Simple Maths For Aspiring Landlords
Every new property investor asks how are they going to know if their investment is profitable or not. Today I’ll show you two simple formulas that you can use to check if an investment property is a good opportunity. These assume the most traditional means of property investment - buying a unit/house and renting it out to the market.
The 1% Rule
You’ll often have many options when looking at investment properties, and having a simple rule of thumb like the 1% rule will help you narrow down options quickly and help you focus your time and energy on the better ones.
Summed up, the rule simply states that a property should rent for at least 1% of its total cost (not what you’ve mortgaged it for, if you’re not buying cash).
So a 100K property would rent for 1k. However, if it needs 50K of work to get it into a rentable condition then you should factor that in, meaning that 1k would be 1.5k.
If a property you are looking at passes this 1% rule it’s usually worth further investigation. Some will rent for much more than that, but many don’t, and some will be a struggle to find tenants for 1% - and those are usually not worth spending more time on. Most importantly, you should account for slumps and dips and not proceed on an assumption of constant rises, or high historical rentals repeating themselves - otherwise you might find yourself over-extended when inevitable slumps and corrections occur.
And as many in the last two years have discovered, borrowing when interest rates are historically low without having a buffer for when they rise can see your carefully considered investment plans scattered to the winds.
Cap Rate
After you have selected a small number of potential properties, it is time to examine the capitalisation rate, or "cap rate" as it is sometimes called. This helps you calculate property's potential for return on investment.
The cap rate is found by dividing the property's net operating expenses by its purchase price. To find the cap rate, I’ve made it easy and provided a link. There are a few sites out there so if you don’t like this one you can search for others.
You shouldn’t include your mortgage payments in your list of monthly expenses if you have any. Every investor uses different rates of down payment/financing etc. The cap rate assumes you purchased cash - this allows you to easily compare one property’s ROI to another.
Every investor will have their own yardstick for what makes an acceptable cap rate, but generally speaking, they want that number to be on the high side before deciding to invest.
We have a variety of ‘hands-on’ and ‘hands-off’ property opportunities including inflation-tied rental income, development stage land investment, and property bonds - all alongside more traditional property. If you’d like to speak about how and where real estate might fit in your portfolio please get in touch.
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