let’s talk : METRICS for assessing RENTAL PROPERTIES

Good morning!

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:

DEAL OVERVIEW

  • Purchase Price
  • Down payment (25% for businesses)

INCOME

  • Monthly Income aka current monthly rent (if applicable)

EXPENSES

  • 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…

 

RETURNS

  • 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…

Calculator Example Updated

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…
VALUATION CALCULATIONS…

PROPERTY VALUE

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.

EXPENSE FORMULAS…

OPERATING EXPENSES

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

 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

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.

FINANCING RATIOS…

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/)!

 Happy Wednesday!

  • Erin

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 Data Sources for today’s content:

https://www.biggerpockets.com/renewsblog/2016/06/10/cash-on-cash-return-2/

http://www.realestateinvestmentsoftwareblog.com/gross-operating-income/

https://www.propertymetrics.com/blog/2013/05/23/real-estate-formulas/

4 thoughts on “let’s talk : METRICS for assessing RENTAL PROPERTIES

  1. Great post that really digs into the numbers with investments. What do other readers typically see as standard property management rates in their areas?

      1. Back in North Dakota the rate has been 7% with both managers I’ve worked with. Not even a few to fill!

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