Rental Deal Analysis

Calculating Cash Flow and Cap Rates<br><br>

The reason to purchase rental properties is for cash flow and income. Cash flow is simply the difference between the income produced by the property in the form of monthly rents, and the expenses associated with the property, such as mortgage payment, property taxes, insurance, repairs, etc. Positive cash flow is always the goal; negative cash flow to be avoided. The capitalization rate (cap rate) is the percentage of the original purchase price paid represented by the net annual income (Net Operating Income or NOI) produced by the property (monthly cash flow multiplied by 12).<br><br>

For example a rental purchased for $100,000 that generates $500 in NOI each month would have a 6 percent cap rate ($500 multiplied by 12 is $6000, divided into the original $100,000 purchase price).<br><br>

To calculate cap rate and cash flow, we assumed a 20 percent down payment and a 4 percent interest rate to come up with an estimated monthly mortgage payment. Real estate investors typically assume an additional 40 percent of the gross monthly rental proceeds for expenses such as property taxes, insurance and repairs.<br><br>

There is an old rule of thumb that many veteran real estate investors use to calculate a reasonable purchase price for a rental, that is, that monthly gross rents should equal one percent of the sales price. This is simply referred to as “the 1 percent rule."<br><br>

While the 1 percent rule and the 40 percent rule mentioned above are useful to provide “general overall initial calculations,” the particular characteristics of each property purchased must be taken into account to determine the true return on investment.<br><br>

Some of these characteristics may include: what is the age, quality of construction, level of past maintenance, physical location within a given neighborhood, will the owner be paying any portion of the utilities such as water, electric, gas, trash or Home Owner’s Association dues, etc.
<br><br>But this quick lesson on cash flow and cap rate will help the investor get started in analyzing rental properties for possible acquisition.
<br><br>For a list of income-producing properties in the Seattle area, please contact Home Land Seattle at HomeLandInvestment@gmail.com or 888-621-4999.
<br><br>Happy Investing!