The rocky bottom immovable prices may be attractive to some novice real estate investors looking to penetrate the market. But, before joining the ranks of owners, make sure you have a good understanding of the financial information that can make the difference between a successful business or ending up in bankruptcy court.
Here are eight real estate investment numbers you need to know how to calculate and use when evaluating a potential investment property.
Key points to remember
- Investing in real estate can generate capital gains as well as rental income.
- Each property will be evaluated based on its unique properties, such as layout, location and amenities.
- However, several other key data can be calculated for any property and allow potential investors to make apples-to-apples projections and comparisons.
- Here, we review eight critical metrics every real estate investor should be able to use when valuing a property.
8 figures to evaluate a real estate investment
1. Your mortgage payment
For a standard owner-occupied house, lenders generally prefer a total debt/income ratio of 36%, but some will go as high as 45% depending on other qualifying factors, such as your credit score and cash reserves. This ratio compares your total gross monthly income with your monthly debt payment obligations. For the housing payment, lenders prefer a gross income to the total housing payment of 28% to 33%, depending on other factors. For a Investment property, Freddie Mac the guidelines indicate that the maximum debt-to-income ratio is 45%.
2. Deposit Requirements
While owner-occupied properties can be financed with a mortgage and as little as 3.5% down payment for a FHA loanInvestor mortgages generally require a advance payment 20 to 25% or sometimes up to 40%. None of the down payment or closing costs for an investment property can come from donations. Individual lenders will determine how much you need to pay to qualify for a loan based on your debt ratios, credit scorethe price of the property and the probable rent.
3. Rental income to qualify
Although you might assume that since your tenant’s rent payments will (hopefully) cover your mortgage, you shouldn’t need the extra income to qualify for the home loan. However, for rent to be considered income, you must have two years of experience managing investment properties, buying a loss of rent insurance cover for at least six months of gross monthly rent, and any negative rental income from any rental property should be considered debt in the debt-to-income ratio.
4. Price/income ratio
This ratio compares the median household price in an area to the median price household income. In 2011, after the housing bubble, it was 3.3, in 1988 it was 3.2, and in October 2020 it was around 4.0. Before the housing bubble collapsed, it was at a high of 4.66.
5. Price/rent ratio
The price/rent ratio is a calculation that compares median house prices and median rents in a particular market. Simply divide the median house price by the median annual rent to generate a ratio. In general Golden Ruleconsumers should consider buying when the ratio is below 15 and renting when it is above 20. Markets with a high price-to-rent ratio generally do not offer such a good investment opportunity.
6. Gross rental yield
The gross rental yield for an individual property can be found by dividing the annual rent collected by the total cost of the property, then multiplying that number by 100 to get the percentage. The total cost of ownership includes the purchase priceall closing costs and renovation costs.
7. Capitalization rate
A more valuable figure than the gross rental yield is the Capitalization ratealso referred to as capping rate or net rental yield as this figure includes exploitation charges for the property. This can be calculated by starting with the annual rent and subtracting the annual expenses, then dividing that number by the total cost of the property and multiplying the resulting number by 100 to get the percentage. Total rental property expenses include repair costs, taxes, owner insurance, vacation costs and agent fees.
8. Cash flow
If you can cover the principal of the mortgage, interest, taxes and insurance with the monthly rent, you are in good shape as a landlord. Just make sure you have cash reserves on hand to cover this payment in case you have a vacancy or need to cover unexpected maintenance costs. Negative cash flowwhich most often occurs when an investor has borrowed too much to buy the property, can result in a default on the loan, unless you are able to sell the property for a profit.
Once you have done all of these calculations, you can make an informed decision as to whether a particular property will be a valuable investment or a lemon.
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