SEATTLE (Zillow) As real estate values rise nationwide and many properties listed for sale are being fought over by investors and home buyers, it seems that, once again, investment property buyers are paying outrageous prices for properties. Anyone recall this phenomenon in 2004, 2005 and 2006?
An "outrageous price" is one that is way too high considering the cash flows the rental property can generate. These negative cash flow properties are rarely profitable investments, compared with other investment options a buyer could have chosen.
Experienced real estate investors only buy properties that are cash-flow positive based on conservative estimates and skip those pesky negative cash flow deals. Note that those negative cash flow properties are typically the fancy prize properties in town; you know, the location, location, location properties.
Penciling out a deal
The main reason investors keep paying these high prices is because 95 percent of them acquire properties without doing any financial analysis to determine whether the property will actually produce decent investment returns. Instead, they hope that a property will go up in value, they'll sell it and make a bundle. Unfortunately, that scenario rarely happens.
Only about half of the properties in a general marketplace would generate positive cash flows and a decent, actual return such as 5.55 percent. In actuality, real estate investing is much more complicated than just penciling out your cash-on-cash return, but that analysis is a good start.