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As an investor, one of the most important lessons you can learn is to look before you leap.
Sometimes, a rental property can appear as if it is going to be one of the most profitable investments you could make, but in the end, it is barely sustainable and pulling you down. That is why it is important to analyze each rental property you purchase for profits.
Often, investors will look at this from a surface level perspective in order to understand their monthly cash flow, but that is not always enough to get a clear picture of how much a property is going to cost and how much you stand to profit by renting it out.
So, if you would like to learn how to properly analyze your rental properties for profit, you are in the right place. But first, if you would like to ensure you maximize your profits while buying a rental property, let us set you up with a strategic mortgage. To get started click the link below to book a free strategy call with us at LendCity.
What Type of Rental Property is It?
One of the first things you need to consider when getting ready to analyze a rental property is what type of property you are looking at.
Single-family properties are relatively straightforward because you only need to factor a single unit into the equation. However, at the same time, it is important to consider that unlike multi-family properties if a single-family unit becomes vacant, that rental property investment immediately loses all of its income.
Multi-family properties are often much more complicated to analyze because you have multiple units to consider. While a single vacancy will not eliminate all of the income that the rental property is producing, the balance between rental income and rental property expenses is going to vary greatly between occupancy rates and the price of each unit.
Collect Your Information
In order to calculate the expected profits for your rental properties, you are going to need to collect certain pieces of information. Let’s take a look at each piece of data and how it will impact your calculations.
The purchase price of the rental property is going to primarily be used in order to determine the cap rate. However, it is important to acknowledge the cost of a property when trying to determine its potential profits to see if other properties at the same price point are going to be better investments.
Up-front or initial expenses are costs that you are going to need to cover before you begin renting a property and generating income from it. This can include the down payment on the home, initial renovations that the property needs, or any other expenses that need to be settled early on. While these will not impact the long-term profits of the rental property, they do establish how much cash you are sinking into the property that you need to earn back before you truly profit.
Your mortgage is one of the primary recurring expenses that you need to be able to factor while you are calculating the cost of owning and operating a rental property.
Other Recurring Rental Property Expenses
On top of your mortgage, your property is going to have additional expenses that you need to consider if you want an accurate estimate of the potential profits a property stands to make. This includes property taxes, property managers, routine maintenance costs, insurance payments, landscaping, and utilities – provided they are not being entirely covered by the tenants.
Number of Units
The number of units your property has is going to greatly impact the importance of the occupancy rate and may also dictate the amount of rent you need to charge per-unit. Typically, if a property as four or more units, rent will be set in such a way that some units will be purely profitable as the other occupied units generate enough income to cover all of the property expenses.
Obviously, when you are analysing the potential profits on a rental property you will not always know the exact rent the property will be bringing in unless the property is presently tenanted. However, what you can do is take a look at the market rent for comparable properties. If a property or unit that is similar to the one you will be offering normally ranges between $1800 and $2200 each month for rent, you can take the lowest value as a safe estimate for your profits.
Occupancy rates give you a clear picture of how often you can expect your rental properties to find tenants and how much you should be concerned about tenant turnover. If the occupancy rate is low for a certain type of property or in a certain market, you may want to look elsewhere to better-manage the risk.
Cash Flow and Net Operating Income
One of the primary metrics people use to gauge the profits on a property. However, this only provides a month-by-month estimate of the profits a property. Instead, you should be getting a look at the bigger picture by calculating the net operating income for the year.
This can be done by taking the gross income of a property, or the total income generated through rent or other means and subtracting the total yearly expenses from that total. For example, if a property makes $2400 each month in rent – or $28,800 annually – and the total yearly expenses came to roughly $21,350, the property will have a net operating income of $7450.
Understanding Cap Rate
The cap rate – or capitalization rate – is the rate of return you can expect from a piece of real estate. This number is a ratio between the property asset value or purchase price of a property and the net operating income. You can calculate this by dividing the net operating income by the market value of the home.
In the case of the previous example, if the house were purchased for $250,000 and had a NOI of $7450, the cap rate would be approximately 2.98 per cent for that property. Normally, you would want to aim for a property with an estimated cap rate between 5 and 10 per cent.
Discover How To Analyze a Properties Cash Flow With This Step By Step Guide
Financing Your Next Investment Property
No matter the property, a profitable investment begins with a good mortgage. That is why at LendCity our team works with a wide network of lenders in order to provide you with the best available rates for all of your investments. To get stated with us, you can call our office at 519-960-0370 or visit us online at LendCity.ca Alternatively, click the link below to book a free strategy call with a member of our team.