February 6, 2020

How to Determine if a Property is a Good Investment

Ascertaining the exact value of a rental property can be challenging. Working with your property management company can make the process easier. For investors, weighing the ROI requires combining a few calculations, doing some research, and reviewing your PM’s sources and listening to their recommendations. 

 Three Rental Property Evaluation Fundamentals

1. Focus on the Bottom-Line Cash Flow

Owning and maintaining a rental property is like owning a business. Therefore, you have to determine if the business of owning a rental will yield a positive cash flow. You may pull in $2200 a month in rent. However, you may find that you are spending $1200 a month in repairs, ongoing maintenance, and other expenses. So, the question is whether a $1,000/month profit is acceptable.

2. Potential Property Appreciation

What is the projected value of the property in a year, five years, or ten years? Since you're looking at a long-term investment, you can afford a slower appreciation. But first, you need to establish that the home’s value will coincide with the rental market enough to help you maintain a healthy profit. You also need to make sure that the property value can ride the storm if the real estate market suddenly drops and values plummet.

3. Focus on the Local Market

By local, we mean the neighborhood. Detroit has a total area of 142 square miles. That’s a large area. What that means is that the rental market can drastically change from neighborhood to neighborhood. Your property manager can provide ongoing updates of rental home values in target neighborhoods. That gives you an opportunity to take advantage of prime markets when they become available. 

A man and a woman signing paperwork

How to Assign Actual Value a Rental Property

Below are some ways that you can assign a value to a property. These methods can work independently or in conjunction with one another. They will help you decide if the rental property is a sound investment. 

1. Annual Gross Rental Yield

Find some comps in the same area as the rental you are considering. Calculate the annual rent of each. Take the annual rent and divide by the market price of the property. That will give you your gross rental yield. For instance:

House 1: Annual rent: $26,400/market value: $300,000 = 8.8% gross rental yield.

This gives you a quick snapshot of the investment potential if you paid cash and had no significant ongoing expenditures.

2. The Risk-Free Rate

The risk-free rate is the 10-year bond yield. The rate is risk-free because the US government will default on debt obligations. If the annual gross rental yield of the property is less than the risk-free rate, then you may want to look at another property. 

3. Net Rental Yield

The net rental yield is your net operating income divided by the market value of the property that you are looking at. Take the annual gross rent and subtract the following:

  • Mortgage interest
  • Insurance
  • Property tax
  • Homeowners’ Association Dues,
  • Maintenance Costs
  • Additional costs

This will give you a figure for your baseline profit. Then divide again by the market value of the property. That will provide you with the net rental yield. As long as you still have a positive cash flow, then you need to determine if it will be enough.

4. Risk-Free Yield vs. Net Rental Yield

In most scenarios, you want the net rental yield to be equal to or higher than the risk-free rate. You need to factor in the likelihood that rents will go up and properties will appreciate. This also depends on if you are taking out a mortgage to rent the property or paying cash. 

5. Property Price and Rental Forecasts

The fastest way to forecast the property price and rental is to consult an expert that crunches these numbers every day. JMZ property managers have access to reliable sources that can help you project how a market or a property should perform over a period. They can also help you determine all the factors that will establish a rental rate such as comp rental rates, amenities, the local economy, and neighborhood variables.

A model house with money around it covered by two hands

Detroit Metro Property Management Company

Are you an out-of-state investor with properties in the Detroit Metro area? Do you need a local property management company you can trust to handle your entire portfolio? Then contact JMZ Management.

We offer a wide range of services for investors and landlords. We can help you maintain your property and ensure that you find the right tenants to fill your vacancies. To find out more about our products and services, contact us at 248-284-6990. You can also message us at info@jmzmanagement.com.

GET MY RENTAL ANALYSIS

Let’s look at a brief overview of some ways that you can determine if the rental property you have in mind will convert to a profitable investment.

Topics: investment property, real estate investment tips, Rental Analysis