Want a quicker way to evaluate a rental property? This modified annual property operating data may be just what you’ve been looking for.
Many Different Rates of Return Investors Look at
There are many different rates of return investor’s consider. This Simple Real Estate Rate of Return can help. You can see quickly if a property will generate the yield you expect. If you get the other benefits like tax advantages and appreciation, it’s just that much better.
Cash on Cash Rate of Return
The first yield is commonly called the Cash-on-Cash rate of return. It is calculated by dividing the initial investment, usually down payment and closing costs, into the Cash Flow Before Tax.
Net Operating Income – Simple Real Estate Rate of Return
To arrive at Net Operating Income, it’s simply taking the gross scheduled income, less vacancy allowance and all operating expenses. From that deduct the annual debt service, (principal and interest payment times twelve). The remaining amount is referred to as Cash Flow Before Tax.
In this example , the initial investment of the down payment and closing costs, $66,000 was divided into the Cash Flow Before Taxes of $5,468 to get an 8.28% Cash-on-Cash rate of return.
Equity Build-Up
Each payment made on an amortizing mortgage pays a portion toward the principal balance to retire the loan. The simple real estate rate of return is calculated by dividing the initial investment into the principal contribution for the year.
Continuing with the example, $66,000 is divided into the principal reduction for year one of $4,606 to get a 6.98% Equity Build-up rate of return.
This approach is easy to understand because you’re not considering depreciation, anticipated appreciation, holding period, recapture of depreciation or long-term capital gains. Simply rent the property, pay the bills and if there is money left over, it pays a return on the initial investment.
The same goes for the Equity Build-up. When you make the payment on the mortgage, the loan is reduced and while you don’t have access to the money like cash flow, it’s definitely your equity and tangible.
To determine whether an ROI on a rental is good, compare it to what your initial investment is earning currently. Ten-year treasuries are earning less than 2%. Certificates of deposit are earning less than 1%.
For more information, download the Rental Income Properties guide and schedule a consultation
Building wealth through real estate ownership has long been recognized as one of the best investments you will make for building wealth. Using these Simple Real Estate Rate of Return calculations make it easier to identify the right deal for your circumstance.
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