Meaningful Metrics to Consider When Purchasing an Investment Property
It’s easy to be overwhelmed by the numbers, stats and details you need to concern yourself with when investing in property. But by paying attention to the right metrics, you’ll save yourself a world of trouble and reduce your frustration during this process.
Focusing on the right data ensures you purchase an income stream that will offer a return on your investment rather than just owning a piece of property. By being aware of the right numbers to crunch you’ll remove speculation and emotion from the equation, therefore leading you towards making better-informed decisions. It’s easy to have your heart stolen by the pure beauty of a home’s appearance rather than the less than attractive numbers behind it which should be at the core of your attention during your evaluation.
Here are the main metrics that I feel are important to be concerned with:
Cash on Cash Analysis
? Use this to evaluate the cash flow from income-producing assets
? Can be considered a quick test to determine if the investment property is worth further analysis
? Can be used to determine if a property is underpriced, indicating instant equity
? The more cash flow, the better (should be > 10% at least)
? A negative cash flow indicates that rather than your investment supporting you, you’ll need to plan to support your investment
Cap Rate Analysis
? This is the ratio between the net operating income produced by an asset and its capital cost (original price paid to buy the asset)
? It can also be considered the current market value
? A lower cap rate for a property indicates less risk associated with the investment due to increased demand for the product
? Be sure to look into historical data for your market when you estimate the cap rate to see what a buyer may expect five years down the line
Cost per Square Foot
? This is a common and easy to understand reality-check that can quickly help determine the value of your potential property investment
? This is the best metric to look at when it comes to physical attributes
? Note that just because a property’s price per square foot falls within your researched market norms, doesn’t mean that it’s a good buy. It just means that it isn’t impossibly overpriced.
Profit Investment Ratio
? This is the ratio of payoff to investment of a proposed project.
? A profitability index of 1 indicates you will breakeven.
? A value < 1 demonstrates that the properties present value (PV) is less than the initial investment, making it a no-go.
Five Year Rate-of-Return
? You may buy a property that appears to have a good monthly rental rate, but may have high turnover, repair costs and other hidden considerations.
? Remember to factor in turn costs, maintenance costs, eviction costs and other incidentals when comparing one or more properties.
? Be sure to always consider long-term returns in your planning.
Rental Market Analysis
? You need to do this analysis to evaluate certain factors to determine the rental rate to charge tenants. Knowing how much money the property can earn in your local market helps you avoid any unfortunate surprises after you close the deal.
? Your evaluation needs to be based on location, comparable units, price per square foot, vacancy rate, and purchase price in order to determine the ideal rental rate.
As with all investments, there is a risk vs. reward consideration at play. The best philosophy to have on this is - the higher the risk the higher potential return; the lower the risk, the lower the potential return. To help reduce these risks, bring in an experienced property management company to help minimize any concerns you have with administration, maintenance and general upkeep. This will free you up further to spend time on the things that truly matter in life.