Landlord Math – Cap Rate and Return on Investment: Million Dollar Journey

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Landlord Math – Cap Rate and Return on Investment Posted: 24 Jun 2010 04:30 AM PDT This is an article from our regular real estate columnist Rachelle. Every landlord should know some basic math. There are calculations that are indispensable to the business. I have seen plenty of fast and loose interpretations of these formulas. Remember when you are buying a property the seller is going to try to get creative to minimize expenses while you the buyer must use proper formulas to determine the purchase price for the property. Capitalization Rate (Cap Rate) This is probably the most common metric used by investors. Sellers will drastically understate expenses. Ask for copies of original bills. If they refuse just move on and find a more honest seller. Gross Operating Income – Expenses = Net Operating Income (NOI) Net Operating Income/Purchase Price = Cap rate Lets talk about expenses. This includes bills such as natural gas, electricity, water and property taxes. This calculation also includes a percentage for maintenance, property management and vacancy allowance. Those expenses are what sellers leave out. This is your safety margin and believe me you will need it at some point. Sample Cap Rate A nice example of a Cap Rate calculation can be found here on CMHC's website. The only item they are being shy about is the percentage for property management. You should calculate your property management at around 7% in my opinion. All things considered, the calculation is well done. You can find vacancy rates for different areas here. Deferred Maintenance & Micro Analysis When deciding what to offer for a property you'll want to look at deferred maintenance both in the apartments and throughout the building. This is the list of stuff the previous owner should have done but did not. You'll also want to know more about the building. Was it a drug den? How do people like living there? Were there three murders in the building two months ago? What is turnover like? Have the tenants been there a long time? How is the street? What is the reputation of the building? For this you'll have to go back to the area without your real estate agent and knock on some doors. Cap Rate Reversed You'll want to calculate the Cap Rate equation in reverse. This way you can decide how much you want to pay for the building. NOI/Cap Rate = Purchase Price Lets assume you want to achieve a Cap Rate of 8%. You'll want to plug in all your numbers for expenses to figure out the real Net Operating Income then do the calculation to figure out how much your final purchase price should be. $40,000 (NOI) / .08 = $500,000 (Purchase Price) Cash on Cash Return This calculation is more complex. Once you have figured out your NOI you calculate this important metric. This measures what the Return on Investment (ROI) will be on the cash used. This is how to operate this calculation. NOI – Mortgage payment = Projected annual cash return Down Payment + Closing costs + Deferred Maintenance Expense = Cash Outlay Projected Annual Cash Return/Cash Outlay = ROI Cash Outlay/Projected Annual Cash Return = How long it will take before you get your money back Buying income property is NOT a POPULARITY CONTEST. The only reason to buy an income property is to make money. The only way you'll make money is to buy properly. With income property, it's all about the cash flow. If you a buy a property without all the safety margin numbers in place, you will end up putting more of your hard earned cash into the property. Month after month, year after year you can look forward to owning a cash-sucking cow of a property. You should put in offers on property using your analysis. Without offers no one will ever say yes. To do this you'll need a real estate agent. Lots of real estate agents will not want to put in the offers you want. If you're serious you might want to respect your real estate agents time by paying him or her something every time you put in an offer. You may have to put in 20 offers before one gets accepted. Why should the real estate agent spend his time and money working with an investor and putting in a bunch of complicated offers when they can go find a nice first time buyer, show them a couple houses and get a sale. Feel free to show your math to the seller. It's very likely you aren't informing them of anything. They want to get as much as possible for their property. Can you blame them? It's not at all like buying a residential house. These properties are not very liquid and the only thing that matters is the income. Return on Investment for Improvements Once you have your property if you're smart you'll want to figure out how to increase the income. Every time you increase the income by $50 you'll increase the value of your building and improve tenant quality. How much is a $50 per month increase in rent worth to the investor? $50 x 12 months = $600 $600/.08 (Cap Rate)= $7,500 increased value of building You'll want to figure out the payback on the improvement. How long will it take to get that money back? Increased building value is great but you don't get that money unless you refinance or sell the building. If the improvement is painting the kitchen, putting new handles on it and installing a counter top. This will cost you $800 (assumed). $800/$50 = 16 month payback $50/$800= 6% ROI $7,500 increased value of the building. Lets try to put the $800 towards a brand new kitchen. The kitchen is 15 years old and beat up. Let's try and get an extra $100 per month rent. We'll spend $2000 on our kitchen. (assumed) $2000/$100 = 20 month payback $100/2000 = 5% ROI $15,000 increased value of the building. The new kitchen is a better investment. At the end of the payback period you have replaced something old with something new that you get to keep. Your building value has increased by $15,000. I urge every landlord/investor to use these calculations. Owning an income property is not the golden path to riches proclaimed in endless programs, courses and seminars. Like any other business you must make wise investments with solid measurable results. It is easy to spend money you don't need to on things that don't need to be done or that don't return any money. Don't pay foolish prices for income properties. Money must be respected. The numbers are your friends. Happy Investing ! About the Author: Rachelle specializes in renting property on behalf of landlords and is the blogger behind Landlord Rescue. She also works with investors to find good investments in Toronto and surrounding areas. Her passion is bringing multi res properties back from the brink and maximizing profitability. Check out some of her other real estate posts on MDJ. 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Frugal Hacks - Posted: 24 Jun 2010 11:59 PM PDT

