
  • Groceries: We all get hungry (some of us hangry), so best allow for the refrigerator to remain stocked, especially if you have little mouths to feed.
  • Transportation: Getting from A to B. Do you prefer to drive, ride, be chauffeur, or catch public transport? Either way, each option will cost something.
  • Life/Critical Illness Insurance: Unfortunately, as we get older and acquire more, these costs become necessary. All is not lost as some universal and whole life policies can provide your future self with access to cash, in essence, a way to be your own bank.
  • Cell Phone/Internet: This can be a contentious one. Is this a necessity? I’m going to go out on a limb and say that it is in this day and age.
  • Medical: Do you require medication or treatments you cannot live without? Either way, you should probably make an allowance for your future self.

 

Wants include items such as:

 

  • Travel: How often? Where? How much per trip? This can be quite a considerable dollar value once you get to the truth but be honest with yourself so we can get to your real ONE number.
  • Education & Self Development: Do you have young ones’ that you’d like to send to that private school down the road, or maybe you fancy doing a course or going back to school? Maybe learn a new language? (I’m self-learning Mandarine, let’s just say I’m stuck at nee yow boo yow chow fan ma – English meaning: would you like, not like fried rice?).
  • Hobbies: Whatever you’re interested in, I’m sure it comes with a price tag, whether it be cars, winter sports, photography, these days nothing is free.
  • Gifts & Charity: Giving back is essential, and being able to afford to give back definitely helps.
  • Recreation: Ski trips, boating on the lake during summer, maybe a cabin in the woods?

 

Okay, now that you have your Needs and Wants listed, it’s time to put a dollar amount next to each item. Now add all of your Needs costs together to get your total base living costs. Do the same for your Wants. You can then add both your Needs and Wants together to reveal your Quantifiable ONE Number.

 

You now know exactly how much income you need to make while you sleep to be financially free, take control of your time and live life your way.

 

You may be thinking, yeah, great, I just want to buy an investment property but bear with me. The calculation above is vital for your portfolio acquisition plan, and here’s why.

 

A residential real estate portfolio can generate approximately 4-8% of the portfolio’s value in gross annual income. So, for example, if you have a portfolio worth $1Million, it will likely generate between $40,000 to $80,000 in gross revenue per year.

To utilize your ONE number, we can now reverse engineer this calculation to determine the size of portfolio you’ll require to produce your Quantifiable ONE Number in annual income based on both 4% & 8%. The estimate is as follows:

 

(100/4) x YOUR ONE NUMBER = High-end Portfolio Value

 

(100/8) x YOUR ONE NUMBER = Low-end Portfolio Value

 

Let’s pretend your ONE number is $120,000 per year, you would need a portfolio between $1.5M & $3M:

 

(100/4) x $120,000 = $3,000,000 Portfolio Value

 

(100/8) x $120,000 = $1,500,000 Portfolio Value    

 

Understanding that the income generated is gross revenue (pre-tax and pre-expenses), these calculations enable you to visualize how many properties you need to purchase to live with financial freedom and security. You’ll also be able to work closely with your mortgage broker to strategize and create a plan to acquire your portfolio successfully.

 

For the most part, investing in real estate is a lot of fun and can provide fantastic benefits like spending more time with family and friends, focusing on a side hustle or business venture, travel and leisure. For these benefits to become a reality, start with a plan, start with your Quantifiable ONE Number.

-Brad Price

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