If you tell me the I:E ratio on your deal, I can tell you how risky it is. The I:E ratio is nothing but representation of the income versus the expenses on a monthly basis on a property. It tells me how likely you are to get into trouble if the property market turns.
Let’s say that my income on a property is $1000 a month, my expenses are $900 a month. If you look at the I:E ratio it’s going to be 1000/9 or if we divide those 2 numbers, it becomes 1.11111… reoccurring. What the I:E ratio tells me is that if you have 1 month where you have no tenant then you’re breaking even and if you have 2 months where you don’t have a tenant then you’re losing money.
Is it a good investment?
The I:E ratio tells us roughly how many months you could go without having income to break-even, but it doesn’t tell me if the investment is good or not. The only way I can do that is by comparing I:E ratios 2 or more deals. When I’m looking to invest, I’m looking to analyze the I:E ratio on as many deals as I can because the higher the ratio, the safer the investment.
If I have a deal where my income is $1000 and all my expenses, including my mortgage, are only $500 that’s a safe investment. The I:E ratio here is 2 and of course 2 is bigger than 1.11. I can tell you that the ratio of 2 deal is safer than an I:E ratio of 1.1 because guess what – I can have many more months with no income and still make money or my expenses could go up and I would still make money.
The fundamental formula
If you’re not looking to make cash flow on a monthly basis, is the I:E ratio is relevant? Some investors are looking to make money quickly and buy a property at $1,000,000 and sell at $2,000,000. That’s what they want to do but success in real estate, I keep on saying, is down to long term management.
Long term management success is down to money on a monthly basis and that means you need a good I:E ratio. So, for me the I:E ratio is the fundamental ratio or formula that I look at on my investments.
Is it a good deal?
But, an I:E ratio of 2 doesn’t tell me it’s a good deal, I need more information other than just the I:E ratio because an I:E ratio of 2 might mean to say that I only make a return on investment (ROI) of 12% but another deal with an I:E ratio of 2, I could be making an ROI of 50% so I have to take more into consideration but of course, the I:E ratio is one of the first things that I look at on an investment – is it higher than two? How easy is it to find an I:E ratio deal of 2 in the world right now? It’s not easy. Most investors are happy with 1.1 and many investors I know are happy with less than 1. That means each month they are paying money into their properties from their own pocket which is crazy.
For me, I won’t invest unless I get a very good I:E ratio. Sometimes I’ll accept 1.5 if the market is at a low point sometimes, I need to accept 2.5 – 3 if the markets at a high point, and these kinds of things based on the market trends are important to understand. Let me tell you some of the ratios as I found recently in places you wouldn’t expect to find those I:E ratios.
What to expect worldwide
In the UK, we found an I:E ratio of 3.65 now that might sound crazy, that means that the income on the property is 3.6 times the expenses on a monthly basis on that property. In Dubai where people again expect to have a very small I:E ratio of maybe 1.1 maybe 1.2 if they’re lucky, we’re looking at 1.8 – 1.9 and in America, wow, that’s the land of I:E ratios, we’ve seen I:E ratios as high as 5 and even as high as 5.5 in some areas.
So, if you want to be a safer or you want to have safer investments and be a safer investor look at the I:E ratio and choose properties with high I:E ratios because you can withstand the ups and downs on a longer term and that guarantees you’ll make money.