Frugal Hacks

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Joyful Frugality Posted: 24 Jun 2010 11:59 PM PDT I scanned through my daughter's pictures for a few minutes last night looking for photographs of frugal good times, and then I started brain-storming a bit to flesh out the list. Some of these things are 'dates' and some of the are family activities, and many of them work just as well in either category. In no particular order, here's a romp through some joyful, and very frugal, memories: . Have a race.  Jump rope.  Play hop scotch.  Find a hill and slide down it on cardboard boxes (wax them by rubbing with the side of a candle for even more speed).  Skip.  Play Mother May I, Red Light, Green Light, or ring around the rosy.  Find a swing set and swing.  Even if you are thirty.  Especially if you are forty. Go to the beach, a lake, a river, a stream, a creek, a brook or any body of water- hang out. Toss rocks in the water. Wade. Sit on a blanket or lawn chair and just talk to one another, enjoying one another's company Have a picnic. We've had picnics at parks, at the beach, by the river, on the verge of a parking lot outside a museum, out of the back of the van, and on blankets on my living room floor. A couple times I even set out plastic ants.  Invite friends.   Bring cards, a ball, a book or all three. You can have a picnic in the rain. This is from somebody's 18th birthday party, and she says it's the best party she had, ever, and all the friends who came agreed. Go for a walk, even if it's muddy outside.  Drive somewhere new, park the car and get out and take a walk.  Go as a family or go with your spouse (above is our youngest child, our third youngest child, and their brother-in-law, only this was taken about three years before we knew that's who he was going to be). Dress up and be silly and extravagant and more than a little ridiculous.  Speak in period or in costume.  Take pictures.  Dress up like this and go out for coffee and a piece of pie.  Split the pie.  Put on a play.  Let your kids put on a play for you.  Go to the thrift shop or a yard sale together and look for the most outlandish piece of clothing you can find for a dollar or less. Yes, my family is macabre.  Go to the cemetary and find the oldest headstone, or the most interesting.  Take a picnic (yes, we do this).  Take a book.   Take paper and crayons and start a collection of tomb rubbings. Find a bridge and play Pooh-sticks.  Walk slowly across it, hand in hand.  Skip across it.  Stop in the middle and sing a song to hear how your voice carries over water.  Sing Bridge Over Troubled Water, very badly.  Drop rocks in the water.  Look for turtles.  Slap mosquitoes and compare bite marks.  Scratch each other's backs. Bake up a storm, take cookies to a neighbor or a new mom from church.  Have friends over for pie and coffee. Eat up your treats while watching a movie together.  Play a board game or a game of cards.  Play Charades. Sing.  Karaoke.  Bring up midi files or youtube videos of songs and sing along with them. Make a family CD- everybody pitches in a dollar to pay to download a favorite song at Amazon and put them all on a single CD reflecting your family's unique tastes and vision. Or you and your spouse put together your own special CD of romantic music and have a candlight ice-cream sundae in your room with the door locked.  REad the Song of Solomon together. Sit under a tall tree in the fall and read aloud from Janice May Udrey's very charming picture book. Pick a book to read aloud to each other, or as a family. Three Men In A Boat (To Say Nothing Of The Dog...) is pretty funny. Look for free events in your town- concerts, lectures, museums, free days at the zoo or aquarium.  Does your little town have a local historical society?  A book club? Volunteer somewhere together. Weed the garden together. Do the dishes together- you'll be surprised how much meaningful conversation can come from doing some mundane task together. Take a free class together- card making night at the library, or a sign language class at church, or get certified by the Red Cross together. The first couple of years my husband and I were married, we had to do our laundry at a laundromat. We would take along backgammon or mastermind and play one of those two games together while doing our laundry. Bring along a thermos of iced coffee or lemon-ade as well. Visit a nursing home together. Write down a list of people you know, put their names in a jar, take turns drawing names out of the jar and saying something nice about them- then write a note of appreciation to some of the people on your list. These are just a few ideas. There are dozens of ways to have fun, meaningful, bonding, delicious, wonderful, joyful times together that do not need to cost much, or even anything. There are deliciously wonderful things which you can do to serve others, to grow together, to increase your level of enjoyment and understanding of one another- things that will bring wonderful memories and sweet fellowship without the bitter aftertaste of adding to your credit card, or finding that you really could use the money you spent on pizza for a pair of shoes or a visit to the doctor. There is no lack of joy in frugal living. There is an abundance of all the things that matter most. Related posts: Cheerful Frugality Plays Outdoors Earlier this spring I decided to let my garden dreams... A Frugal Past Time The picture of husband, book in hand, surrounded by precious... Cheerful Frugality In The Lean Times This week I listened to a conversation between 2 friends. "Beans...

