Before you jump into any real estate investment deal, you should answer the common question, “How much profit should this rental property make?”

This will be a critical step in determining the viability of your given rental property investment.

Overall, rental property investments are a great place to start your real estate investment business. It’s perfect for beginners and experienced investors for long-term wealth creation and retirement planning.

Think about it. You can start real estate investing even while in college by renting out rooms in a house you buy near campus. That’s pretty simple to do.

However, if you decide to purchase a rental you won’t be living in, the complication of rental property investing comes in managing tenants and the property itself. That’s why in this case, which applies to most rental property investors, you should consider hiring a good local property manager.

All this to say that you can’t forget to calculate the time and energy you will spend managing the property when you forecast the profits you hope to make from the property.

The last thing you want to do is purchase a rental property to build long-term wealth for retirement and end up with a J.O.B. that pays 10 bucks an hour when you actually calculate all of your energy and time spent on the ‘investment.’

Whether you are considering a traditional rental property or real estate investment through Airbnb, you should take the time to figure out how much profit rental properties make prior to signing on the dotted line.

How Much Profit Do Rental Properties Make?

There are several factors that you should take into account to figure out how much a rental property will make for you.

• Property price
• Local market rates
• Costs
• Projected returns

Property Price

The first thing you will factor in is the property price, which will determine your top-level hard costs in the form of mortgage repayment, taxes, and insurance for that property. A general rule of thumb is to estimate paying around $10 per $1000 that you finance.

Focus your property searches on neighborhoods that fit into the price range you want to be in.

Rental Rates

The price range of a given property will directly influence the rental rate of that property.

You can gather this information from the city’s municipality, property management companies, and real estate agents. Very quickly, you will notice that having a good real estate agent on your team will help you; particularly real estate agents that cater to real estate investors. You’ll want to project your rental rate based on the comps in that neighborhood.

Additional Costs

After you’ve got your rental rate, then you need to deduct your estimated mortgage, insurance, and tax costs from that monthly rate. The next expense you’ll have to take into account is maintenance costs. Generally, the older the house, the more maintenance costs you’ll have.

While newer properties will costs more upfront, they’ll have less maintenance costs and the older ones will cost less but have more maintenance costs.

Rental costs will include:

• Property management
• Insurance
• HOA Fees
• Utilities
• Rental income tax
• Property maintenance
• Property taxes

Projected Returns

Once you know all of the above – property price, rental rate, and expenses – you can determine the following metrics to determine how much profit should this rental property make:

Cap Rate

This is a very important metric used to calculate a property’s returns and determining the amount of profit you will make from it. This equation uses the cash flow to calculate the profit from the investment to come up with a percentage of it’s current market value.

Cap Rate = (Cash Flow/Property’s Value) X 100

Cash Flow

Cash flow is the rental income you make after deducting expenses from the gross income.

If you have a property that has a rental rate of $2,000/month ($24,000 annually), and $15,000 in annual expenses then the investment property’s annual cash flow will be $9,000, which gives you a positive cash flow.

Cash on Cash Return

The equation for this is simple. (Cash Flow/Cash Invested) x 100

The cash on cash return gives you the amount of profit you’ll make as a percentage of the amount of cash you invest.

Wrap Up

Figuring out the numbers of how much profit should this rental property make is absolutely critical before you sign you name on the dotted line. Too many investors have ended up with properties that generate negative cash flow and you can safeguard yourself from this by using the above.

CTTO Article Source: www.biggerpockets.com