The Napkin Test

The back of a napkin, really?

Have you ever heard the term, the Napkin Test?  It’s quite common, really.  It just means, the best business ideas don’t always come from long, drawn-out documents, mission statements, or flashy power-point presentations.  The best business ideas sometimes come from the back of a napkin, literally.  Some of the biggest companies in the world actually started with a beer, some peanuts, and the back of a bar napkin.  One such great story is Richard Trait, founder of Cranium.  It’s a great story.

The founder of the newly formed toy company was on a plane trip cross country when suddenly he was struck with an idea for a new board game.  He and his wife were both big fans of the games Scrabble, and Pictionary, and he suddenly it came to him, what if there was a game where just about anyone could have the chance to show off his or her knowledge when choosing a particular category?  Everyone likes to be able to look good in front of family and friends.  So he created this new game where just about everybody gets their moment in the sun.  Everyone is happy.

Napkins and Multi-family investing?

Being in the real estate business myself, I’ve been turning houses and investing in the real estate market for years.  But just like with anyone else, I’m always trying to move up in the world.  Managing so many individual, single-family properties can be quite prosperous, but it can be quite time-consuming as well.

So I was talking to a friend of mine and he was telling me about multi-family investing, or multi-unit investing, as it is known in other circles.  They are the same thing.

Not to get bogged down too much in the definition of multi-unit investing, it is quite simply what it says.  It’s the whole idea of owning a complex with multiple units, for the purpose of renting out those units.  And the complex doesn’t even have to be large.  Even a six-unit complex counts.  That’s what I’m looking at right now, just a small, six-unit complex to get my feet wet.

The Napkin Test, and how it pertains to multi-family investing

So I was looking everywhere on the web for ideas on real estate investing when I came across this great YouTube video by this Mr. Clean-looking guy by the name of James Fales.  It’s called, aptly enough, “The Napkin Test.”  Yes, it’s that same theory I talked about before, just now applied to the subject of multi-family investments.

Take it away, Mr. Fales

James Fales is one of the best in the business.  He not only goes into detail all the ins and outs of multi-family investing, he has such a matter-of-fact, everyday approach that even someone like me can understand.

While I’m not going to get into the details, you really have to let the man himself take you step by step, I will give you a brief summary of some of the things he covers.

He uses 407 units in Houston, Texas as an example.  He goes over such important aspects as

  • Gross potential income possible
  • Total gross income figured at a reasonable 80% occupancy
  • Total expenses are: $4000, per unit, per year.  (A proven formula used by experts all over, which covers everything.)

And then all he does is subtract expenses from the gross potential income possible, and Wallah!, he has is net income expectations.  All this is based on a property that is managed correctly.  If management correctly, as he states, there is no reason you can’t make money.

He even makes a funny comment on how if you are at 100% occupancy rate, your management company is not doing its job right, and the rents need to be raised.

But just like the above bullet points suggest, you could figure out all this on the space of a small bar napkin.  What really amazes me is the property he uses in the example, the real numbers are pretty close to his estimate.  But there is room in the middle for more money to be made, and this is where someone like him sees opportunity. 

But as he mentions, this is just a matter of the property not being managed to its full potential.  When he finds a property not living up to its full potential, as he states, that’s when he’s interested in making an offer.  Simple as that.

In closing

Fales makes it all look so easy, because in reality, it is.  With someone like him managing your property, you too could realize maximum gross potential income.  But don’t just take my word for it.  Watch the video.

Here is a link to that YouTube video I was talking about called “The Napkin Test” by James Fales.  This Fales guy, I’ve heard, is like the Wyatt Earp of the multi-family investment industry.

Fales does multi-family investments in Houston, Texas, but the technique is a sound one most anywhere.  Make sure and pay attention.  This guy talks fast, but he makes a lot of sense.