Maximize Returns by Minimizing the Mystery Around Property Analysis
Whether you have one income rental property in your portfolio or dozens, you should be tracking your investment portfolio’s performance. Part of that process includes evaluating each income property individually to determine whether it is serving its purpose in your portfolio and to assess the viability of future, similar investments.
With terms like cap rate, cash-on-cash returns, NOI, and ROI floating around and half a dozen different formulas for evaluating income property performance circulating throughout the industry, it can be hard to make sense of it all. Most investors are not entirely sure what numbers they should be tracking or which calculations the very people selling them properties are using, so do not worry: You’re not alone. Fortunately, analyzing property performance is not rocket science and it does not have to be difficult once you have the right tools for the job.
Here are the six most common ways investors track returns and profit and assess rental property performance:
1. The One-Percent Rule
This back-of-the-napkin calculation is a good way to work through prospective properties. If a property meets the One-Percent Rule, monthly rents will equal at least one percent of the purchase price including any upfront repairs necessary to get the property rent-ready. If a property meets this minimum requirement, keep going. If not, then start looking at other options.
For example, a $100,000 property should rent for $1,000 per month.
2. Cash Flow
Cash flow is the monthly or annual profit from the property. If this number is negative, then the property is likely not performing as it should be. To calculate cash flow, subtract your monthly expenses from your monthly income. Monthly expenses include: mortgage payment, insurance, property taxes, management fees, accounting fees, HOA fees, maintenance costs (usually between four and eight percent of your rent), vacancy-related carrying costs (also usually between four and eight percent of your rent), and utilities.
3. Net Operating Income (NOI)
NOI refers to the income you should expect to generate from a property after acquisition. Take the monthly income and multiply by 12, then subtract your monthly expenses with the exception of your mortgage payment. That number is your NOI. This number can help you standardize a group of properties for easy comparison, but you should not usually use NOI on its own since it leaves out the cost of acquisition.
4. Return on Investment (ROI)
Calculating ROI enables you to compare returns on multiple properties worth different amounts. Add your cash flow and your principal payment together, then multiply that sum by 12 to figure out your annual return. Divide the annual return by the total cost of your investment, and you will have your ROI.
5. Capitalization (Cap) Rate
Cap rates are another good way to compare properties that might not otherwise be particularly similar. The cap rate gives you the returns on a property without factoring in its financing, as if it were paid off. When you divide the annual NOI by the price of the property, you get the cap rate.
In general, a good cap rate hovers between eight and 12 percent.
6. Cash-on-Cash (CoC) Returns
Cash-on-cash returns, also known as CCR, allow you to compare properties and evaluate performance based on the amount of cash that you put into the investment. When you divide NOI by the investment costs, you get CCR. Most investors aim for at least 10 percent CCR, but this goal is highly specific and depends a great deal on your purchase and investment strategies.
Of course, looking at the cold, hard numbers will only get you so far. If you are evaluating a potential purchase, then you also will need to evaluate the deal in the context of other, similar properties available to you, survey the local market to determine the availability of renters and the viability of the local economy, and get an appraisal and inspection before you move forward with the purchase.
While all this evaluation may seem tedious, don’t make the mistake of diving in and buying a rental just because it seems like a good deal. Take the time to assess whether or not you will get a decent rate of return! Analyzing real estate requires diligence and patience, but securing a profitable investment that will produce cash flow for years to come is the reward for your efforts.