Is It Worth It? Key Metrics for Real Estate Investors
You know you want to expand your investment portfolio and real estate investment makes a lot of sense to you. But, what do you really need to know to make a wise investment? Let’s look at key metrics that will help you:
If you’re looking at a property that already serves as a rental, this is a no-brainer. But, that doesn’t mean you shouldn’t check out other comparable properties for a comparison. Don’t forget that neighborhood/region is as important as size, number of bed/baths etc.
For residential investments, it’s sometimes easier to determine this, because current owners might be forthright and hopefully keep good records. Remember to include these metrics:
- Taxes on the property
- Any utilities that you would pay
- Insurance (property and liability)
- Projected maintenance and repair costs: Will the house need a new roof soon? How are the appliances (fridge, washer/dryer) holding up?
- Projected vacancy costs. A safe bet is 5-10% of the annual rent.
Your Projected Annual Net Income
This is simple—just subtract estimated annual expenses from estimated annual rent.
The Cap Rate
The most basic way to do this is by dividing your projected income by the cost of the property. The resulting percentage can give you an estimation of what you might get annually in return on your investment. Cap rates are not a guarantee of return on your investment property and there is a healthy range of what is an acceptable estimation (4-10%), depending on the locale and what you require to make it a successful investment.
Cash on Cash Return
You may be a savvy investor, but that doesn’t mean you have the means to buy a property with cold hard cash. If you have to borrow money for the purchase, you need to figure out the annual cost of the debt.
When you are gathering this information, you will often acquire pro-forma data (which is estimated). It’s important to gather as much actual data as possible to make a decision based on accurate projections. Ask for:
- Previous tax returns on the property
- Property tax bills
- Maintenance records
- Current rental receipts, etc.
If the seller can’t or won’t provide it, go to the county records office and see what you can dig up there. It’s also worth talking to a property manager to gather data for comparison.
The idea is that you determine the best estimation of these metrics so that you can choose a property that will give you the highest return possible.