Mom gave great advise when warned us to look both ways before crossing the road. She was teaching us the importance of analyzing your situation before stepping into potential disaster.
That principle serves real estate investors well when analyzing rental properties to purchase. Calculating the conservative profit potential is critical to the success you’ll have with any given investment property.
Rental property investments are a great place to start your real estate investment business.
However, if you decide to purchase a rental you won’t be living in, the complication of rental property investing comes in managing tenants and the property itself. That’s why in this case, which applies to most rental property investors, you should consider hiring a good local property manager.
Whether you are considering a traditional rental property or real estate investment through Airbnb, you should take the time to figure out how much profit rental properties make prior to signing on the dotted line.
Calculating Rental Property Profits
There are several factors that you should take into account to figure out how much a rental property will make for you.
- Property price
- Rates of the local market
- Projected returns
The first thing you will factor in is the property price, which will determine your top-level hard costs in the form of mortgage repayment, taxes, and insurance for that property. A general rule of thumb is to estimate paying around $10 per $1000 that you finance.
Focus your property searches on neighborhoods that fit into the price range you want to be in.
Rate of Local Rentals
The price range of a given property will directly influence the rental rate of that property.
You can gather this information from the city’s municipality, property management companies, and real estate agents. Very quickly, you will notice that having a good real estate agent on your team will help you; particularly real estate agents that cater to real estate investors. You’ll want to project your rental rate based on the comps in that neighborhood.
After you’ve got your rental rate, then you need to deduct your estimated mortgage, insurance, and tax costs from that monthly rate. The next expense you’ll have to take into account is maintenance costs. Generally, the older the house, the more maintenance costs you’ll have.
While newer properties will costs more upfront, they’ll have less maintenance costs and the older ones will cost less but have more maintenance costs.
Rental costs will include:
- Property management
- HOA Fees
- Rental income tax
- Property maintenance
- Property taxes
Once you know all of the above – property price, rental rate, and expenses – you can determine the following metrics:
This is a very important metric used to calculate a property’s returns and determining the amount of profit you will make from it. This equation uses the cash flow to calculate the profit from the investment to come up with a percentage of it’s current market value.
Cap Rate = (Cash Flow/Property’s Value) X 100
Cash flow is the rental income you make after deducting expenses from the gross income.
If you have a property that has a rental rate of $2,000/month ($24,000 annually), and $15,000 in annual expenses then the investment property’s annual cash flow will be $9,000, which gives you a positive cash flow.
Cash on Cash Return
The equation for this is simple. (Cash Flow/Cash Invested) x 100
The cash-on-cash return gives you the amount of profit you’ll make as a percentage of the amount of cash you invest.
In a Nutshell
Figuring out the numbers is absolutely critical before you sign you name on the dotted line. Too many investors have ended up with properties that generate negative cash flow and you can safeguard yourself from this by using the above.
Or, even better, doing the below!
If you would like to speak with the best property management experts in Westminster, Maryland about other benefits of rental property investing, schedule a PROPERTY PROFITS STRATEGY SESSION.
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