Cash-on-Cash Return is what you would use to compare your investment to other types of investments, like stocks. To calculate Cash-on-Cash Return, take the Annual Cash flow and divide it by the Down Payment amount. Annual Cash Flow Down Payment Lets see it with an example from Camden Towns.
Investment Anaylisis from HarrisonburgInvestmentProperties.com
This is a continuation of a serious entitled: The Top 10 Terms of Commercial/Investment Real Estate.
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Most buy and hold real estate investors agree that cash flow is the ultimate goal. To calculate cash flow, you take the NOI and subtract it by the Debt Service. NOI - Debt Service = Annual Cash Flow See how the cash flow is calculated for Pheasant Run in Harrisonburg. Click here for available properties. This is a continuation of a serious entitled: The Top 10 Terms of Commercial/Investment Real Estate.
Cash Flow Calculations Source: http://www.harrisonburginvestmentproperties.com/pheasant-run/ Debt service is simply the mortgage payment associated with a property. This can be annualized by multiplying one payment by 12.
If you are considering purchasing a property that has a NOI of $60,000. To better understand what your cash flow will look at, you will want to subtract your debt service from the NOI. Example Property 1 NOI: $60,000 Monthly Mortgage Payment: ($896 x 12) Debt Service - $10,752 Cash Flow $49,248 This is a continuation of a serious entitled: The Top 10 Terms of Commercial/Investment Real Estate. The net operating income is the income minus the expenses excluding the mortgage. The NOI is used to help determine the profitability and value of a property. So, the NOI is effectively what the property would be making a person who buys in cash. Here's an example.
Annual Income: $100,000 - Annual Operating Expenses: $45,000 __________________________________________________ Net Operating Income (NOI): $55,000 The NOI is important if you are thinking about purchasing a property. It will not only give you a sense of what you will be earning but it will also help the bank determine if you can afford the mortgage payments. If you own the property, it's a helpful tool to help determine the value of your asset. Furthermore, you can look to increase the value by increasing the NOI. This is a continuation of a serious entitled: The Top 10 Terms of Commercial/Investment Real Estate. Operating Expenses are what it costs to run a business. Some examples of operating expenses include: taxes, insurance, utilities, management fees, landscaping, maintenance, repairs, and advertising. The following is what buying a Campus View Condo may look like. The expense sheet is from HarrisonburgInvestments.com This is a continuation of a serious entitled: The Top 10 Terms of Commercial/Investment Real Estate.
Effective Gross income is also known as EGI. This number is one of the first things you will want to look at when determining a property's income potential. This will be a key figure in determining the Net Operating Income.
Keep in mind that you can add other income sources such as parking, vending machines, laundry, etc... The following is an example of calculating EGI: Gross Income – Vacancy Costs (vacancy rate (%) x income = $ amount) – Credit Loss (i.e. collections, evictions, etc) = Effective Gross Income (EGI) For example, using the same property information above: Gross Income: $120,000 (minus)Vacancy Rate (20%): $24,000 (minus) Credit Loss (2%): $2400 (plus) Additional Miscellaneous Income (Laundry, Parking, etc.): $3500 =Effective Gross Income (EGI): $97,100 This is a continuation of a serious entitled: The Top 10 Terms of Commercial/Investment Real Estate. Example Source: Biggerpockets.com Vacancy rate is the percentage of vacant units in comparison to all the units in the property.
Vacancies Total Units An example would be if a hundred unit property had 5 vacancies, the property would have a 5% vacancy rate. As mentioned in the Vacancy blog, one could purchase a property at a discount, due to a high vacancy rate, solve the reason for the vacancy, fill the vacant units, and then have a more valuable property. This is a continuation of a serious entitled: The Top 10 Terms of Commercial/Investment Real Estate. Gross income is the total amount of income you can get in a property. This is important to understand because this number isn't necessarily guaranteed. For example, if a property has 4 units that rent for $500 a month, the gross income would be $2,000 a month. However, this property may only be partially rented.
