The bottoming out of real estate prices may attract some novice real estate investors who want to enter the market. However, before joining the ranks of landlords, please make sure that you have a sufficient understanding of the financial information needed to be a savvy investor.
There are eight real estate investment numbers; you need to understand how to calculate and use them when evaluating potential investment properties.
1. Your Mortgage Payment
Lenders usually want a total debt/income ratio of 36% for standard homeownership, but some will rise to 45%, depending on other eligible factors, such as your credit score and cash reserves. This ratio compares your total monthly income with your monthly debt payment obligations. For housing payments, the lender wants total income to account for 28% to 33% of total housing payments, depending on other factors. For investment properties, the Freddie Mac standard states that the maximum debt-to-income ratio is 45%.
2. Down Payment Requirements
Although self-owned homes can be financed through mortgages, and FHA loans have a down payment as low as 4.5%, investors usually require a down payment of 30% to 35%, and sometimes as high as 40%. Neither the down payment nor the closing cost of the investment property shall come from the grant funds. A single lender will determine how much you need to put down to qualify for a loan based on your debt-to-income ratio, credit score, real estate price, and possible rent.
3. Rental Income to Qualify
While you can assume that since your tenant's rent will (hopefully) cover your mortgage, you shouldn't need any additional income to qualify for a home loan. However, for rent to be considered income, you must have a two-year history of investment property management, have taken out rental loss insurance for at least six months of gross monthly rent, and any negative rental income on any rental property must be treated as debt to income ratio.
4. Price to Income Ratio
This indicator compares the median household price with the median household income in a given area. After experiencing the real estate bubble, it was 3.3 in 2011 and 3.2 in 1988-October 2020. 4.0. Before the housing bubble burst, it peaked at 4.66.
5. Price to Rent Ratio
The price-rent ratio is a calculation that compares the median of housing prices to the median of rents in a given market. Just divide the median home price by the median annual rent to get the ratio. As a general rule, consumers should consider buying when the index is below 15, and the rent is above 20. Markets with a high price-to-rent ratio usually do not offer such a good investment opportunity.
6. Gross Rental Yield
By dividing the collected annual rent by the total cost of the real estate, then multiplying by 100 to get the percentage, the total rental income of a single real estate can be derived. The total cost of the property includes the purchase price, all transaction costs and renovation costs.
7. Capitalization Rate
A more valuable number than the total rental yield is the capitalization rate, also known as the cap rate or net rental yield, because this number includes the operating expenses of the property. This can be calculated by starting from the annual rent, subtracting the annual expenses, dividing that number by the total real estate cost, and then multiplying the resulting number by 100 to get a percentage. The total cost of renting a property includes maintenance costs, taxes, landlord insurance, vacancy costs, and agency fees.
8. Cash Flow
If you can use the monthly rent to pay the mortgage principal, interest, taxes, and insurance, then you are in good condition as a landlord. Just make sure you have cash reserves on hand to cover the payment, just in case you have a vacancy or need to pay unexpected maintenance costs. Negative cash flow usually occurs when investors borrow too much money to purchase real estate, and unless you can sell the real estate for a profit, this may lead to loan default.
Conclusion
After completing all these calculations, you can make an informed decision about whether a particular asset is a valuable investment or a lemon.
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