Rock bottom real estate prices can be enticing to some novice real estate investors looking to break into the market. But, before you join the ranks of the landlords, be sure you have a strong grasp of the financial information that can make the difference between a successful endeavor or else finding yourself in bankruptcy court.
Here are eight real estate investing numbers you need to know how to calculate and use when evaluating a potential investment property.
Key Takeaways
- Investing in real estate can generate capital gains as well as rental income.
- Each property is going to be evaluated based on its unique properties, such as layout, location, and amenities.
- However, several other key pieces of data can be calculated for any property and allow potential investors to make projections and apples-to-apples comparisons.
- Here, we go over eight critical metrics that every real estate investor should be able to use to evaluate a property.
1. Your Mortgage Payment
For a standard owner-occupied home, lenders typically prefer a total debt-to-income ratio of 36%, but some will go up to 45% depending on other qualifying factors, such as your credit score and cash reserves. This ratio compares your total gross monthly income with your monthly debt payment obligations. For the housing payment, lenders prefer a gross income-to-total housing payment of 28% to 33%, depending on other factors. For an investment property, Freddie Mac guidelines say that the maximum debt-to-income ratio is 45%.
2. Down Payment Requirements
While owner-occupied properties can be financed with a mortgage and as little as 3.5% down for an FHA loan, investor mortgages typically require a down payment of 20% to 25% or sometimes as much as 40%. None of the down payment or closing costs for an investment property may be from gift funds. Individual lenders will determine how much you need to put down to qualify for a loan depending on your debt-to-income ratios, credit score, the property price, and likely rent.
3. Rental Income to Qualify
While you may assume that, since your tenant's rent payments will (hopefully) cover your mortgage, you should not need extra income to qualify for the home loan. However, in order for the rent to be considered income, you must have a two-year history of managing investment properties, purchase rent loss insurance coverage for at least six months of gross monthly rent, and any negative rental income from any rental properties must be considered as debt in the debt-to-income ratio.
4. Price to Income Ratio
This ratio compares the median household price in an area to the median household income. In 2011, after the housing bubble, it was 3.3, in 1988, it was 3.2, and in October 2020, it was about 4.0. Before the housing bubble crashed it was at a peak of 4.66.
5. Price to Rent Ratio
The price-to-rent ratio is a calculation that compares median home prices and median rents in a particular market. Simply divide the median house price by the median annual rent to generate a ratio. As a general rule of thumb, consumers should consider buying when the ratio is under 15 and rent when it is above 20. Markets with a high price/rent ratio usually do not offer as good an investment opportunity.
6. Gross Rental Yield
The gross rental yield for an individual property can be found by dividing the annual rent collected by the total property cost, then multiplying that number by 100 to get the percentage. The total property cost includes the purchase price, all closing costs, and renovation costs.
7. Capitalization Rate
A more valuable number than the gross rental yield is the capitalization rate, also known as the cap rate or net rental yield because this figure includes operating expenses for the property. This can be calculated by starting with the annual rent and subtracting annual expenses, then dividing that number by the total property cost and multiplying the resulting number by 100 for the percentage. Total rental property expenses include repair costs, taxes, landlord insurance, vacancy costs, and agent fees.
8. Cash Flow
If you can cover the mortgage principal, interest, taxes, and insurance with the monthly rent, you are in good shape as a landlord. Just make sure you have cash reserves in hand to cover that payment in case you have a vacancy or need to cover unexpected maintenance costs. Negative cash flow, which occurs most often when an investor has borrowed too much to buy the property, can result in a default on the loan unless you are able to sell the property for a profit.
The Bottom Line
Once you have made all of these calculations, you can make an informed decision about whether a particular property will be a valuable investment or a lemon.
FAQs
Here, we go over eight critical metrics that every real estate investor should be able to use to evaluate a property.
- Your Mortgage Payment. ...
- Down Payment Requirements. ...
- Rental Income to Qualify. ...
- Price to Income Ratio. ...
- Price to Rent Ratio. ...
- Gross Rental Yield. ...
- Capitalization Rate. ...
- Cash Flow.
