One of the biggest mistakes I made when first getting started in analyzing properties was not getting the math 100% dialed in. It’s so crucial to account for everything and be as accurate as possible.
Always spell out the costs and profits you can gain before making any rash decisions.
Investment Property Evaluation: Cash Flow Is Important
If someone says their rental property is a “gold mine” it brings attention to the most significant influence in choosing a rental property for investment. What we’re talking about is the cash flow. It can be thought of in many ways, but the main idea is the rental expenses deducted from rental income.
For example, if you make $5,500 in income and your expenses for the property are $5,000 then your profit gained is $500.
That $500 is what is coined as CASH FLOW.
The Appreciation of a Property Is Uncertain
When you hear stories about people buying a property for less than they end up selling it for, it’s called appreciation.
But it’s not that simple. Unless you have psychic abilities, it can be difficult to determine if a future property value will increase immensely. That is why focusing on cash flow is more beneficial than trying to analyze appreciation.
Buying a property with the hopes of it appreciating in value is speculation and a HUGE gamble. It’s a good idea to buy properties in an area that could appreciate but look at that as more of a bonus. Anything more than that and you’re not making sound investment decisions.
Analyze the Return on Investment
One way you can evaluate your future rental property is by using an ROI analysis. After you calculate the annual ROI that the property offers, you can start comparing the returns offered by other potential investments.
Step one is to figure out the cash flow. You can subtract all expenses such as mortgage and non-mortgage from the total rental income. The rule of thumb for most investors is that the non-mortgage costs will be equal to one-half of the rent received.
Let’s break it down in an example. A property that earns $3,000 in rent every month, the non-mortgage costs are estimated to be $1,500. If you’re wanting to know the monthly cash flow, total the non-mortgage expenses – $1,500 for our example – add in the mortgage costs, and minus that figure from the $3,000 rental income.
Now to know the building’s ROI, you will have to divide your annual cash flow by the amount of the down payment for the building. If you put a $50,000 down payment on the building, then the annual cash flow is $5,000. The estimated return on investment is 10 percent. To make this calculation more manageable, we recommend you use an online rental property calculator.
The calculation above is commonly coined as Cash on Cash return (CoC%). Ultimately it’s pretty difficult to calculate an exact ROI on an investment property because of things like appreciation, depreciation, and tax savings. However, calculating COC% can let you know what your exact cash outlay is producing.
Do an Analysis on The Per-Unit-Profit
Looking for a faster way to make the analysis other than the ROI calculation? We’ve got you covered! You’ll need to check if the property will yield a profit per unit. The way to do this is figuring out if you’ll realize consistent cash flow from each building.
Using the formula, you will need to add up all the units’ rental income, compute the non-mortgage expenses using the 50 percent rule, and add the mortgage expense. Get the total number of groups and divide the total costs by this number.
When you complete the transaction, it will look like this: Say you have $2,000 in rent each month on a 4-unit building with non-mortgage expenses at $1,000, and a monthly mortgage bill of $600, your cash flow will be roughly $100 per month or $400 per unit.
There are tons and tons of resources online to help you dial in your math. Feel free to reach out with any questions you have! We are here to help you on your journey to building massive wealth through real estate investing.