How To Buy A Rental
When it comes to investments, it is all about Return On Investment (ROI).
Hypothetically speaking, if you invested $100,000 in say stocks, mutual funds, bonds or rental property for one year and your $100,000 became $105,000, the $5,000 return (or 5.0% per annum) is what we call the ROI.
When it comes to rental properties, the Return On Investment is derived by simply dividing the property’s annual cash-flow (NET income) by the total cash invested.
For example, if you bought a property for $250,000.00 and it is providing a positive annual cash flow of $18,000.oo, you’d simply divide $18,000 by $250,000 and you’ll come up with a 7.2% ROI.
What is CAP rate? Cap rate is short for capitalization rate. And it is derived by simply dividing the Net Annual Operating Income of a property by its price. Cap rate is a good starting point when shopping for a rental home or commercial property to buy. Initially, you can gauge whether a property is over-priced or not by just comparing its Cap rate with the average Cap rate in the area. Sellers and Listing Brokers alike will easily divulge the Net income of the property they’re selling.
A property with a higher-than-average Cap rate however, doesn’t always translate into an acceptable ROI. Cap rate doesn’t incorporate nearly all of the other financial factors that should be considered when buying an investment property.
ROI calculation seems simple in the example above. But there are intricate details that should not be overlooked when calculating the ROI. This is where your knowledgeable real estate broker comes into play. Not all real estate Agents/Brokers have the knowledge in properly calculating a property’s ROI based on each individual buyer’s unique financial situation.
There are inherent advantages that are unique to investing in real estate over other investment vehicles. Most notably is the yearly depreciation deductions. Another is the property appreciation over time.
In the real world, most buyers will need a purchase loan when buying a property. This is where calculating the ROI gets a little complicated. When an investment purchase is financed, stealth cash-flow (as I like to call it) should also be taken into account.
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Decisions, decisions: To Sell or To Hold onto a Rental
... article to be published soon.
Simple: When the average Cap Rate in the surrounding area where the property is located is at an all-time low, it is a good time to sell! J
This simply means that property values have gone up drastically that the rental market has not caught up or it has lagged behind. This could stem from migration into the area in which buyers would rather buy than rent.
Sometimes selling an investment to roll-over into another investment that provides a better return might just be the right recipe. Circumventing capital gains tax via a 1031 Tax Exchange is the answer.
What is a 1031 Tax Exchange? Stay tuned for the next post...
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