When you’re first getting into the real estate investing business, many will tell you to invest where you live. And so you start searching for an income property in your local housing market. However, you shouldn’t simply put an offer on the first property for sale that you come across as not all properties have investment potential. Beginner real estate investors often ask “How can I assure that a rental property for sale near me will give me the return on investment I’m aiming for?” Keep reading as we break down four ways to quickly analyze properties and determine their investment potential.
1) Follow the 1% Rule
The fastest way to determine if an investment property is worth purchasing states: In order to say that a rental property for sale near me is profitable, it must rent for (at least) 1% of its purchase price. This is a real estate rule of thumb that helps property investors find out if their monthly rental income will cover/exceed their monthly mortgage payments. So, for example, a $200,000 property must generate $2,000 monthly rental income in order for a real estate investor to consider it profitable and worth the investment.
Related: 3 Real Estate Investing Rules of Thumb Every Investor Should Know
This real estate rule of thumb aims to give property investors a better understanding of the investment property’s monthly cash flow. Additionally, it provides a baseline of how much to charge for rent in order to guarantee positive cash flow. As a real estate investor, we advise you to do your due diligence which is to analyze the fair market rental rates in the area. Look at comparable rental listings to get a sense of what you could reasonably charge for rent in your housing market. Then, try punching in your numbers (from rent to mortgage to maintenance costs) into an online investment property calculator like the one Mashvisor provides to analyze the potential return on investment and see if it meets the 1% rule of thumb.
Is a rental property for sale near me a smart investment decision? Find out with Mashvisor – click here to start looking for and analyzing investment properties in your city/neighborhood of choice!
2) The 50% Rule
The second real estate investing rule of thumb for analyzing investment properties is the 50% rule. This rule states: The total expenses for running and operating an income property (like taxes, insurance, repairs, utilities, management, turn-over costs, etc.) should average out to about 50% of the gross rent. Let’s take the above property that generates $2,000 per month in rental income for an example. According to the 50% rule, this property should cost you $1,000 per month in rental expenses.
So if I’m analyzing a rental property for sale near me, I would use this rule of thumb to assure it doesn’t generate negative cash flow (in which the rental expenses exceeds the rental income). Nonetheless, this is only a generalized rule. In addition, different investment properties have different expenses depending on their size, age, location, and other factors. So, property investors shouldn’t use the 50% rule in place of an actual expense history.
3) Assess the Cap Rate
Cap rate (i.e. annual net operating income/the property’s price) is one of the most commonly used real estate metrics to measure the return on investment and profitability of investment properties. What’s special about this metric is that it doesn’t factor in investment property financing. In other words, the cap rate is totally dependent on the property, not on the real estate investor. Most real estate experts consider anything above 10% a good cap rate.
Why should I know the cap rate of a rental property for sale near me? Well, the cap rate corresponds to the level of risk associated with investing in a property. The higher the cap rate, the higher the level of risk (theoretically). However, property investors should aim to buy investment properties with high cap rates simply because higher risks yield higher profitability.
Thus, you should know the average cap rate in your local housing market. After that, use a cap rate calculator to assess the cap rate of the income property you’re eyeing to see whether or not it meets that average. Wondering where to find a cap rate calculator? Look no further – our investment property calculator acts as a cap rate calculator and quickly calculates the cap rate for you! To learn more about our product, click here.
4) Calculate the Cash on Cash Return
Another metric that a real estate investor needs to analyze the investment potential of a certain property is the cash on cash return. This metric estimates the return on investment you’ll receive based on the amount of cash you actually invest in that property (net operating income/total cash investment). Hence, it takes into account your financing method – all cash vs. loan.
How will this contribute to my property analysis and determine if a rental property for sale near me is worth the investment? First of all, you should know that 8% – 12% is what real estate experts consider to be a good cash on cash return. Doing your due diligence is important here as you should know the average CoC return in your housing market. After that, use a cash on cash return calculator to see which financing method gives you a higher ROI.
Therefore, calculating the cash on cash return will give you the answer to the best way to finance a rental property for sale near me in order for it to have investment potential! You’d be happy to hear that we also provide a cash on cash return calculator as part of our investment property calculator.
Related: Investment Property Calculator for Analyzing Real Estate Investments
Should I Buy a Rental Property for Sale Near Me?
Why not? If it has great investment potential, owning an income property near you is a great strategy for making money in real estate. One thing to remember is that you should not depend on only one of the above-mentioned ways of analyzing the profitability of an investment property. To make the best investment decision, property investors conduct a thorough real estate market analysis using these metrics and rules hand-in-hand with the help of real estate investing tools.
Mashvisor provides all that a real estate investor needs to find, compare, and analyze properties to identify the one with the best investment potential to start making money. Sign up for our services or click here to start your 14-day free trial and subscribe to our services with a 20% discount after!