Whether you are renting out your own place to the public or thinking about buying a rental property, you should take into consideration the investment risks of the property against the income you're receiving. One risk I use is the equation I=V/R, what this equation tells me is the cap rate, the income, and the value of the property, once I have the NOI or even the total annual income of the property after expenses which is NOI (net operating income) I can conclude if I want to buy or not. So to quickly sum all this up, the higher the cap rate the higher the risk of the property meaning what you're up against when trying to collect rent or sale it. The lower the cap rate the better chances the income will be produced on-going for the property which will generate a good value. Here is an example of this equation:
Location= A+
NOI= $15,000
Value= $125,000
So my cap rate is 12%, for me even though this property looks enticing because of the price & location I would pass on it, because later on that high cap rate will affect you too keep it stable with income, because of that high cap rate of 12%. Most non risky investors will pass on this property too, because of the high cap rate, and now you got a rental you can't sell coupled with a high cap rate. Here is another scenario:
Location C-
NOI= $15,000
Rate 6%
So in this case my value is $250,000, so I would pass on this property too, because yes the cap rate looks very good since its very low, but I would pass on the income because it doesn't make since to take home $1,250 per month as net pay on a property that is going to cost me $250,000 to buy it.
Another equation I like to use if I don't have the numbers for the I=V/R is I will use the GRM equation. This means gross rent multiplier, and to use this you have to have all the expenses coupled with the most recent comparable rent sale leased in the area of the property. Example would be:
Most recent comparable rent was: $1,050
Total Expenses: $650
Interest Rates are going for 6%-9% for your typical investment property
List prices generating median: $115,000
Sold Prices Median: $95,000
What this equation is telling me if I apply The GRM with the I=V/R this property is generating a cap rate between 4% & 5% and this is a really good investment to have long-term. So it looks like this:
GRM generated the numbers for the I=V/R so $4,800/$95,000= 5% cap rate. So understand how to use these 2 equations when using metrics to analyze rental properties, and you will be a "smart wise investor" for years to come.
Merry Christy & Happy New Year To Everyone!
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