I am mostly opposed to get-rich-quick methods of real estate investment because they often assume you self-manage the property at the same they ignore your cost of time and the risks of high leverage. Besides, who actually discovers a goldmine and then publishes a map.
There is no secret way to attain real estate investing success. In real life, you must work hard with good research and systematic analysis. To help you better understand some of the nuances associated with real estate investing we would like to suggest a few business goals for you to consider along with the formulas to four popular cash flow analysis models.
Business Goals You Might Consider
- Maximize long term wealth
- Short term financial goals like cash flow
- Develop or own only the highest quality properties in prestige locations
- Own the largest market share of a certain type of income property in a local market
Short Term Financial Goals You Might Consider
- Satisfy the requirements of the lender in terms of pre-leasing or debt coverage cash flows
- Satisfy the minimum required first year cash on cash returns required of investors
- Project minimum internal rates of return for the entire holding period of some minimum percentage
- Maintain occupancy levels above 95% in all portfolio properties
Popular Financial Analysis Models
- Cash on Cash Return (CoC)
- Gross Rent Multiplier (GRM)
- Capitalization, or Cap Rate
- Internal Rate of Return (IRR)
Cash on Cash Return Cash on cash measures the initial profitability of a rental property. The higher the better, and typically a first-year cash on cash return ranges from about 4% to 10%.
Formula: Cash on Cash = Before Tax Cash Flow / Cash Equity (Initial Investment)
Gross Rent Multiplier Gross rent multiplier measures the ratio between annual gross rental income and sale price. Think of it as an indication of the number of years it takes the annual rental income to equal the price, so the lower the better. It is good for simple comparisons to other rental property opportunities but insufficient as a stand-alone number.
Formula: Gross Rent Multiplier = Purchase Price / Gross Rent
Capitalization Rate "Cap Rate" is essentially a return on asset indicator of how much debt an income property can carry. The higher the return rate, the more debt a property can support, and hence the better the investment opportunity for the real estate investor. Sellers of income property, of course, prefer to sell at lower cap rates. Local markets dictate capitalization rate (there is no one-size-fits-all) but they typically run from about 5% to 12%
Formula: Capitalization Rate = Net Operating Income / Purchase Price or Value
Internal Rate of Return The IRR model essentially calculates the average discount rate that equates all future returns over the projected holding period back to the present value of the initial equity investment.
It is the most frequently used measurement of projected holding period overall returns because IRR delivers in one number an investment return that integrates rental growth rates and property value appreciation.
RR should be used as a comparison to the real estate investor's required rate of return for making capital allocation and initial investment decisions. An IRR can be before or after tax using before or after tax cash flows.
[To view this formula please click here]
Although you can make the calculations yourself on some hand-held calculators or in Excel, both your time and money would be better spent if you invest in good real estate investment software that can quickly make the calculations for you.
About the Author James R Kobzeff is a real estate broker and developer of ProAPOD Real Estate Investment Software - Rental property cash flow, rate of return, and profitability analysis. Real Estate Investor Software - So those just starting to invest in real estate can determine whether the property makes money before invest. Mortgage and Financial Calculator - Compute hundreds of mortgage, time value, and cash flow computations in seconds! Preview our software reports and screen shots at proapod.com |
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