You need to be able to judge if an income property is a good investment if you want to get into rental property investing. This article goes into the most important things to consider.
The One Percent Rule
This is a key rule investors use to assess a rental property. Most people find an investment is worthwhile if the gross monthly rent (what you get prior to deducting costs) equals at least one percent of the buying price. If this is not the case, they won’t invest in the property.
Using this rule of thumb, a $100,000 apartment should bring you at least $1,000 per month. If it doesn’t, then it’s not worth investing in. According to the rule, the apartment will earn you gross income of 12 percent of the purchase price annually. After expenses, the apartment might earn net income of 6-8 percent of the price. Of course, the neighborhood is important too.
The Cap Rate
The cap rate is another essential aspect. This is the ROI you’d make on a property if you bought it in cash. The cap rate is the net earnings divided by the cost of the asset. For example, if you purchase a property for $200,000, you find someone who’ll pay $1,500 per month to live in it, and your expenses (repairs, taxes, maintenance, insurance, management) amount to $500 per month, your net operating income will come to $12,000 a year. Thus, the cap rate is 6% ($12,000 / $200,000 = 0.06).
Is this a good ROI? It depends on who you ask. 6% could be a good ROI if you can find reliable tenants in a nicer neighborhood. It might not be if your property is in a shakier neighborhood with many risks, such as tenants going AWOL.
Let’s take another example. An investment property in a neighborhood costs $150,000. The monthly rental income after accounting for monthly expenses (your net income) is $3,000. The ROI on this property is 2%. This is a good return for any neighborhood.
A property yielding high returns will require major cash investment because it is in high demand from tenants and real estate investors alike. The rental income from a property like this is very likely to generate reliable and steady cash flow.
You have to keep investing!
Remember that returns diminish in the case of non-compounding interest. You’ll have to reinvest all of your proceeds to ensure compounding over the long term.