When it comes to making the right choice in real estate investment, there’s a lot more to think about than just the property’s price and rental income potential. Experienced investors rely on a set of carefully refined tools and calculations to guide them. These tools are not just for risk reduction but also for maximizing returns.
In the following sections, we’ll explore some critical metrics that serve as invaluable compass points, steering astute real estate investors through the complex landscape of property options and enabling them to make informed decisions.
Cash flow is the lifeblood of any investment. If this vital number slips into the red, it’s not merely a warning; it’s a loud siren signaling financial trouble. Negative cash flow means you’re struggling to cover expenses, let alone turn a profit. It’s also an indication that you may be overspending on the property or dealing with problematic tenants whose late or partial payments are eating into your bottom line.
To calculate cash flow, subtract capital expenditures and debt service (mortgage) from net operating income.
Capitalization Rate (Cap Rate)
The cap rate is a universal metric because it assumes that the property is purchased outright, without a loan, which can vary significantly. It reveals what percentage of your investment constitutes profit.
You can determine the cap rate by using the property’s operating income and recent selling prices of similar properties. Divide the net operating income by the total property price to find it.
Gross Operating Income (GOI):
GOI in real estate refers to the total income generated by a property after accounting for vacancy and credit losses. Vacancy-related costs may include expenses for finding new tenants, minor maintenance, repainting, renovation, and management fees associated with securing a new lease. As a rule of thumb for established properties, you can estimate vacancy expenses at 5% to 10% of your gross rental income.
Net Operating Income (NOI):
NOI is a key indicator of your property’s profitability. It provides a high-level overview of your property’s financial health. To calculate NOI, subtract operating expenses (excluding mortgage payments) from your total income. Operating expenses encompass property management fees, legal costs, general maintenance, property taxes, and the utilities you cover. Investors rely on NOI to assess a property’s revenue-generating potential and its ability to cover mortgage payments.
In the realm of real estate investment, these metrics can make the difference between a solid, revenue-generating investment and a financial pitfall. Venturing into the property market without considering these calculations is akin to navigating uncharted waters without a map – it’s a risky endeavor. So, equip yourself with knowledge and let these tools be your guiding stars on the path to real estate success.
When you’re prepared to secure financing for your investment, consider partnering with a trusted expert like Rock East Funding. With over 30 years of experience, we take pride in our strong client relationships. Contact us today to explore your real estate financing options and embark on your investment journey with confidence.
About Ed Hendrickson
Ed has been originating private loans since 2017. He also owns a portfolio of multi-family properties.