Rental properties are a great way to earn passive income. But in order to find good rental properties to invest in, we need to analyze the properties carefully especially when you are taking out a loan. There are a lot of factors when it comes to analyzing your rental property - monthly expenses related to the property, cash flow, Net Operating Income (NOI) and return on rental property etc. And on top of that, your calculation might differ based on how you’re paying it - full cash or mortgage. So let’s talk about numbers today!
You need to calculate Cap Rate when you have invested full cash on your property and Cash on Cash Return Rate when paying mortgage. The simple formula to find return on your investment or ROI is:
ROI = (Gain from Investment – Cost of Investment)/Cost of Investment
Let’s take an example – a $239,300 4B,3B house in Lubbock, TX. These are the estimated income and expenses from the property:
Like we mentioned before, the rate of return in the properties will be different based on how you are paying.
ROI when paying cash: Cap Rate
Let’s talk about ROI for all cash which is called the Cap Rate Calculation. Return on rental property for Cap Rate identifies the profitability of your investment when you pay in full cash. You can calculate using this formula:
Cap Rate = NOI / Purchase Price X 100%
You need to make sure that the purchase price includes your closing cost and the remodeling cost (if any). So let's do some calculation!
1. Closing Cost: $2,000 (A little less when you are paying in full cash)
2. Remodeling cost: 0 (let’s saying we did not remodel our property)
We’ll calculate the Net Operating Income (NOI) first.
NOI = Income – Expenses = 24,000 – 6,180 = 17,820
Cap Rate = NOI / Purchase Price X 100% = 17,820 / 239,300 X 100% = 7.44%
ROI when paying mortgage: Cash on Cash Return
Let’s move on to the next return on rental property, cash on cash (CoC) return. This method is used when you have taken out a mortgage for your property. You can calculate this by using
CoC = NOI / Total Cash Invested X 100%
We will continue with the above example and use the same numbers. The difference here is, we will be using the down payment amount and the mortgage interest you need to pay monthly.
Down payment = $70,100
Closing cost = $4,000 (A little higher when mortgaging)
Total Cash Invested = 70,100 + 4,000 = 74,100
NOI = Income – Expenses = 24,000 – 18,348 = $5,652
CoC = NOI / Total Cash Invested X 100% = 5,562 / 74,100 X 100% = 7.5%
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It’s definitely difficult to analyze all this to get the best deal on properties, especially when you are analyzing more than 1 property at a time. It takes time and patience to grab all of this data and analyze all this. However, we have introduced a feature to make this process a little easier and bearable. When you get an email from us showing your cash flow properties, the cap rate and cash on cash return will be included in it. This makes it easier to narrow down your property research. Sign up today to get your cash flow properties!