To start your budgeting process, you should be determining the following costs and considering some important issues:
The purpose of the budgeting study it to understand your cash flow, which is basically the annual or monthly profit you will be making from the property’s rental. To calculate cash flow precisely you will need to calculate investment costs, monthly expenses and monthly income of investing in the property you are planning to buy. Investment costs include price of property, inspections and closing costs. Monthly expenses are mortgage payments, taxes, interest fees, utilities and maintenance. Finally the monthly income is the simple one factor, which is how much the property will be rented for. To have a successful investment the cash flow should be a positive after all costs and expenses or otherwise the investment is considered a potential loss.
The cash flow is the determining tool that helps you understand if you have made a profit from your rental investment or not. However, there are the two formulas that you should definitely look at when budgeting and making a choice about which investment property to buy. The formulas do not contradict each other. One does not have to be false for the other to be true. Each formula has a logical backing to it and how you use it depends on your expectation, expenses and how you plan to budget your cash flow.
The Cap Rate (Capitalization Rate)
The capitalization rate is in simple terms percentage of your investment property value divided by the property’s net operating income. For example, if the property’s value is $400,000 and the net operating income is $40,000 then the cap rate is 10%. This basically means that you are getting back 10% of the initial value you have paid for the investment, which is considered a positive cash flow. When we talk of real estate you can’t expect that you will have your initial investment repaid in one or two years. It is a long-term investment that will pay its dividends with time. Over the course of 10 years, your net operating profit will have gave you back your initial investment. If that is not good enough, then consider the property that you still own, the property’s value could in 10 years depending on location is expected to also rise in value.
The One Percent Rule
This formula is a simpler one and it is still being used today around the world. This formula I would like to consider it a pre-cap rate study. You can use both formulas easily because one is extremely detailed with a study of all factors and aspects, while the other acts as a general quick rule. The formula basically says that if the monthly rental of the property you are planning to purchase is equal to one percent of the property’s value it means you will have a positive cash flow. For example, if the property costs $150,000 to purchase including all fees then the monthly rental should be $1,500 to come up with a positive cash flow. Following this formula basically requires that you know how much the property can be rented for and how much is its initial cost then make a decision. It is not that complicated at all. Like I said before, it is not detailed and not an expressive formula. It is only advisable to use this formula as a screening one, just to know if you need to use up your time to do a budget study or not.
This is where Mashvisor comes in to save the day. Both formulas are good to do your own calculations and to be sure. However, Mashvisor’s investment property calculator offers way more than that. It allows you to budget your investment to predict your cash flow but its data algorithms helps you predict income based on a certain locations. One more thing the investment property calculator does, it is gives you projected incomes not only of traditional rent, but it calculates accumulated data of Airbnb listings in a certain location and provides you with an estimate of how much profit you’d make renting it on Airbnb. If you are an potential investor and you care about positive cash flow and having a platform that breaks down every budgeting detail to its bare core then Mashvisor is definitely a must.