Real estate is attractive to many budding investors who see it as a passive but reliable income-generating enterprise. However, property investment, especially in rentals, is anything but passive and can lay an unexpected financial burden on a novice first-time investor. That’s why before you jump in with your hard-earned dollars, assess the potential of the planned investment against your financial strength and market prospects.
Understanding how the property market works, the preferences in the target area, and detailed information about the probable property itself are critical for analysis before commitment. Here are some things to consider before buying that property.
How to evaluate the property’s rental potential
The primary objective of any investment is profitability, and to achieve this, the first thing to consider before purchasing a property is its rental potential. Location is one of the basic criteria when selecting a potential property for purchase that has a direct influence on the purchase price, class of tenants, and the level of rent payable. A consultation with a licensed property management company in Nashville can help you map out the best locations for investment with higher rental yields. The best options in Nashville include Evernest, Browning-Gordon, Fyve, Renu and Apex property management services.
Assess the competition in the preferred location and the popular property user types to help in developing a superior rental strategy for your investment. The rental strategy could focus on short-stay visitors or long-term tenants depending on the popular user type in the area. Once you settle on a location and rental type, assess the potential tenants and formulate the right marketing strategy to attract immediate occupancy.
Comparative market analysis
Serious investment is never a hurried exercise, and an investor must take time to align all elements perfectly before committing funds. To find out if you are getting value for your money, consider carrying out a comparative market analysis on the property. A detailed assessment of similar properties in the area can indicate the correct fair market value of the unit and a better analysis of the capitalization rate.
Capitalization rate or cap rate is another metric that can help you determine what property among many will ultimately yield a better return on investment. Ideally, a higher cap rate equates to a bigger risk but with higher profit potential and is often attractive to daring predatory investors. By analyzing the factor of expected net operating income against the property valuation, you can easily determine potential performance against the competition.
Use investment property data
Most business decisions today are heavily data-driven, and an investor must collect all relevant records on the property they plan to invest in to make a better judgment. The first source of information is naturally the seller, who will provide a carefully worded pro forma. Whereas this pro forma may contain pertinent details such as monthly rental income, the information therein is provided selectively for marketing purposes and must be taken cautiously.
Sit down with the seller for a thorough interview on factors such as utilities and other maintenance costs that have an ultimate effect on profitability. You are also likely to access this data from the local Multiple Listing Services (MLS) platform to verify what the seller claims in their pro forma. Collect this data progressively and cumulatively for a more comprehensive analysis of the rental property’s investment potential when you ultimately decide to buy.
Consider the net operating income (NOI)
With all the data previously collected, take a look at the metrics that emerge to figure out if the rental property will yield a profitable investment. A vital metric in this analysis is the net operating income (NOI) factor that determines the likely income the property will generate less the operating expenses.
The formula is simple and entails rental income plus other income, less operating expense at its basic level, and provides the benchmark for related but critical metrics in real estate investment analysis.
A key factor to note while calculating your net operating income is that mortgage payments are not included in this equation. Mortgage payments are treated as debt service and not standard operating expenses for purposes of accounting in real estate books. Other income in the same context includes additional sources such as parking revenue, errand service, or laundry facilities provided separately from the leased property.
Assess the cash-on-cash return
What is the potential for a faster return on upfront cash payment on initial investment costs? Initial investment costs include closing costs, first repairs, if any, and other expenses incurred to prepare the unit for listing and eventual move-in after purchase. To calculate your cash-on-cash return, divide the net operating income by the amount paid on the property.
The CoC rate is calculated pre-tax and measures cash flow in relation to the cash invested in the property. The rate provides the ROI margin the investor makes on a property relative to the mortgage payments in the same year. Cash-on-cash return is an excellent predictive metric for setting income and expense projections.