From the previous article, cash flow and NOI is mentioned. Next we go deeper into Returns and Profiting from the investment.
Returns & Profiting
There are also different ways to analyze returns.
A. Return on Investment
This number gives the annual return on the investment by taking in all factors that affect the bottom line.
1. We know our monthly cash flow.
Monthly Income – Monthly Expenses = Cash Flow
2. We know our mortgage payment (principal + interest). The principal amount of the payment is the monthly equity build, meaning how much has been put in into obtaining the property. Add the cash flow to the monthly equity build.
Cash Flow + Principal Payment
3. Multiply that by 12 months, which gives the annual return (it’s a return because it’s cash in the pockets and a payment closer to owning the property).
(Cash Flow + Principal Payment) X 12 months = Annual Return
4. Divide that by total investment costs.
Annual Return/Investment Cost = ROI
Tip: Cash Flow and ROI are the most important formulas in making the best decision during an investment analysis.
What is a Good Return?
Excellent question! What’s the use of calculating all these numbers if an investor doesn’t know what to aim for? Here are some additional numbers to look at when inferring this.
A. Capitalization (Cap) Rate
This number tells the returns of the property independent of the financing. Why is this number important? This is an utter way to understand a property’s returns independent of how the property is financed. In other words, this is the return of a property as if it was already paid off.
Cap Rate = NOI/Property Price
Cap rates are usually 8-12% but the best way to determine if a property has a good cap rate is dependent on the location. Set the average cap rate in an area as the minimum goal.
B. Cash-on-Cash Return (CoC)
This number tells the returns of a property based on the amount of cash put in the investment.
CoC = NOI/Investment Costs
Generally, 10% is considered a good cash on cash return but again, that depends on property type, location, and rental strategy.
The different computations for analyzing a property can get overwhelming but these are the major ones to look at. There are other values that are good to know when comparing an investment properties. They can be helpful in indicating what are the average ranges based on areas since property performance is so dependent on location.
The thing to remember when doing a real estate investment analysis, costs are current but they can change every year. For example, rental rates and expenses will most likely increase every year so don’t expect these calculations to stay constant throughout the investment. Appreciation is another factor when calculating returns. Although it is not guaranteed, an investor can include this in the Total Return to calculate Total ROI.
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