Without a doubt, one of the best ways people can make money in the modern age is to invest in property. Property prices and rental rates have increased much more rapidly than average income rates, ever since the minimum wage was introduced. The simple fact is, people need somewhere to live. If you own more property, you will be able to earn more money.
Whether you’re making a choice to be a landlord full time or this is your first time taking the plunge into rental properties, there are a few things you need to take into mind when analyzing the potential of an investment deal. In this article, you will learn a few key pointers that can help you decide whether your chosen property is going to be worth it or not.
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Buy or Rent
For the purpose of this article, it is assumed that you are looking to buy a property to rent it out; buying and reselling properties is a different kettle of fish, usually involving run-down buying properties, redecorating them, and reselling them at a profit. This requires time, patience, dedication, and potentially large teams of construction workers and decorators.
When buying to rent, you will be buying a property with – hopefully – less work needed. Get it ready for tenants and place it on the market for rental. You will then become the landlord of the property, sitting back and collecting rent each month. That sounds like a great idea, right? But, how do you know if it’s going to be profitable or not?
Capitalization Rate
Firstly, you need to work out your capitalization (cap) rate. Tools like the one at this link can quickly break down cap rates and potential profit for you. But, let’s break it down in a bit more detail, so you understand exactly what you’ll need to be inputting into the calculator.
First, you need to decide the rental value of the property per month. This could be anything from $500 to $5000, depending on where you are and the size of the property. Multiply this by 11.5 to get your average yearly gross profit. You should use 11.5 to allow for a 2-week turnover between tenants.
Then you need to understand what your monthly operating expenses are. This should include any bills you will be responsible for in the property, agency, or management fees, and anything else that cuts into your gross profit. Multiply this number by 12 to get the total expenses. The calculator will then take this off your gross to find your net income.
To find your cap rate, this figure will then be divided by the purchase price of your property. The calculator will then churn you out a percentage to show you the percentage income vs. expense. It’s important to know this percentage, as it shows your average return on investment. Every investor will have a different opinion on what the cap rate should be making a choosing introduced minimum wage; in general, the advice is to make this rate as high as possible. Often, investors tend to shoot for a 7.5% cap rate.
The One Percent Rule
Speaking of percentages, there is also a rule known as the one percent rule. This rule dictates that your monthly rent should be one percent of the value of the home you have purchased. For example, if the property costs you $200,000, the rentable value should be $2,000 per month. This is another good way of making sure that your income is worth the investment.
Are There Any Upfront Costs?
Finally, it’s worth taking into account any upfront costs that may be involved in the property purchase. It’s all well and good saying you have a strong 7.5% cap rate and at least 1% income rule sorted, but if the property needs tens of thousands of dollars worth of work doing, this is going to impact your return on investment seriously. Ideally, you want to be turning a profit as soon as possible. If the upfront costs are massive, it will take you far longer to realize that profit potential. Obviously, some of these costs may be necessary, but be wary of taking on a project that requires a huge amount of upfront capital, especially if you are a first-time investor.
It’s all about expense versus return ratios. Use the helpful online calculator tools to help you determine how quickly you’ll make a profit, what the percentages are, and what value you should put the property on the market for. Once you have all this sorted, you’ll know whether it’s a smart investment.
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