Investment Property Evaluation
Real Estate Finance
It is all in the numbers. Real Estate can behave like a bond once it is rented long term. Look at it this way. You invest in a property, which is like buying a bond, and the monthly rental check is similar to a bond coupon. Now the ratio of the price you paid for the property and the rent you receive annually is equal to your yield. If the property cost you $200,000 and you receive a total of $12,000 in rent you would be yielding a 6.00% return.
If you could borrow the entire purchase amount at an interest rate lower than your yield you would have money in your pocket at the end of the year. The property would yield a positive cash flow. Likewise if the mortgage rate was higher than the rental yield you would have to chuck in some of your own money to pay the mortgage.
It is important to understand that in this example we assumed an interest only mortgage. In real life the mortgage lender would most likely require a repayment of the principal over 15 or 30 years. As repayment is like savings it changes your cash flow but does not alter the yield.
There are two fundamental goals in real estate investing. Firstly the property you are buying should have an acceptable rental yield and secondly it should appreciate over time. The first objective depends on the rent you can ask and the ability to keep the investment property rented. The second objective depends on external market conditions and the area and type of property you invest in.
Expected Rental Yield
In times of falling interest rates the rental yield tends to increase making it more attractive to purchase investment property. But often falling interest rates coincide with uncertain economic conditions. So it is important to ensure a property will rent long term otherwise your investment yield is in danger. In markets with rapidly increasing real estate prices the rental rates often lag behind. This is equivalent to lower yields, which makes investing less attractive and should slow down the property price appreciation until rental rates have increased or property prices have devalued.
Picking the right area
Think of real estate as a commodity. Would you rather own something that is rare and precious or something that is available in abundance? Look for the diamonds for your real estate investing. Find areas that are confined and do not offer much more development potential. For example, rental property east of I-65 is much less abundant than rental property west of I-65. It may be more expensive with a larger barrier to entry versus a home in the west end selling for $10,000 but remember these are driven by supply and demand.
Picking the right agent
Choosing to work with a Realtor employed by a management company that oversees the management of over 450 rental units in Louisville metro and Southern Indiana has major advantages. Combine that with a Realtor that is exposed to distressed properties in all stages of foreclosure and you have a recipe for successful real estate investing.