Getting into the rental property business is an exciting time, especially if you are a new landlord. With the dream of making money, whether just to supplement your current income or become financially independent from the grind of the corporate world, there is much to look forward to!
The good news is that most people who make rental property investments do become successful over time. With some hard work and determination, earning a steady flow of income is not unreachable. There are, however, some important financial considerations to make before jumping into a property investment.
Today we will look at some of the most crucial real estate numbers associated with rental property investment success that you should know before you join the ranks as a landlord.
8 Real Estate Numbers to Know
1. Your Mortgage Payment
Although it seems obvious you would know this number when purchasing a rental property, there is more to it than just knowing a price tag.
Before working with a lender, it is not only good to know the purchase price of the home you are interested in, but how it matches up to your debt-to-income ratio, as well as your cash reserves. The lower the ratio, the better chances you have of getting approved for a loan. Similarly, the more savings you have set aside for things such as maintenance, repairs, taxes, and HOA fees, the better.
With ratio requirements ranging between 28-45%, along with a high credit score and cash on hand, you must be qualified to make an investment if you want to get approved to buy a rental property. Plan ahead so that you are financially secure before setting out to make any property investments.
2. Down Payment Requirements
Unlike owner-occupied homes, investor mortgages typically require larger down payments in order to secure a sale. Sometimes requiring as much as 40% down, investment properties command a lot of upfront costs. In addition, you many not use a gift fund for either the down payment or the closing costs of an investment property.
Your credit scores, debt-to-income ratio, cash on hand, purchase price, and estimated monthly rent of the property will determine how much money down you will need to make your dream of becoming a landlord a reality.
3. Gross Rental Yield
A great way to help decide whether an investment is a good one or not is by calculating the gross rental yield of the property to get a general expected annual return. Simply divide the annual expected rent by the total property cost, then multiply it by 100 to get the percentage. Anything above 10% is a great investment and is worth your consideration as rental investment.
For instance, if you pay $100,000 for a house and you can $12,000 per year for the house, the gross yield is 12%.
Keep in mind while making your calculation that the total property costs consists of the purchase price and closing costs, and does not include and deductions such as maintenance, vacancies, taxes, insurance, etc.
4. The 1% Rule
A quicker way to decide if an investment has potential is to apply the 1% rule to the property you are interested in.
Ideally, you would like to be able to collect 1% or more of the purchase price in rent each month. So, if you bought a rental for $100,000, you would need to collect $1,000 or more each month for it to be considered a good deal.
5. Capitalization (Cap) Rate
A step up from the gross rental yield, and a more accurate description of your expected returns, is the cap rate. This real estate number takes into consideration all operating expenses for your property and attempts to give you an idea of how much income to expect.
Calculating the number is just as easy as calculating the gross rental yield. Simply start with the annual rent and deduct any expected expenses for the year. This will provide you with a net operating profit. Then, divide that number by the total property costs (purchase price and closing costs) and multiply it by 100 to get your percentage. The higher the percentage, the better rate of return and the more successful you will be in the end.
6. Cash Flow
In order for your investment to be considered a successful one, you must have an overall positive cash flow. This is not to say that you can never be in the red, because you can and you will, but the point of investing in rental properties is to come out ahead.
Make sure that your monthly rent payments can cover the mortgage, interest, taxes, and insurance. Anything left over is your positive cash flow and is how you make money. Understand that maintenance costs and repairs can creep up on your quickly and damage your positive cash flow in an instant, so be prepared.
7. The P/E Ratio
As one of the most widely used indicators of a good investment in all financial sectors, the P/E Ratio (or price to earnings ratio) is used to compare differing investments on a more level playing field.
This real estate number is useful in determining whether a rental property purchase is good or not. To calculate the P/E ratio, just take the current market value of the property and divide it by the current net operating profit (remember, above you used this value to calculate the capitalization rate). The number you receive is approximately how many years of net operating profit years it would take to get back your original investment.
For example, if you purchased a property for $100,000 and make a net operating profit of $8,000 a year, it would take about 12.5 years of tenant payments to get back your original $100,000. This does not consider any extra expenses you may have to put into your investment, nor does it calculate things such as rent increases. It does, however, give you a good idea as to whether your investment option is worth considering.
The average P/E rates for solid investments range from 12-25. The lower the P/E rate, the better it is for someone looking to purchase a rental property.
8. Check Your HOA
Something very important to take note of when making a rental property investment in a neighborhood with a Homeowner’s Association is to take stock of their financial health. Asking for the HOA’s financial statements will give you an idea as to how stable the neighborhood is.
If the HOA is in the red, you will likely see poor maintenance of the neighborhood or spike in HOA fees, neither of which you will want to contend with. You also want to avoid investing where the HOA is in litigation. This type of situation can negatively affect your tenants and may cause you to have some unexpected vacancies.
In the end, understanding some of the most prevalent real estate numbers is what is going to allow you to make an informed decision when it comes to your rental property investments.
It is important to understand, however, that these numbers are not concrete. Many things can change over the course of a year and you may find yourself starting out with what seemed like a great investment in the beginning and ending with a problem investment whose value simply dropped.
While you cannot avoid market fluctuations and unexpected costs associated with rental properties, you can help to secure some things by using a good property management team like Bay Management Group. Helping you to find high-quality tenants, routinely inspecting your property for damages, and even supporting you should need to file a lawsuit, many unexpected costs will never become a reality because Bay Management Group will be warding them off from the start.
