If you’ve decided that purchasing an investment property is right for you, the next step is to figure out what constitutes a good investment. You can check what we look for in an investment property here – the post is older, but the idea is the same. Once you know what type of property you want, and in what condition, you need to figure out if a particular property is worth the money – after all, it is an “investment.” There are various formulas to calculate whether an investment is “good” for you. The simplest is the ROI – return on investment. It’s simple because you just need to compare what you’ll get out of it to what you’re going to have to put into it. However, it’s perhaps a little too simple. The three calculations below will provide you with a more strategic outlook on such an investment.
Cash on Cash Return = Annual Before Tax Cash Flow/Total Cash Invested A higher cash on cash return is typically a better investment (“typically” because it doesn’t account for appreciation/depreciation). This calculation is overly simplistic, but a quick way to determine if further examination is warranted. Let’s say an investor puts $150,000 down on a $600,000 property and expects to generate a $4,000/mo. return on that property, after expenses. The before tax income would be $6,000 x 12 = $72,000. So, the Cash on Cash return would be $72,000/$150,000 = 48%.
Gross Rental Multiplier = Sales Price/Annual Rent The lower the GRM, the better the investment. This calculation, like the above one, is highly limited, but it can be compared to the area’s average GRM. To get information on that, contact your Realtor®. In the above example, if the monthly rent were $12,000, this would give you an annual rent amount of $12,000 x 12 = $144,000. The GRM would then be $600,000/$144,000 = 4.2 (rounded up).
Capitalization Rate = Yearly Income/Total Value The higher the cap rate, the better. Let’s consider the running example of the $600,000 property. With a yearly income of $72,000/$600,000, the Cap Rate would be 0.12 (or 12%). Where this differs from the cash on cash is that it does allow for appreciation/depreciation. Let’s say in 3 years, the value of that home rises t0 $1.2M, the Cap Rate would be 0.06 (6%), a much less favorable number. The investor could then consider options.
Making these calculations is easy with this online calculator. For those wanting a more robust calculation, you can also take a look at this cash flow calculator.
At the end of 2014, RealtyTrac® released an analysis of fair market rents and median home prices. Most markets – and the market overall – said buying is better than renting. In areas with an increase in millennials, like Portland, the rental market showed increasing strength. With more renters in the market, having a good investment property can prove to be the right move for many. If you’re interested in what investment properties Portland offers, give us a call at 503-406-5232.