Today we’re discussing how to analyze a rental property with some of the key calculations that help you decide if the investment property you’re considering makes financial sense for you. Investors should base their calculations on a minimum of a three to five year investment horizon. Since housing prices are on the rebound, this is a great time to invest.
Monthly Gross Income
First, look at the monthly gross income. Be realistic and accurate with this number. You can learn more about setting rental rates in our blog on that topic.
Next, you need to calculate all the expenses. This includes property taxes, insurance, HOA fees, property management fees and maintenance. If you’re going to add pool and lawn care, consider adding those into your rental rate. Don’t forget to compensate for vacancies and repairs. We recommend adding about five percent for each of those.
Net Operating Income
Subtract your expenses from your gross income, and you’ll get your net operating income, or NOI. This is your cash flow before debt service if you have a mortgage. Hopefully, you’ll get a positive number. If not, move on to another property.
Now, you’ll want to calculate your yield so to give you a barometer for how it will perform and whether you will achieve the results you require. Simply divide the NOI by your purchase price, and you’ll get a capitalization rate or a cap rate. This is the percentage rate that property yields if it’s purchased in cash. For example, if the NOI is $15,000 per year divided by a $125,000 purchase price, you have a 12 percent yield or cap rate. We recommend looking for a minimum of an 8 percent cap rate.
Cash on Cash Returns
Finally, you want to understand cash on cash returns, especially if you are using leverage. If you’re financing, this number is the most accurate way to see the return you’re getting on your cash in and the leverage. Here’s the equation and remember to include the mortgage payment, since this one is totally based on financing. Take the NOI plus mortgage payments and divide it by total cash invested. This will be your cash on cash return.
If you’re thinking about a rental property, please contact us at InvestPro Properties. We can help you locate and analyze potential investment properties.