How to Evaluate Your Real Estate Investment
Investing in the property market can generate rental income and capital gains. Low prices of real estate investment properties can be enticing, especially if you are a novice property investor looking to enter the market. However, before that, have a full grasp of the fundamentals of the real estate market. Read on to know more.
The one-percent rule
The one-percent rule is a good way to calculate prospective properties. According to this rule, the rent will be a minimum of one percent of the price of the property. If a real estate property meets this requirement, keep on. If it does not meet this, then look at other properties.
The key to managing rentals in Denver is to see how much monthly rental income your property will generate. However, use this only as a rule of thumb. You should consider other market conditions when determining the monthly rental figure to charge the tenants. For this, you can take help from property management experts from Evernest, Mynd and Keyrenter.
Net operating income
NOI is the income you are expected to generate after acquiring the investment property. Take monthly income and subtract all expenses, excluding your mortgage. The resulting number is NOI, which can help you compare a set of properties for easy standardization, but you must not usually use it on its own.
Calculated annually, NOI is useful for calculating the potential of a real estate property. It is not influenced by how you acquire the property, whether you bought it upfront or got a mortgage. Along with net operating income, you must also consider potential or actual vacancies.
The annual or monthly profit from the real estate property is the cash flow. If the cash flow is always negative, the property may not be performing as it is supposed to be. To derive the cash flow, deduct all monthly expenses from the monthly income. The expenses include insurance, mortgage payment, property taxes, HOA fees, and utility.
Real estate property can generate negative cash flow or positive cash flow. When the cash flow is positive, the income of the property exceeds expenses. The return on investment is better when the margin is wider. If the cash flow is negative, the expense of the property exceeds income.
Return on investment
With return on investment, you can compare returns on several properties with different multiple amounts. Add the principal payment and the cash flow together. Then derive the annual return by multiplying that amount by 12. Divide this amount by the total investment cost, and you get the return on investment.
ROI is calculated using two common ways. They are the cost method and the expense method. The cost method divides the gain in the investment property by the property’s cost. The expense method divides the out-of-pocket financing expenses by the property’s cost.
Cap rates compare investment properties that might otherwise not be similar. The rate gives you the property’s returns without factoring in the investment it took to finance it. You get the capitalization rate by dividing the net operating income of the property by the property price. A healthy cap rate is between 8 to 12 percent.
The capitalization rate is used to make accurate investment decisions. However, along with the cap rate, you must also consider market size, asset stability, and liquidity. Cap rate is ideal for evaluating commercial properties but not single-family homes, flipping homes, or properties with unsteady income streams.
CCR, also known as cash-on-cash returns, compares investment properties and evaluates their performance depending on the cash you put into them. You get this rate by dividing NOI by the costs. Most investors look for at least a CCR of 10%, but this depends on your investment and purchase strategies.
The CCR rate provides investors with an assessment of the property’s business plan and the cash distributions of the investment. It is used for real estate properties with long debt. It measures the actual returns of the cash invested and thus provides an accurate analysis of the performance.
Gross rent multiplier
GRM helps investors compare investment properties and estimate their value. The price of the property is divided by the rental income to get the gross rent multiplier. The lower the GRM, the more appealing the investor finds the investment because the investment generates a high income that can pay for itself faster than similar homes.
The gross rent multiplier is the ratio of the market value over the rental income. This metric is used by property investors to compare rental opportunities in a particular market. A good GRM property depends on the potential rental income where the property exists.
Return on equity
Create an amortization table, which will tell you the amount of the mortgage and the mortgage balance each year. Then make a price appreciation assumption for each year. Finally, evaluate the tax implications of the property. To arrive at the return on equity, divide the annual appreciation by your property value minus mortgage.
Rental income and the losses from rental properties are considered passive for tax purposes. That means you can use the losses against other passive income but not active income, such as a monthly salary from a job. However, this rule is not applicable if you are a real estate professional.