This tool will figure factors for determining the viability and potential of a residential income property. Calculated factors include: debt service coveratge ratio (DSCR), net operating income (NOI), net income multiplier (NIM), capitalization ratio (CAP), and more.
An investment property is one of the most secure ways to establish a monthly cash flow, but it’s not one of the easiest. Our convenient residential income property potential calculator will help you decide what kind of home to invest in, as well as show you the full monetary potential of a particular property.
From 2002 to 2007, investing in rental properties became all the rage for average Americans, thanks to easy-breezy financing and small down payment requirements. Suddenly, residential income property and house flipping spawned their own websites, TV shows, and subculture.
Predictably, whatever goes up must come down, and the real estate market came tumbling back to earth in 2007. Since then, rental properties have fluctuated, but a good investment opportunity can still be had if you know where to look - and what to look for.
So how can one evaluate the potential earnings from a rental property? Well, here are four ways investors look at residential income property potential.
This popular method of valuing income-generating houses simply compares similar houses that have rented or sold over a specified term. In order to plot any trends, many investors like to look at the sales comparison approach (SCA) over a long period of time.
For example, the SCA can be computed using the price per square foot. This makes it easy for investors to understand what the value of their property should be. If a 2,500 square foot property is renting at $1 per square foot, investors can expect to fetch the same rental income from a similar home in the same area.
Bear in mind that the SCA is a generic comparison that doesn't take into account the uniqueness of every rental property. That said, you should always enlist the help of a certified appraiser when you request a sales comparison analysis.
The capital asset pricing model (CAPM) is a more complex tool that takes into account the financial risks of income property investing. In essence, it compares the return on investment (ROI) you would reap from a rental property to other investments that are considered risk-free, such as treasury bonds.
Because properties come in every size, shape, and condition, it's important to note that the CAPM includes risk factors of real estate income generation. An older property will likely incur more maintenance expenses, and a property located in a high-crime area will cost more to secure. Once you include these risk factors, the expected ROI on a guaranteed (risk-free) investment may well exceed the ROI from rental income. In that case, it doesn't make much sense to take the risks associated with property investment. Real estate management firm CBRE conducted a survey of North American cap rates which showed the following cap rates in the second half of 2019.
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Their full survey results also include breakdowns by class level. Across any property category cap rates are higher on higher-risk units with lower class ratings.
The cost approach to evaluating real estate investment in rentals is the most practical approach because it assesses the value of the property in relation to its best use. In other words, the value is linked to probable best usage. Because this approach is often used to gauge the value of vacant land, as an example, let's take a vacant lot and find its best use value.
A real estate developer will pay a pretty penny for a few acres of land to build condominiums. But if the land in question is twenty miles away out in the middle of nowhere and surrounded by oil fields, the best usage of that land is not in building condos. Instead, the value is in possibly annexing the land to find more oil, and that's how its market value is established, long before any ground is broken.
The cost approach and best use determination are also useful in putting a price on property, which has yet to be zoned as residential. This is because the developer will have to spend a bundle on rezoning. This method is much more accurate when applied to newer houses than to older structures.
This method of tabulation takes the potential income for the rental property and compares it to the initial investment. Often used for residential rentals and commercial property investments, the income approach focuses on the projected annual income divided by its current value. If a rental cottage costs $120,000 to buy and the projected monthly income from the rental is $1,200, the capitalization rate is 12 percent (12 x 1200/120,000).
Of course, the above example is oversimplified. In real life, you would have to pay interest charges on the mortgage, and there is one additional factor in the equation: the dollars you receive in future rent payments may or may not be more valuable than today's dollar.
The income approach can go into minute detail for precise calculations. Here are some of the considerations of the long-form calculations:
While there is still a small fortune to be made in income property, times have changed. No longer can you hope to flip a house with no money down. But if you know how to value real estate property, and you employ a little of each of the four valuation methods outlined above... your fortune awaits.
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