In the last two years, low interest rates and a high demand for rental properties have made it easier for amateur investors to invest in real estate. Real estate investment is a good source of income, even though rates are expected to rise in 2022.
Before you jump in, make sure to familiarize yourself with six key metrics that will help you achieve long-term success.
How to Value a Property
You’ll need to familiarize yourself with the metrics of your potential investment before you begin investing. Check out the video for tips on how to purchase a property.
Gross Rental Yield
Calculate the gross rental yield if you are unsure about which property to choose or want to make sure that you will get a good ROI. Divide the projected annual rent by the cost of the house and multiply by 100.
| Gross rental yield example |
|---|
| Purchase price of $450,000 Weekly rent = $400 The Gross Rental Yield for this property is 4.62%. |
What are you searching for? Even savvy investors consider a gross rental yield of less than 10% to be a good figure. You may find in some cases that properties with lower upfront costs yield a smaller ROI over time.
Capitalization Rate (CAP)
This number, also known as net rental yield or CAP rate (Cap Rate), takes gross rental yield up a notch.
Divide the estimated annual operating costs by the total property cost. Include taxes, insurance costs, vacancy expenses, and agent fees in the total cost of your property. Multiply the result by 100 to calculate your capitalization rate. Investors aim to have a capitalization rate (CAP) of at least 10 percent.
| Example capitalization rate cap calculation |
|---|
| Annual Operating Expenses: $55,000 The total cost of the property is $475,000. Your CAP rate will be 11.5%. |
Price-to-Rent Ratio
Calculate the price-to rent ratio to get a more accurate picture of the local housing market. Divide the median home value of the area by the median rent. If the number is 15, it’s a good idea to buy.
| Example price-to-rent calculation |
|---|
| Median home price in the area: $480.750 Rent Median: $22,272 This tells us that now is not the best time to purchase. |
Find financing and prepare to buy
Pay Down Payment
When it comes to getting a mortgage, investors are treated differently from the average homebuyer. Investors are required to pay a higher down payment than a typical home buyer. While the average homebuyer may only put down 5 percent for a homeowner-occupied house, most lenders require investors to make hefty down payments of 20 to 25 percent. Some lenders will even ask for up to 40%.
Before you invest, consider the required percent and whether you can afford to pay the upfront cost.
Debt-to-Income Ratio (DTI)
Lenders look at your total recurring debt in relation to your total income when putting together mortgage packages. This particular number is more favorable for investors than the average homebuyer. Lenders generally require that a debt to income ratio of 36% be met when purchasing a home for an owner-occupied person, but some allow as much as 45%.
Divide your gross monthly income by the total of your debt payments.
| Example DTI Calculation |
|---|
| Monthly payments of $2,600 Gross monthly income of $5,800 This is a debt-to-income of 48%. |
You may not be able to qualify for a mortgage if you intend to use future rental income from the property. The majority of lenders will not consider rental income as income, unless the following conditions are met:
- You must have experience managing investment properties and be in business for at least two years.
- You have taken out an insurance policy covering at least six month’s rent per month.
- In your calculations of debt to income ratio, you have included all negative rental income.
Loan-to-Value Ratio (LTV):
Lenders place great importance on the loan to value ratio, particularly for investment properties. Divide the total mortgage by the price of the home and multiply by 100. This is the simplified version of the equation.
Other factors can be taken into consideration depending on the financial situation. Useful calculators can be found in investor tools at Bigger Pockets.
You should aim to have a LTV between 80-95%. However, it cannot be higher. The lenders view cases with high LTVs as risky (although they allow slightly higher LTVs to investors), which can have serious implications for the borrower. You may have to pay additional fees or be forced to purchase private mortgage insurance until your equity is at least 80 percent.
You’ll make a better decision if you understand the metrics of a potential investment.
+ There are no comments
Add yours