let’s talk : METRICS for assessing RENTAL PROPERTIES
Over the past month or so, we have set up our business, explored different methods for obtaining deals, and found financing. Now let’s talk about what we do once we find deals, and how we determine which projects are best to pursue.
SO, as we do, let’s talk real estate, let’s talk METRICS for RENTAL PROPERTY DEAL ANALYSIS…
Personally, I have taken the different formulas listed at the bottom of this note & “built” my own calculator. Based on the returns generated from this calculator, the team will decide whether or not this property is “worth” pursuing. On a super high level my inputs are the following:
- Purchase Price
- Down payment (25% for businesses)
- Monthly Income aka current monthly rent (if applicable)
- Property Management (usually a % of your monthly rental income)
- Insurance (actual – can find online or on MLS)
- Property Taxes (actual – can find online or on MLS)
- Lawn Care / Snow Removal (estimate – we use ~$40/month)
- Additional Expenses (estimate- we use ~$200/month)
- Principal + Interest (Interest is ~4.5%-5.5% on a mortgage today)
We look at the above to determine the following…
- Annual Return = Income – Expenses – Principal & Interest Payment
- Cash on Cash Return = Annual Return / Down Payment
- Total Return= Annual Return / Purchase Price
…I have included a small screenshot of the excel template below…
SO, while my above method is SUPER high level, for an initial screening, it works! We use the above “calculator” as a way to help us consolidate some of the below metrics and quickly analyze opportunities. Below are a list of FORMULAS that may further assist you in your investing journey…
Property Value = Net Operating Income / Capitalization Rate x 100
OR, in the case of a fixer upper;
Property Value= (Net Operating Income / Capitalization Rate) – Repair Cost
Property values can be used to help determine an offer amount.
Operating Expenses = Property taxes + Insurance + Property Management + Utilities + Maintenance + Landscaping + Snow Removal + Pest Management + Leasing Commissions + any other service contracts
Mortgage is NOT included in operating expenses because a mortgage does not determine the value of a property as this amount can vary from buyer to buyer.
INCOME FORMULAS (CASH)…
GROSS OPERATING INCOME
Gross Operating Income (GOI)= Gross Scheduled Income – Vacancy Assumption
The GOI reflects the gross annual rental income. The scheduled income is the income we can expect if all of the units are 100% occupied. The vacancy rate assumption can differ depending on the market, however many case studies have typically used ~2%-5%.
NET OPERATING INCOME
Net Operating Income (NOI)= Gross Operating Income – Operating Expenses
The NOI reflects the ability of a property to produce income after operational expenses are paid. NOI is unique to the property vs the investor as it does not include any financing or tax costs, therefore it can be helpful to look at NOI when assessing the value of a property.
Cash Flow= Net Operating Income – Financing Costs
Cash flow, aka the amount of cash you are earning on your investment.
RETURN RATE RATIOS (% RETURN)…
Capitalization Rate = Net Operating Income / Purchase Price x 100
Your cap rate gives you the rate of return you can expect on your investment based on the income your property generates. “Typical” cap rates differ depending on the area so make sure to find out or calculate the average cap rate for the city in which you are looking to invest, so that you can best assess how a property is performing. For example, in New York City investors can expect a ~3% cap rate, while in upstate New York investors may see cap rates of 10+%.
CASH ON CASH RETURN
Cash on Cash Return = Annual Cash Flow / Cash Investment x 100
This can be used as an initial screening tool to help quickly determine the return you will make on the hard cash you plan to invest.
DEBT SERVICE COVERAGE RATIO
Debt Service Coverage Ratio= Net Operating Income / Debt Service
The bank typically requires 1.25x minimum debt coverage, meaning your income covers 1.25x of your expected debt.
LOAN TO VALUE
Loan to Value (LTV) = Loan Amount / Value of the Property
Another metric a lender will assess in order to determine how much $$$ to loan against the property.
Please let US know if there are any other metrics we should be reviewing for our rental property assessments!
Feel free to comment on the post here (https://lets-talk-re.com/blog/)!
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