In the United States, most professional real estate investors make use of a series of financial tools with the objective of making a sensible investment. Among these, they usually consider first the "maximum rates" or the annual return calculated for an investment.
On the other hand, people who are just beginning to look for a single-family home or other residential property in which to invest, almost always make use of instinct or emotion when making a purchase decision. It is possible that these people simply love the property and hope that one day its value will increase considerably. But, even if a property increases in value (which is not always a fact), can it be valued enough to cover the annual costs of the property?
The main financial promoter who conducts an investment property decision must be the annual income that will be generated before the time comes to sell.
Calculation of income and the "maximum rate".Here are four tips for making sound financial decisions:
1. Decide the annual rent that you can expect a residential rental property. If the property is already rented, you should have knowledge about the expected income (received). Otherwise, review similar property rentals in the area, this can be done at real estate offices.
2. Estimate the annual expenses of ownership of the property, which will include the following:
- The projected costs when the property is unoccupied.
- Real estate taxes.
- The public services that you (not the tenant) will pay, such as water.
- Property and civil liability insurance. For example, an owner's policy.
- Repair costs to deal with home wear.
4. Calculate the capitalization rate of the property ( cap rate ). This is the annual return that can be expected from your investment. This rate is obtained by dividing the net income by the cost of ownership.
Example: You rent a small two-bedroom house for $ 2,000 per month or $ 24,000 per year. Anticipate annual expenses as follows:
- Unemployment rate of 5% ………… .. $ 1,200
- Real estate taxes ………. $ 3,800
- Maintenance and other expenses …………. $ 2,000
Annual net income = $ 17,000 ($ 24,000 - $ 7,000)
In the previous example, the sale price for the property was $ 325,000 dollars. The calculation of the maximum rate then is: $ 17,000 / $ 325,000 = 5.2%
This property produces a return or "capitalization rate" of 5.2% (unless you can obtain the property for a lower price).
Understanding the "capitalization rate."The higher the capitalization rate, the better the annual return on your investment. You can divide the value of your calculated net income by your target limit rate to determine the price you would be willing to pay for a particular property. The "capitalization rate" that you must buy will depend on the location of the property you want to acquire and the return you need for the investment to be profitable for you. Generally between 4% and 10% per year is a reasonable range to earn for your investment property.
Regardless of the rate of return you are looking for, you must ensure that the projected income can allow you to obtain a good amount of cash after the mortgage payment has been made. If you have a tenant who does not pay for a few months, and the maximum rate of your potential property is only 2% or less, your investment property can quickly lose money. It is for this reason and others that you should be sure to verify the projected performance in the worst case of loss of rent, to ensure that you can handle the transportation of the property when it is unoccupied.