If you’re looking to invest in real estate, understanding the math behind your investment – and how much money you stand to make (or lose) is critical.
Investment, Income and Expenses
When evaluating whether or not to buy a particular investment property, you’ll need to estimate:
Your Investment
You need to have a good understanding of all the costs that make up the initial purchase price – that’s the real amount of your investment. Your investment includes:
• Your down payment
• Land transfer taxes
• Immediate repairs and renovations
• Home inspection cost
• Financing costs (eg appraisal)
• Legal costs to purchase the property
Income
To help you decide if a property is a good investment, you need to forecast the potential income.
Your real estate agent should be able to estimate potential rent, based on how much similar nearby properties are renting for.
Make sure to include the following in your income calculations:
• Rental income for the apartment
• Any additional possible income – for example, additional rent from parking spots or garages or money earned from coin-operated laundry
You should also estimate a vacancy allowance, to account for times when the property isn’t occupied, or rent isn’t being paid.
Expenses
You won’t know if something is a good investment until you estimate all of the potential costs. Make sure to include these operating and financing costs:
• Financing costs (ie, the amount of the mortgage payment)
• Heating
• Electricity
• City services (garbage, water)
• Property taxes
• Condo fees (if applicable)
• Insurance
• Property management
• Repairs and maintenance
• Snow removal and yard maintenance
• Pest Control
Key Investment Metrics
While experienced property investors have their own favourite ways of evaluating investment properties, the metrics they usually use include:
• Cash Flow
• The difference between the income and the expenses
• Capitalization or CAP Rate
• Estimates an investor’s potential return on a property
• Cap Rate=Annual Net Operating Income / Property Cost
• Debt Coverage Ratio (DCR)
• DCR is the ability of the projected rent (after operating expenses) to cover the mortgage obligations
• Debt Coverage Ratio = Net Operating Income / Annual Debt Service ? A DCR of less than 1 indicates a negative cash flow
• Yield
• Annual income from the investment expressed as a percentage of the investment’s total cost
• Gross Yield = Total Rents / Purchase Price
• Net Yield = (Total Rents – Operating Expenses) / Purchase Price
Return On Investment (ROI)
A property’s Return on Investment or ROI is a combination of:
• Cash on Cash Return
• Calculates the cash income earned on the cash invested in the property
• Cash on Cash Return = Cash Flow (before taxes) / Investment
• Mortgage Paydown
• Every month, part of the principal of the mortgage is paid down by the rent ? Mortgage Paydown = Mortgage Paydown /Investment
• Appreciation
• If home prices increase, that increase in value is part of the ROI when you sell it
Questions? Your real estate agent and mortgage broker can help you better understand the investment property math. While we love to help educate our readers on this blog, please understand that we are unable to provide guidance or specific advice about real estate investments to non-clients.
Thanks for reading today’s BLOG!!!
Brian Kondo
Sales Representative / Team Leader
The Brian Kondo Real Estate Team
Re/Max Hallmark First Group Realty Ltd.
905-683-7800 office
905-426-7484 direct
brian@briankondo.com
www.BrianKondo.com
www.BrianKondoTeam.com
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