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
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 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 is the 10 rule in real estate investing? ›
It involves calculating the expected annual income from the property and ensuring it equals at least 10% of the property's purchase price. This rule considers various expenses, including property taxes, insurance, maintenance, and property management fees.
What is the rule of 8 used for? ›
The octet rule dictates that atoms are most stable when their valence shells are filled with eight electrons.
What is the 10 second rule in real estate? ›
As part of its REALTOR safety program, NAR trains its REALTORS to practice the “10-Second Rule.” It says one of the reasons REALTORS and agents end up in dangerous situations is because they are not paying attention. To counteract, they should take 10 seconds to observe and analyze their surroundings.
What is the 90 10 rule in real estate? ›
Roger shared his 10/90 rule, balancing risk by investing 10% in higher-risk projects and 90% in stable, cash-flowing properties. This strategy helps navigate economic cycles and maintain a steady income stream.
What is the rule of 7 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 formula for real estate investing? ›
Value per gross rent multiplier measures and compares a property's potential valuation. It is determined by taking the price of the property and dividing it by its gross income, or Gross Rent Multiplier = Property Price or Value / Gross Rental Income.
How do you calculate investment evaluation? ›
Return on Investment (ROI) is a popular profitability metric used to evaluate how well an investment has performed. ROI is expressed as a percentage and is calculated by dividing an investment's net profit (or loss) by its initial cost or outlay.
What are the best numbers to use when selling a house? ›
What numbers are best for pricing real estate? When it comes to the last digit of your home's listing price, choosing a 7, 8, or 9 can be a solid strategy for a variety of reasons — especially if you can match the numerals in your listing price to where you live.
The golden rule
“Buy a property with 20% down. [That] has always been my formula because they used to do with 10%, but it's not possible anymore. I repeated that formula again and again and again, and then making sure the tenant has paid my mortgage. It's pretty easy that way.”
What is the 80% rule in real estate? ›
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 28% rule in real estate? ›
According to the 28/36 rule, you should spend no more than 28% of your gross monthly income on housing and no more than 36% on all debts. Housing costs can include: Your monthly mortgage payment.
What is the 8 percent rule? ›
As Morningstar noted, Ramsey recommended that retirees invest all of their assets in equities and then withdraw 8% a year of the portfolio's starting value, with each year's expenditures adjusted for inflation. For example, if you have a $500,000 starting portfolio, you would withdraw $40,000 in Year 1.
What is the 7% rule in real estate? ›
It has often been said that 20% of the players do 80% of the business: the 80/20 rule as it is sometimes referred to. However, this contrast has reportedly become even starker in the real estate world. According to the data, just 7% of real estate agents do 93% of the business.
What is the 7 8 sell rule? ›
The "7-8% loss rule" is a risk management strategy commonly used in stock trading and investing. This rule suggests that an investor should sell a stock if its price falls 7-8% below the purchase price. The main idea behind this rule is to limit potential losses and protect capital.