A Frugal Hero Posted: 24 Jun 2010 07:10 AM PDT Sitting with Dear Friend, enjoying the view of Pennsylvania hills massed with lush and  large green leafed trees, our conversation was filled with memories. Family and I were on a trip to the East Coast, and had some precious moments to visit with this woman.  Alzheimer's, seeking to steal this incredible, fascinating mind, had left remnants strong and clear.  She remembered us and was thrilled at our visit! A child of the Depression, Dear Friend was truly a frugal hero.  Even now in later years, the choice of modest living was still her mantra.  Her abode was simple and well cared for.  With nature to observe and pictures of loved ones close, Dear Friend was content. A childless couple, Dear Friend and her husband had traveled many a country and 49 states.  She regaled our minds, just as many times before, with tales of the past and her trips abroad. Now a widow for 30 years, frugality was not a choice of necessity for this Dear Friend.  Few knew, she could be living like a queen if she so desired. Chuckling to myself, I recalled those many years ago, when Dear Friend was child-watching for me.  Returning home, I discovered she had found a half eaten box of cereal in my trash and had resurrected such, to my chagrin.  Sheepishly confessing that I had lost sight of said box and that now the contents were no longer edible, I again placed the box in the trash.  I learned to be more careful with my cereal!  Yes, we had some funny stories about Dear Friend.  We also learned to check dates on any food gifts she might give us and, yes, she might have been called a bit eccentric.  But the lessons learned from this frugal hero were many. Generous beyond compare, she chose to live a simple life and gave away to her favorite charities and organizations more than she ever spent each year upon herself.  Always seeking to be a good steward of all the Lord had blessed her with, Dear Friend's example blazed upon my life.  People were her joy, and possessions only important for how they could be used in service to others. Hugging this grandmother of the heart to my children, I said goodbye.  We may never meet again on this earth, but I will carry her legacy with me forever. She is and always shall be, my frugal hero. Do you have a frugal hero? Related posts: To Registry Or Not To Registry? Sitting at my computer and scrolling through the list of... A Frugal Past Time The picture of husband, book in hand, surrounded by precious... A Call To Being Not Frugal I wondered if this was the place to write about...

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Frugal Hacks

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Do you know what an Opaque Hotel is? Posted: 23 Jun 2010 02:15 PM PDT According to Travelocity, between 20 and 30 percent of online hotel bookings are for "opaque" hotels, the industry term used to describe a hotel whose name is not revealed until AFTER the hotel room has been purchased. We rarely use hotels ourselves since we usually stay with family or friends when we go out of town.  However, for the rare occasion that we do use a hotel the tips below seem very useful. Dos and Don'ts of booking an opaque hotel: DO: Choose an opaque hotel if price is more important to you than hotel name or exact location. You'll get access to unpublished hotel rates at a huge savings – as much as 45% off. So here's an example – the opaque rate at a 4-star Chicago hotel is just $95 per night – 55% off the regular rate. DON'T: Choose an opaque hotel if you're a brand loyalist or need a specific location. While you'll get general location (i.e., Midtown Manhattan vs. 5th and 53rd), the trade off is that the consumer doesn't know the name of the hotel until the booking is complete. DO: Make sure the hotel has all the amenities you require for your trip. Make sure to book through a site that shows amenities such as pool, courtesy breakfast, non-smoking, high-speed Internet and shuttle service before making a decision. DON'T: Book on a site that doesn't allow you to see customer reviews of the properties. Traveler reviews and ratings on things like cleanliness, location, staff and service, room quality and more are vital to making an informed decision. DO: Consider the kind of trip you're taking. If it's a business trip, an activity-filled vacation, a last-minute getaway or a whirlwind city tour, an opaque hotel is probably a good choice for you. DON'T: If you're a hotel junkie, a stickler for thread count, or in general will consider the hotel the make-or-break of your entire trip, this might not work for you. What about you?  Have you ever reserved a room with an opaque hotel?  Were you happy?  Do you have anything to add to the tips above? Related posts: Non-chain Travel: Looking For Local Last week we took a rare fishing break. We researched the town via Google,... No Bills To Be Paid Crossing the Texas border, images of the wedding week flooded... How to request a product for review I mentioned requesting items for review in my list of...

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MoneySense.ca Small Business Newsletter - June 18, 2010

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