The advice of American businessman Peter Lynch holds true when it comes to managing your real estate investments: “Know what you possess, and know why you own it.”
That attitude has become a reality thanks in large part to the internet and big data. No effort has been spared in examining how these two technologies have altered real estate and real estate investing, despite the fact that it has taken almost two decades. The information you need, which once required many hours and resources to gather and analyze, is now just a keystroke away. You no longer need to purchase pricey books to study investing advice or to master real estate investment phrases.
Understanding the key areas of research that seasoned investors utilize every day will help you make a more solid financial decision, whether you’re purchasing your first investment property or your 50th.
General Real Estate Investment Advice
A real estate investment is, in reality, only as good as the calculations you’ve done. The good news is that you can outsource a lot of the labor-intensive tasks to websites. Also, keep in mind that real estate investing has many subtleties. For instance, given that prices have climbed more quickly in California than in most other states, investors intending to invest in single-family homes in that state should be more concerned with price appreciation potential than yield. On the other side, markets in the Midwest often have high yields but little opportunity for gain.
Investors should consider whether they are looking for a market that balances income and appreciation or an annuity, which is an investment that pays out consistently over time. You can choose which measure of return on investment is most important to you and, in turn, which market is best for you by responding to basic questions like these. Nevertheless, you must first understand these five key concepts related to real estate investing before you can even begin to consider what you want from your investment.
- Money Flow
- Rate of Capitalization (or Cap)
- Return on Cash Invested
- Net Yield
- Decreasing in Value and Appreciating
1. Money Flow
In the simplest terms, this refers to the cash entering and leaving a firm, and your investment is your business. Cash flow helps you assess if you’ll be able to cover the costs of owning the property because it demonstrates how liquid, or flush, your investment is over a specific time period.
Gross income minus operating costs equals cash flow.
2. Rate of Capitalization (or Cap)
The cap rate is a ratio that illustrates the link between the cost of real estate and the income it generates after expenses in the form of a percentage. It’s how you figure out what percentage return you might get on your investment.
Year Net Operating Income/Cost = Capitalization Rate
3. Return on Cash Invested
As with the cap rate calculation, you divide the annual before-tax cash flow by the entire amount of capital invested. It’s crucial to keep in mind that the cash-on-cash return accounts for any financing that may have been used to leverage the property as collateral. When assessing an investment property, cap rate and cash-on-cash are both crucial variables to consider.
4. Net Yield
By dividing the whole annual predicted gross income by the total current property price, yield—a fancy way of describing how much money your property will make—is computed. Although taxes or valuation changes are not taken into account in this calculation, it nevertheless provides you with a reliable benchmark for how your property will perform.
Gross yield is calculated as net income less investment costs.
5. Decreasing in Value and Appreciating
In fact, determining how a property’s value has changed over time is essential to the investing process. Yet there’s a good reason this is last on the list. Never examine valuation in a vacuum without considering the other data factors. Making an investment decision based on expected growth is more risky than making one based on current income because it is speculative in nature.
Nobody knows the exact recipe for investing in real estate profitably, but you can give yourself a competitive edge by brushing up on your financial literacy, researching the local market dynamics, and comprehending property-specific costs like taxes and insurance.
Why not take advantage of the extraordinary technology, data, and tools available to investors today to help you make better, more educated purchasing decisions?
