What are Rental Property Investments?
Rental property investment refers to real estate investment that involves real estate and its purchase, followed by the holding, leasing, and selling of it. Depending on the type of rental property, investors need a team certain level of expertise and knowledge to profit from their ventures. Real property can be most properties that are leasable, such as a single unit, a duplex, a single-family home, an entire apartment complex, a commercial retail plaza, or an office space. In some cases, industrial properties can also be used as rental property investments. More commercial rental properties, such as apartment complexes or office buildings, are more complicated and difficult to analyze due to a variety of factors that result from the larger scale. For older properties, it is typical to assume higher maintenance and repair costs. Below is our formula to gauge for future
repairs of a fully renovated Turnkey property:
C-class rental property investments are generally cash flow dependent with lower levels of liquidity. B-class properties see a linear appreciation and have a slightly higher liquidity option. B+ and A-class properties offer the owner a wider variety of options and are much more liquid. Compared with equity markets, rental property investments are normally more stable, have tax benefits, and are more likely to hedge against inflation. Given proper financial analysis, they can turn out to be profitable and worthwhile investments.
Older than 1985 = 8% of collected rent
Newer than 1985 = 5% of collected rent
Brand new homes = 3% of collected rent
What is Rental Income?
There are several ways in which rental property investments earn income. The first is that investors earn regular cash flow, usually on a monthly basis, in the form of rental payment from tenants. In addition, as with the ownership of any equity, rental properties give the investor the possibility of earning profit from the appreciation, or increase in value over time, of the property. Unlike rental income, a sale provides one large, single return.
What are my Responsibilites when it comes to Rental Investment?
Rental property investing is not a completely passive income. It requires time and work. The investor or owner has to take on the role of the landlord and all the job responsibilities associated with it. However, if you have a competent property manager, most of these tasks can be delegated to them.
General responsibilities of owning a rental property include:
It is common for rental property owners to hire property management companies at a percentage fee to handle all the responsibilities. Investors who have limited time, who don't live near their rental property, who aren't interested in hands-on management, or who can afford the cost can benefit from hiring a property management company. This is roughly estimated to cost about 10% of rental property income.
Tenant Management—finding tenants, performing background screenings for potential tenants, creating legal lease contracts, collecting rent, and evicting tenants if necessary.
Property Maintenance—repairs, upkeep, renovations, etc.
Administrative—filing paperwork, setting rent, handling taxes, paying employees, budgeting, etc.
What are some General Guideline when it comes to Rental Investing?
Real estate investing can be complex, but there are some general principles that are useful as quick starting points when analyzing investments. However, every market is different, and it is very possible that these guidelines will not work for certain situations. It is important that they be treated as such, not as replacements for hard financial analysis nor advice from real estate professionals.
38% Rule - A rental property's sum of operating expenses hover around 38% of income. Operating expenses do not include mortgage principal or interest. The other 62% can be used to pay the monthly mortgage payment. This can be used to quickly estimate the cash flow and profit of an investment.
1% Rule - The gross monthly rent income should be 1% or more of the property purchase price, after repairs. It is not uncommon to hear of people who use the 2% or even 3% Rule – the higher the better.
What is Internal Rate of Return?
Internal rate of return (IRR) or annualized total return is an annual rate earned on each dollar invested for the period it is invested. It is generally used by most if not all investors as a way to compare different investments. The higher the IRR, the more desirable the investment.
IRR is one of, if not the most important measure of the profitability of a rental property; capitalization rate is too basic, and Cash Flow Return on Investment (CFROI) does not account for the time value of money.
What is Capitalization Rate?
Capitalization rate, often called the cap rate, is the ratio of net operating income (NOI) to the investment asset value or current market value.
Cap rate is the best indicator for quick investment property comparisons.
It can also be useful to evaluate the past cap rates of a property to gain some insight into how the property has performed in the past, which may allow the investor to extrapolate how the property may perform in the future.
If it is particularly complex to measure net operating income for a given rental property, discounted cash flow analysis can be a more accurate alternative.
What is Cash Flow Return on Investment?
When purchasing rental properties with loans, cash flows need to be examined carefully. Rental property investment failures can be caused by unsustainable, negative cash flows. Cash Flow Return on Investment (CFROI) is a metric for this. Sometimes called Cash-on-Cash Return, CFROI helps investors identify the losses/gains associated with ongoing cash flows. Sustainable rental properties should generally have increasing annual CFROI percentages, usually due to static mortgage payments along with rent incomes that appreciate over time.