The chance to invest in a particular thing comes up all of the time in life. It’s not necessarily just limited to one arena, either. We all have the chance at various times to invest in businesses, stocks, real estate holdings, commodities or a million and one other entities. We of course always go into these with the utmost optimism and with dollar signs dancing in our eyes, but it’s important to stay a prudent course and understand how exactly an investment opportunity could go right (or wrong) if you decide to take the plunge and sink some money into it. The analysis of investments is oftentimes a skill set that is acquired throughout a lifetime, but fortunately, there are some simple tips that you can keep in mind going into these situations.
Table of Contents - How to Analyze an Investment Opportunity
Single-family homes vs. multi-unit properties
If you’re looking into real estate investments, then one of the first things you’ll encounter is that you can either choose to go with single-family properties or with multi-unit ones. The latter tend to be more expensive but also have the opportunity to generate multiple monthly rental fees rather than just a single one. Multi-unit investments are also interesting because their value doesn’t necessarily correlate with home prices in an area—they can even increase in value as home prices are dropping. Be sure to check out comparable opportunities, or “comps,” in any area before choosing to invest. This means finding properties of similar quality and size and making sure that their prices are roughly in line with what you’d be expecting to pay on your next investment.
Figure out how properties will generate revenue
Rental properties in Canada can make money for you in basically two ways—you can use it as a source of cash flow, or you can think of it as a vehicle for building equity. Equity is going to be built as you make more and more mortgage payments and chip away at the principal of your loan, but it takes a long time to get to the point where any amount of equity is appreciable. As a result of this, the common wisdom is that real estate investors should be driven more by cash flow since this offers more a short-term payoff that many people are likely in the market for. However, if you believe that you’re in on a rental property for the long term (as in decades), then equity appreciation could prove to be more what you’re looking for.
Analyze your potential cash flow
One of the biggest misconceptions about real estate investing is that most of the costs are relatively straightforward. You calculate how much money you need to buy the property, how much you’ll rent it for, and that’s that, right? Unfortunately, this is not the case, and many other factors need to be considered when thinking about the costs in cash of investing in property. First off, you need to figure out your mortgage payment, which is a fairly basic step that most people undertake immediately.
On top of that though, you need to sit down and work out all of the costs associated with property ownership. Will you be paying utilities? Which ones, and how much will they cost? Are there HOA fees associated with the property? Are you going to hire a property manager to help you maintain your property? If so, you need to be prepared to pay them around 10 percent of the collected rent.
How much rental income will a property generate?
If you’re buying a property you need to have an idea of how much it will generate in the way of rental income. If a property is already owned and rented out, then this is a relatively simple endeavour. You can figure out how much is being charged for rent and then simply continue charging that amount. This gives you the added benefit of having a place already filled with reliable tenants, eliminating one of the biggest headaches of landlords—finding good occupants for their properties. If the property is vacant or currently owner-occupied, that makes calculating rental income a bit more complex. You can try and dig up a rental history for the property, but more likely you’ll want to find comparable properties in the area to help you calculate what type of rent you could charge for a property.
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Know about the gross rent multiplier
Some shortcut numbers can help you quickly narrow down your research scope, and the gross rent multiplier is one such little trick. This number is the price of the property expressed as a multiple of the monthly rent that you can expect to collect for it. To use round numbers, if a property costs you $75,000 and the monthly rent is $1,000, then the gross rent multiplier on that property is going to be 75. You of course want this number to be as low as possible since that means you are generating the most income against your investment amount, which is of course always desirable. Some investors use these numbers fairly religiously and have rules about gross rent multiplier numbers that they won’t even consider (over 100, etc.) but that doesn’t necessarily need to be true for everyone.
Get the real data
One other thing to consider is that if you’re ballparking numbers ahead of time to calculate mortgage fees, etc., then this is known as “Pro-forma” data. While it’s useful for doing rough calculations, be sure to get the real numbers as soon as possible. Before closing ask to see the tax returns from previous years, maintenance records and try to determine if the property is due for an assessment, just for starters.
Investing in anything is a big decision. You’ve worked hard for your money, so it makes sense that you’d want to keep it invested in areas that have the potential for a further payoff while also covering all of your bases. The above investment analysis tips should get you started at thinking critically about investments, but be sure to do thorough research before pursuing any opportunity.
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