2 of the Most Important Formulae for Assessing a Property Investment

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All too often I hear would-be investors use the same rhetoric as realtors to assess an investment property:

• “Location, location, location”,
• “Close to schools”,
• “Safe neighborhood”,
• “Marble finishes.”

These are good mantras for a home buyer who is a corporate professional like yourself, but probably not so much for an investment property.

Being an engineer by training, I guess I will always be a numbers guy at heart. There are renters in both extremes of the market and many more between. Some rental bands are more popular than others. Why would you want to pit yourself against statistics?

In my country, most renters occupy the $275 to $550 band (this will obviously vary from country to country). This obviously means that the higher you go above this band, the fewer your potential clients become. I wouldn’t want to put myself in harm’s way if the entire point of getting an investment property was to keep it tenanted. My first piece of advice would be to play within the popular rental band.

Property is a numbers game. Nothing more, nothing less.

Cap Rate

With this out of the way, one has to find a metric against which to separate good investments from bad ones. My favorite metric to use is:

Cap Rate =    (NOI) Net Operating Income / Capital Outlay

where “NOI = Income – Expenses”.

If you have read my other blog posts like 3 Things You Need BEFORE Investing in Property you will know that I always expect to pay a deposit when acquiring property as well as other costs, which become my Capital Outlay.

I will not get into the minimum Cap Rate because investors are different. The most important part is that your Cap Rate needs to be positive from the beginning of your investment; the higher the better.

Having a formula like this to use, you are able to compare investments that have vastly varying numbers behind them and easily determine which investment would be most profitable. That is the most important part

Cash Payback Period 

Another formula I like to use is the Cash Payback Period. This allows you to predict how long your initial investment will be tied up before it can be freed to make other investments at the end of the period.

Cash Payback Period =   Capital Outlay / NOI

This will give you the Cash Payback Period in months (if your NOI is in months).

In Conclusion

Use these formulae as a means by which to create minimum qualifying criteria for yourself.

The higher the Cap Rate or lower the Payback Period you look for, the more aggressive your growth will be, but the fewer deals you will come across.

There are several ways to own the process and thus become more in control on the parameters, but we will look into these in future posts

To continue learning, read: 3 Things You Need BEFORE Investing in Property