If you are considering becoming a landlord and have researched the neighborhood including crime statistics then it’s time to run the three most important numbers to see if the property is a good rental.
1. Net Rental Income = Gross Income – (Operating Costs + Debt Payments)
In this case your operating costs include such things as taxes, insurance, utilities while vacant, property management fees, monthly mortgage payments as well as annual or variable costs like repairs, vacant periods and possible utility deposits. Many investors utilize 1.5 times the monthly rent amount for repairs during tenancy and 2 times the monthly mortgage payments for your vacancy costs. If your result seems to be less than you consider “worth your time”, it’s time to start looking at a different property.
2. Calculate Cash-on-Cash Return: to do this multiply the net rental income by 12 to determine your annual cash-flow. Next divide your annual cash flow by the total amount you’re going to have to invest to get the property rented out not including the cost of the mortgage but the out-of-pocket expenses. For example, if you will be purchasing the property for $100,000 with a mortgage for $75,000 you divide the annual cash flow by $25,000. The closer your result is to .4 the better and really .3 and up is a good sign to move forward. With a number less than .2 you probably want to move on because it will simply take too long to recoup your expenses.
3. Determine your Net Rental Yield = Net Rental Income *12/Property Value. For example, if you have the $100,000 property from the example above and the rental income is $900/month than the Net Rental Yield is 10.8%. In other words, your investment property will produce 10.8% of it’s own value each year paying itself off in under 11 years. Once you reach 100% your investment is paid off and you have an investment that is producing “pure capital”. Keep in mind that property values change and as such the Net Rental Yield will change. The higher the Net Rental Yield of the property, the better the opportunity for net positive cash flow. Many investors think that 8% is a good bench mark however you can calculate these numbers for several properties in your area to get a good idea of the range.