JUDGE AN INCOME PROPERTY BY RETURN ON YOUR INVESTMENT

If you are thinking of investing in income property, here are some tips to determining whether a property is an investment you would like to pursue.

Aside from the physical details of the property, and as part of your due diligence, you will want to look at the financial viability of the property. You will want to analyze rents and expenses.

You will come across phrases like Vacancy and Bad Debt, Effective Gross Rent, Net Income, Cap. Rates, Net Income Multiplier, Cash Flow and Return on Investment to name a few. Here are some simple explanations.

Vacancy and Bad Debt: This is an allowance for any apartment vacancies and arrears in rent. Vacancy rates might be 3.6%, but most lenders tend to deduct 5% from the Gross Rent to allow for unpaid rent as well.

Effective Gross Rent: This is the rental amount remaining to pay for expenses and looks like this:

Gross Rental Income:

$22,100

Less Vacancy & Bad Debt:

  -$1,105

Effective Gross Rent:

$20,995

Net Income: Once expenses are deducted you are left with Net Income. Expenses typically stated in listings include Taxes, Insurance, Heat, Electric and Water/Sewer Charges. To complete the expense picture allowances should be made for maintenance, possibly management, and other-such as accounting and advertising.

Cap. Rates are percentages or ratios that are divided into the net income to arrive at the properties estimated value. Depending on the quality, condition, location and income of a property, capitalization rates or Cap. Rates typically range from 7% to 12% and sometimes more in the Niagara Region. The formula is:

Value = Net Income:

$13,895

= $185,000

Divided by Cap Rate:

7.5%

Among others, the most reliable way for your REALTOR® to arrive at a suitable Cap. Rate is to review income and expenses of similar income properties that have sold.

Net Income Multiplier: This is arrived at by dividing the Cap. Rate into 100, as follows: 100 ÷ 7.5 = 13.3.

Value: $13,895 x 13.3 = $185,000.

Here is a simple way to decide if the property is a good investment for you called a Deal Check.

Cash Flow: The mortgage is 80% of sale price. So let’s says that the mortgage payment for the year is $9,821. The Net Income of $13,895 minus the $9,821 mortgage payment =’s a Cash Flow of $4,074.

Return on Investment is the Cash Flow divided by your down payment; in this case $37,000 or 20% of the purchase price of $185,000. So $4,074 divided by a down payment of $37,000 =’s an 11% annual return on investment.

Most investors would say this is a good investment.

 

Allan Lent

Allan Lent

Sales Representative
CENTURY 21 Today Realty Ltd., Brokerage*
Contact Me

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