How To Analyse A Real Estate Investment
Before you get carried away by the purchase price and potential rents of a particular property, you must remember there is so much to real estate investments than meets the eye.
The right investment can make the difference between climbing the ranks of a landlord or finding yourself in a bankruptcy situation.
As one of the best strategies, you can make use of real estate investment tools such as Property Deals Insight to get access to hot deals in seconds.
Apart from using the tools, here are some metrics that savvy real estate investors use to minimize risks and maximize profits when analyzing real estate investments.
Net operating income
Calculating the net operating income (NOI) gives you a clear idea of whether the property will generate enough profits to cover your mortgage payments. In simple words, it informs you how much money you will make by investing in a particular property. It is as simple as subtracting the total operating costs from total income.
Operating costs include legal fees, general maintenance, property taxes, utilities, and service fees such as parking spots. Note that NOI calculation doesn’t include mortgage payments, capital expenditures, or interests. Also, the rents you project could prove inaccurate, and the income could be inconsistent if you don’t manage the property efficiently.
The capitalization rate or cap rate informs you of the profit percentage out of the investment value. It is the ratio between the property’s current value and the amount of income it produces. You can calculate the cap rate of a potential investment property by dividing the net operating income (NOI) by the asset’s value or the property’s sale price.
So why does the capitalization rate matter? A higher capitalization rate results in higher returns, but the risk is also greater—the riskier the market, the higher the cap rate, and vice versa.
The internal rate of return
Another metric to use is the internal rate of return (IRR). It is the rate of growth the property can generate, and it helps you know if a property will perform well for you or not. When calculating the IRR, you should ensure that the net present value of the property is at nil and use the expected cash flows for all the years you intend to hold the property.
You can use the IRR function in excel to make the calculation easier since it can be complicated. Also, ensure that the properties you compare are similar in size, holding period, and use.
Gross rent multiplier
The gross rent multiplier (GRM) helps you determine if a potential deal is a viable real estate investment. The best real estate investment tools can calculate a property’s GRM depending on the local market and comparable aspects. You can also determine the gross rent multiplier by dividing the asset’s price by its gross rental income.
Generally, a lower GRM is better. But this metric doesn’t account for expenses and vacancies, so it is unwise to make an investment decision based entirely on GRM.
The price to rent ratio
The price to rent ratio compares median home prices and median rents in a particular region. You can calculate the cost to rent ratio by dividing median house price by median yearly rent. Generally, property markets with a high price to rent ratio do not have the best investment opportunities.
The occupancy rates matter because a vacant unit doesn’t generate any income, but it still costs you money. In real estate investments, the operating costs remain unchanged regardless of whether or not you have tenants. You should identify the overall market vacancy rate before investing to ensure you can cover the potential costs when a unit goes unoccupied.
Every real estate investment metric informs you of a different aspect of your potential investment property. Therefore you should also consider your investment goals, type of property, and the market before using it to inform your investment decision.