The one question that haunts real estate investors is whether it’s ok to break even on a real estate investment property or not.
This article is going to have all the answers associated with the matter of breaking even on a rental property. However, as a real estate investor, you’ve got to understand that it is a part of the investment property analysis process. So, really, there is no way to go about the whole analysis process without considering this type of calculation.
Related: Is It OK to Break Even on a Real Estate Investment Property?
Before we get into the issue of whether you should settle for it or not, let’s take a look at what it means and why is it important to calculate it.
What does breaking even on a real estate investment property mean?
The easiest way to put it is by saying that to break even on a real estate investment property is when your monthly operating expenses are equal to your monthly rental income. This means that the property is paying for its own expenses leaving you with zero cash flow/profits.
Note that this definition reveals the 3 most important factors that contribute to the break-even point, which are: 1) The monthly rental income, 2) The monthly operating expenses which include maintenance and repair, property management, and insurance among other expenses, and 3) The mortgage payments.
The definition also means that there are cases in which you won’t need to deal with the concept of breaking even. First of all, if you bought the property all in cash, then breaking even is not something you will have to worry about. Another case is long-term leases. If you could guarantee a long-term tenant occupying your rental property then go ahead. This dramatically decreases the possibilities of breaking even on your real estate investment property.
Looking at the previous information, it leads us to another term relative to breaking even on a real estate investment property: the break-even ratio.
What does the break-even ratio mean and why is it important?
The break-even ratio is a measure that is important for both real estate investors and mortgage lenders. Basically, it indicates how vulnerable a real estate investment property is to default on the debt in case the rental income decreases.
The significance of the break-even ratio shows in two aspects. First, for a real estate investor, it is part of the investment property analysis when buying an investment property. In other words, you’ll be able to determine the amount of money coming in and the amount going out from a real estate investment property. Therefore, you want to know the possibility of not gaining money while still not losing any.
As for the second aspect, it comes from a mortgage lender’s perspective. This measure is mostly used by lenders to determine whether you are eligible for financing a real estate investment property. Lenders want to see a break-even ratio that is as low as possible. The lower, the better of an indicator it is to the profitability of the rental property.
Related: What You Need to Know About Investment Property Mortgage Lenders
How to calculate the break-even ratio for a real estate investment property
Calculating the break-even ratio for a real estate investment property is not a big deal. In fact, it is as easy as 1+1= 2. Here is an example of a rental property so you could see it in action:
After analyzing a few rental properties, John finally decides on one. He applies for a mortgage and the lender wants to calculate the break-even ratio in order to determine eligibility for financing. After the lender analyzes the property, he/she comes out with the following numbers: $700 in monthly mortgage payments, $2000 in monthly rental income, and $300 in monthly operating expenses. So, this is what he/she does to figure out the break-even ratio:
Step 1: He/she calculates the gross annual rental income:
$2000*12 = $24,000
Step 2: He/she calculates the annual mortgage payments:
$700*12 = $8,400
Step 3: He/she calculates the annual operating expenses:
$300*12 = $3,600
Step 4: He/she applies the break-even ratio formula:
BER = Total debt service+Annual operating expenses/Gross annual rental income
BER = $8,400 + $3,600 / $24,000 = 0.5 or 50%
This leaves us with the question: “What is a good break-even ratio?”
There is no specific answer to this question other than saying that any percentage less than 85% is ideal for a mortgage lender. Therefore, if you are thinking of financing a rental property, make sure you crunch some numbers beforehand.
Is breaking even on a real estate investment property an option?
The answer is yes, indeed. Breaking even on a real estate investment property is an option. A break-even point is great news of no losses. For you, I guess it would be better if the property is not generating cash flow as long as you know that it’s taking care of its own expenses.
Also, breaking even does not mean that you are not gaining anything at all. After all, a property will experience a rise in value over time (appreciation). This means that you are not gaining anything in the short run. Still, you will be able to gain something in the long run instead.
Related: How to Calculate Real Estate Appreciation
Moreover, with a property that is at a break-even point, you could easily turn that around and start generating some cash flow. As a matter of fact, boosting your rental income does not have to be so hard. Even a few minor changes in your strategy could make a huge difference. Therefore, a break-even point is good news of potential for your business.
Mashvisor can help!
When it comes to real estate investing, Mashvisor is the source to turn to. Moreover, when it comes to breaking even on an investment property, our rental property calculator is the ultimate tool. In fact, it is the tool to use when you are investing in income properties. Not only will it help you to calculate the potential rent, but also the potential profits you could expect. Also, it will help you calculate the break-even ratio for your income property.
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