A few calculations to determine if a rental property is a good investment.
How do you calculate the numbers for a rental property? Real estate investments can be a great way to earn passive income, but you need to be careful. Not all rentals are the same, so you need to be able to identify which ones make sense financially. That can change based on various factors, but the main way to determine if an investment will be a good one is to run the numbers.
The first thing to do is figure out how much your rental income, operating expenses, and mortgage payment would be. The trickier part of this is determining your expenses. Of course, it’s always possible for unexpected things to pop up, but here is a list of some common expenses: accounting for a vacancy, the fees of a property management company if you want one, leasing fees, repairs, insurance, taxes, utilities, etc.
This is where the math comes in. We recommend you calculate what your net operating income and cash flow would be. For the first equation, simply subtract your expenses from your rental income, and that’s your net income! Then, take that number and deduct your mortgage payment, and that leaves your cash flow. If those two don’t end in a positive number, run away! That property is not the right investment.
Additionally, you should also evaluate the cap rate and the cash-on-cash return. The cap rate is another calculation that helps you gauge whether or not a property is a good deal. Essentially, it compares the return on investment to the purchase price to indicate how good of a deal you’re getting on the purchase price. To get the cap rate, simply take your net operating income and divide it by your purchase price.
“The main way to determine if an investment will be a good one is to run the numbers.”
If you already own the property, use market value instead of purchase price. Cap rates vary based on the type of property as well as many other factors, such as location and market conditions.
Lastly, we want to calculate the cash-on-cash return to determine exactly how much money you’ll be getting back from what you invested. To calculate your cash-on-cash return, simply divide the net annual income by the total cash invested. As with the cap rate, a good cash-on-cash return for a residential property depends on a variety of factors, including the location, market conditions, property type, and financing terms. If you need assistance calculating your cash-on-cash return and cap rate, please reach out. We’d be happy to run these numbers for you.
While we consider these numbers to identify and assess potential real estate investments, there are many subjective considerations to also take into account, which is why you should consult with an experienced Realtor or certified financial planner before you make any final decisions.
If you have any questions about the viability and profitability of a potential real estate investment, please give us a call or send an email. We’ll help you run the numbers on any property and explore all the possibilities to ensure you optimize your investment. We look forward to hearing from you.
