Many people always hear about how great an investment rental properties are, but does that generally accepted rule of thumb hold up when looking at some actual hard numbers? There are many different factors that go into each situation to see if a property is a stud as a money maker or as a dud.
There are several things you need to take under consideration when running the numbers, including:
- Property taxes
- Insurance
- Repairs
- Built in buffer for vacancy times
- Property management (if you go that direction)
You will also want to make sure you know the purchase cost of the property as well as what the average rent is for in the area not only for similar types of property, but also what people are getting for that property as a rental right now.
You need to add up those total expenses that are on a month to month basis. Obviously for something like hiring property management specialists, it’s important to figure out what the percentage cost each property bears for that based on how many different rental properties the manager takes care of.
Take the monthly rent and subtract your total monthly expenses for that property. That number (x) needs to be multiplied by 12 to get a yearly amount. Divide this by the cost of the property to purchase.
What this number gets you is a percentage. That percentage is called your “Cap Rate.” If you have a mortgage, you simply add in that monthly payment to your monthly expenses to figure out what the cap rate is with all expenses considered.
If you actually buy the property straight up, you’re done once you have the cap rate because that number is also your CoC, which stands for Cash on Cash rate. This helps tell you what type of a return you’re getting on investment.
If you are financing your purchase of the property, you take your yearly numbers for actual cash profit after expenses and you divide it by the actual cash you put down. The reason you do this is you get the actual percentage return on however much cash was used. This percentage lets you know what your return on investment actually is.
Some properties are going to be a great deal, while others are going to show themselves to be a major dud once all the numbers are done. Your first step is always going to calculate numbers and expenses, and then always check to see what the next cash flow will be. If the numbers don’t give you back a positive cash flow, then never buy that property!
A great rental property is one that starts giving you a cash return right off the bat!
If you’re paying straight up with cash you want to figure out the cap rate, and if you’re financing you want to figure out your cash on cash returns. Those are the critical numbers that will tell you if the property that you’re looking at is a great deal or a dud.
