Thinking of investing in real estate? Good start. Real estate investing is one of the most prosperous ways of making profit. However, any expert real estate investor has to keep in mind some of the basics regarding real estate investment analysis. Real estate investment analysis means the process of evaluating the investment to explore its projected profit and risks to know whether it deserves the risk of investing process or not. There are several points to care about besides calculations and comparisons that should be done before the purchase process. Alternatively, there are many market analysis tools that can spare the real estate investor the time and efforts and do the job for him/her. Here we will be exploring some of the major key points to consider during investment analysis.
Location: The Milestone
The milestone factor when it comes to buying a rental property investment is to know where the best places to invest in are. If you aim to have a profitable real estate investment, you must have your property in a high demand location. There are many diverse factors to consider: Is the neighborhood of the investment property near the city center or not? Is the neighborhood reputation good or not? Is it near a college or a school? Is it close to vital services or not? All these points including others matter to the rentals, and consequently, should matter to the real estate investor. The question is: Is it reasonable for the real estate investor to be well aware of all these factors or to have enough and reliable data to build on his/her analysis? Simple answer? No!
The good news is that there are some investment analysis tools that can offer the real estate investor such data in minutes. Mashvisor, for example, helps you explore the neighborhood while offering all the needed analysis about it.
Related: What Is Location in Real Estate Investing?
Calculations
It is no secret that a real estate investor must make some basic calculations before purchasing his/her rental property: return on investment (ROI), cap rate, cash on cash return, etc. Still, relying on few calculations isn’t a proof that this is the best choice to buy. An investor who is concerned with making profit in real estate should rely on a superb investment analysis that involves different calculations before taking any risk and buying a rental estate property.
There is no sole magical calculation to achieve all real estate investment analysis. However, every real estate investment needs a certain type more than any other. Here we will be showing different basic calculations, and which investment they are most suitable for.
1. Return on Investment (ROI)
Return on investment means the amount of return a real estate investor can gain in relation to the amount of the money invested. It’s calculated by subtracting the costs of the investment from the costs of the investment, then dividing the result by the costs of the investment.
Return on investment = (Net profit/Cost of the investment) x 100
If the percentage/ratio is positive, then there will be profit, and it’s advisable to buy this property. If it’s negative, then there will be a loss, and buying this rental property won’t be a wise decision. This kind of calculation is best used when the cost of the investment is paid in cash, not in debt or loans. And when the costs of the investment are clear and easy to calculate. The real estate investor should care about all the costs without ignoring any factor no matter how tinny it may seem; otherwise, the investment analysis will be misleading.
Related: Become an Expert on Return on Investment Analysis in Real Estate
2. Net Operating Income
Net operating income means the amount of annual profit generated from operating an investment. It is calculated by subtracting the operating costs from the potential income of the rental property. The operating costs include taxes, maintenance, insurance, supplies, etc. It’s crucial for real estate investors to take the property age into consideration before buying the investment property. The older the investment, the more operating costs it costs.
Net operating income= Net income – Net operation costs
3. Cash on cash return
Cash on cash return means that the real estate investor can know how much cash ratio he/she will get from the investment to the amount of cash invested before tax in a year. Cash on cash return calculation is very useful for investors who aim to finance their investment with a long-term debt when the investors are not mainly concerned about all the operation costs of the investment. Cash on cash return gives them an idea about the performance of the property and whether it needs further investment analysis or not.
4. Capitalization Rate
Capitalization rate or cap rate is one of the basic calculation of the investment analysis process. It’s a metric calculated by dividing the net operating income by the property value in the current market. The net operating income can be calculated by subtracting the costs of the investment from its potential income.
Cap rate = (Net operating income/Property value in the current market) x 100
Before buying the rental property, the real estate investor should know if the property value in the market changes dramatically or not. If the real estate investor gets the same amount of money from the rental property while its value in the markets greatly increases, then the cap rate will decrease with time. The opposite will happen if the property value in the market decreases significantly.
Calculating the cap rate of several similar rental properties is pretty essential if the real estate investor aims to choose the most profitable real estate investments in a certain area. It’s a quick and easy calculation that facilitates the comparison process.
Related: Cap Rate vs. Cash on Cash Return
5. Rent Ratio
It means the ration of the monthly rental income to the cost of the property. It is calculated by dividing the monthly rent by the total cost of the property. If the ratio is higher than 1%, then the rental property will most probably generate a good income for the real estate investor. If the ratio is less than 1%, then it means that the investor needs more than eight years to recover the cost of the property, not to forget that there are several costs that will appear during these years.
To conclude
Buying the rental property is one of the most important challenges that face real estate investors. If you want to know how to make money in real estate, then you have to know how to evaluate the rental property and do a compressible investment analysis. There are several evaluations and calculation that should be done before the purchase. Either the real estate investor has to have the supermind, abilities, and energy to do all that, or he/she had better use one of the market analysis tools that can handle the job effectively.