The 8% rule is a simple guideline that helps you calculate the total cost of home ownership on a monthly basis. Here's how it works: Property Taxes: In the United States, the average property tax rate is 1.11% across all residential real estate. So, for a $500,000 home, you'd pay $5,500 in property taxes every year.
What is the 7 rule in real estate? ›
In fact, in marketing, there is a rule that people need to hear your message 7 times before they start to see you as a service provider. Therefore, if you have only had a few conversations with the person that listed with someone else, then chances are, they don't even know you are in real estate.
What is the 4 3 2 1 rule in real estate? ›
Analyzing the 4-3-2-1 Rule in Real Estate
This rule outlines the ideal financial outcomes for a rental property. It suggests that for every rental property, investors should aim for a minimum of 4 properties to achieve financial stability, 3 of those properties should be debt-free, generating consistent income.
What numerology number is for real estate? ›
What is a Good House Number As Per Numerology? Numerous figures are regarded as ideal for houses. For residential properties like houses, numerals like 3, 6, 8, 9, 11 and house number 38 are all regarded as lucky or good house numbers in numerology.
What is the 80 20 rule in real estate investing? ›
In the realm of real estate investment, the 80/20 rule, or Pareto Principle, is a potent tool for maximizing returns. It posits that a small fraction of actions—typically around 20%—drives a disproportionately large portion of results, often around 80%.
What is the 8% rule in investing? ›
Recently, a radio talk show host named Dave Ramsey recommended that retirees invest 100% of their assets in equities, from which they would withdraw 8% per year of the portfolio's starting value, with each year's expenditures adjusted for inflation.
What is the 8% rule? ›
The 8% Rule states that you should dedicate 8% of the time in any work meeting to making personal connections. For example, you could talk about your pets, do a quick round of icebreaker questions or play team trivia.
What is the golden rule in real estate? ›
Corcoran's Golden Rule of real estate investing consists of two main parts. The first is being able to purchase property with at least 20% down, ideally in a location that has started seeing an increase in demand. The second is to have tenants living on that property paying the mortgage.
What is the 1 rule in real estate? ›
The 1% rule of real estate investing measures the price of an investment property against the gross income it can generate. For a potential investment to pass the 1% rule, its monthly rent must equal at least 1% of the purchase price.
The 50% rule is a guideline used by real estate investors to estimate the profitability of a given rental unit. As the name suggests, the rule involves subtracting 50 percent of a property's monthly rental income when calculating its potential profits.
What is the 2 rule in real estate? ›
Applied to real estate, the 2% rule advises that for an investment property to have a positive cash flow, the monthly rent should be equal to or greater than two percent of the purchase price.
What is the 80% rule in real estate? ›
What is the 80/20 Rule exactly? It's the idea that 80% of outcomes are driven from 20% of the input or effort in any given situation. What does this mean for a real estate professional? Making more money in real estate is directly tied to focusing your personal energy on the most high value areas of your business.
What is the 90 10 rule in real estate? ›
This concept shows that if you have 10 tasks that are 90% complete, you've essentially accomplished nothing. For some real estate professionals, this can be the crux of their business. It also may mean the difference between success and failure for them.
What is the rule of 72 in real estate? ›
Just take the number 72 and divide it by the interest rate you hope to earn. That number gives you the approximate number of years it will take for your investment to double.
What is the 5 rule in real estate investing? ›
The first part of the 5% rule is Property Taxes, which are generally around 1% of the home's value. The second part of the 5% rule is Maintenance Costs, which are also around 1% of the home's value. Finally, the last part of the 5% rule is the Cost of Capital, which is assumed to be around 3% of the home's value.
What is the 4% rule in real estate investing? ›
It's relatively simple: You add up all of your investments, and withdraw 4% of that total during your first year of retirement. In subsequent years, you adjust the dollar amount you withdraw to account for inflation.
What is the 10% rule in real estate investing? ›
This rule is basically to avoid paying the sticker price. Instead, look to buy at least 10% under the listed price. In real estate, there's a saying that most of the return is made at the time of purchase. Meaning that most of the money is made on the purchase rather than rental income.