Having a property only partially rented could be a bonus if the purchase price reflects the occupancy status. In other words, if you buy the property and make do what it takes to make it fully rented, you can increase the value of the property quickly. In addition to rent, other items such as coin operated laundry, storage fees, late fees, vending machines, etc, can be factored into gross income. Top Ten Terms for Commercial and Investment Real Estate Investing in Real Estate
Real estate is often one of the first things people think of when they consider investments. Why is real estate such a great tool for investing? Let's explore a few reasons.
You can Borrow Money to Invest
If you walked into a bank and told them you wanted to borrow $150,000 to buy stocks in a company, they may laugh at you. However, if you wanted to borrow the same amount for a rental property, they'd take you seriously. There are many reasons why a bank is willing to loan you money to invest in real estate; the main one being real estate is easier to reclaim then other investments.
Aside from the fact that banks will actually lend you money to invest, there are advantages to leveraging your money. A big reason investors leverage properties is for return on equity (ROE). Interestingly enough, the return on equity goes down as your equity goes up. For this reason, some investors will pull equity from their existing properties to invest in others. Check out my previous blog post for more information. Each investor has their own strategies and not all investors try to maximize their ROE. Many investors enjoy seeing their equity and net worth increase. Cash Flow
Earning a monthly income off of your investment is one of the biggest reasons investors choose real estate. The income you receive is called cash flow. To calculate cash flow, you take the Net Operating Income (NOI) and subtract it by the Debt Service.
NOI - Debt Service = Annual Cash Flow To see an example from Harrisonburg, read my previous blog post. Renters Pay Down your Mortgage
We talked about how real estate is unique in it's ability to be financed. Another amazing part of real estate investment is that the tenants, then, pay down your mortgage.
It's important to realize that even if you do not make a lot of cash flow upon first investing in a rental, part of the money earned is the equity build up from your renters paying your mortgage. Furthermore, historically, the cost of living has increased overtime and will result in better cash flow in the future. This leads us to our next point: appreciation. Real Estate Appreciation
As I just mentioned, histrionically, the cost of living goes up, which means rent and real estate purchase prices. Of course, there will be drops in the market, but the market has always recovered from these recessions.
If you hold your rental property for 30 years, your investment should be worth more than what you paid for it. You don't always need to wait 30 years. If you time the market correctly, the value of your house can increase much more quickly. There will be costs in maintaining a house for extended periods of time. This brings us to our next point: depreciation. Depreciation
Deprecation is the least commonly understood factor of real estate investment. In short, depreciation is a tax benefit to rental properties. The government understands that it costs money to maintain properties. The most common way to depreciate a property is by dividing the value of the property, not including the land, by 27 (years). The quotient is then a tax write off.
Example: Value of Structure alone: $150,000.00 Divide by 27 Equals $5,555.55 So, at tax time, you would be able to reduce your taxable income by $5,555.55. This starts becoming significant when you begin to own multiple rental properties. Next Steps
If you are interested in learning more or looking at options near by, call me at (540) 246-9067.
Many investors will argue different sides on this topic. Some investors will say that more cash flow with a 30 year mortgage is more advantageous because it frees up your money to do what you please, including reinvest. While other investors will argue that you pay less interest with a 15 year mortgage. Also, you pay the loan off more quickly and at that point get more cash flow. So is there a clear answer? I have my opinions but I think that looking at the numbers will be more helpful. To help see the numbers, lets create a hypothetical rental that you are purchasing and how the numbers play out on a 15 year note and a 30 year note. Purchase Price: $144,000 Down Payment: $28,800 Loan Amount: $115,200
I think a hybrid approach can also be a good approach if you have the discipline. That is, put the loan on a 30 year note but pay it down on a 15 year schedule. This way, should you need more flexibility one month, you are able access more of the cash flow. So what are your thoughts? Comment below as to what you think is the best route to take. |
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