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June 2, 2017

Derek’s Quick Guide to Real Estate Investing

by derekespeer

We work with some investors for are looking to either:

  1.  Flip
  2. Invest and Rent

This quick summary and example is NOT for flipping.  In fact, with a supply shortage, flipping is tougher to manage since there is so much competition (buyers) seeking primary residence in addition to other investors.

 Here’s my “see ball, hit ball” approach to acquiring rentals and investments

  1.  Determine the annual rent you can expect from a residential rental property.
  • We will help you determine rental rates
  • We can target rentals that may already have tenant

     2.   Estimate the annual expenses of owning the property. 

This may include but not be limited to:

  • Vacancy costs – estimate 5-10% of annual rent. This helps cover rent loss from nonpayment or vacancy between tenants
  • Taxes
  • Utilities that you will pay (not tenant)
  • Insurance – landlord’s policy
  • Repair costs

 

  1. Calculate your annual net income

(annual rent minus annual expenses).

  1. Calculate the property’s capitalization rate, or “cap rate.

The capitalization rate is the rate of return on a real estate investment property based on the income that the property is expected to generate. The capitalization rate is used to estimate the investor’s potential return on his or her investment.

Some additional links to investopedia.com are included.

Cap Rate = net income/cost of property

Example: You rent out a house for $1200 per month or $14,400 per year. You anticipate annual expenses as follows:

vacancy rate of 5%          $720

real estate taxes              $1200

maintenance and other expenses              $2,000

Total expenses   $3920

Annual net income = $10,480 ($14,400-$3920)

In the example above, the asking price for the property was $100,000. The cap rate calculation then is:

$10,480/$100,000 = 10.48%

This property therefore yields a “cap rate” return of 10.48% (unless you can get the property for a lower price).

Cap rate is typically in indirect proportion to location.

High demand/desired location = lower cap rate

Lower demand = higher cap rate

 

ROI for Cash Real Estate Deals – $150,000 purchase price

Cash Purchase

Purchase price:  $150,000 with cash

$12,000 on closing costs plus remodeling, and then rent it out for 12 months.

$1500 Rental rate/month or $18,000/year

Total out of pocket cost $162,000 ($150,000 + 12,000)

ROI=18,000 (annual income)/$162,000 (total investment) = 11.1% GROSS (not including costs)

ROI for Financed Real Estate Deals

20% Down

$150,000 purchase price

$15,000 on closing costs plus remodeling ($3000 more than cash for financing)

Out of pocket cost:  $30,000 (down payment) + $15,000 = $45,000

Financed amount:  $120,000, 30 year am, 4.5% = P/I payment of $608.02/month.

Taxes and Insurance – $300/month

Total Payment – $908.02

$1500 Rental Rate/month

Cash flow of $591.98/month (rent – mortgage)/ $7103.76 annual

$7,103.76 (annual cash flow) ÷ $45,000(original cost out of pocket from down payment, closing costs, and fix ups)   = 0.157 or 15.7% ROI

An amortization schedule will also show principal paid down each year which increases this return.

 Length of Mortgage Loan Term Affects ROI

Term Sales Price Repairs & Closing Costs Total Spent Monthly Rent Yearly Rent Net ROI After Taxes & Insurance
Cash / No Mortgage $150,000 $12,000 $162,000 $1,500 $18,000 8%
15-Yr. Mortgage (20% Down) $150,000 $15,000 $ 45,000 $1,500 $18,000 21.0%
30-Yr. Mortgage (20% Down) $150,000 $15,000 $ 45,000 $1.500 $18,000 15.7%

Looking to increase or start a rental portfolio, please contact me.

Derek

Read more from Progression to Success

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