I see it in real estate advertising all the time. This ___plex is a great investment opportunity. However, when I run the numbers it isn't. Often the return on investment is lower than a GIC or sometimes, it doesn't even carry itself.
Here is how I decide if a property is worth introducing to one of my clients.
First I obtain the Gross Revenue. How much does this property bring in adding up all the rental income. I always check to confirm if the actual rent and the potential rent is the same number!
Next, regardless of what the vendor claims, I take 3% off the Gross Revenue to allow for vacancies. That's the approximate number CMHC is using for this area. Next, I add in any other income like the laundry, etc. Now I have the Revenue.
Next, I do my research and chase down all of the expenses on the property. Subtract the Gross Expenses from the Revenue gives me the Net Operating Income (NOI).
Next I calculate what amount will be needed to service the debt. Typically I use the listied price as the purchase price. If the property works at full price, whatever I can negotiate it down below that just makes it better. I use the going rate at the bank, with a 5 year term and a 20 year amortization period. Down payment amount depends upon the client and whether it will be a residential or commercial loan. Putting all this information together gives me the annual amount of cash needed to service the debt.
I subtract this number from the NOI and I get the "profit" of this investment before income tax and depreciation.
Finally, I always assume my client has a sum of money to invest and is looking for a maximum rate of return on his/her investment. So in this case the Return on Investment (ROI) is the "Profit divided by the down payment. This is often referred to as the "cash on cash" rate. Basically it is the amount of cash the investment makes divided by the amount of cash you took out of your pocket to buy the investment in the first place.
Once I go through the numbers, I look for the property to make in the range of 12%-15% ROI. If it does, then I introduce it to my client. If not, I try to see if there is anyway to get it there. Perhaps the rents haven't been raised in 5 years or something. Anyway, that's a quick check that I use to make the decision to look. I calculate this for my clients as part of my service to them.
If you are interested in looking at the pros and cons of getting into investment properties, contact me anytime. I would be happy to speak with you to see if this is something that is right for you ......... or not.