Calculate Return on Equity for Real Estate Investments in First Year
Many real estate investors are involved in multiple properties and use leverage in their purchases. When deciding on the viability of an investment, one of the measures used is the expected Return on Equity in the first year.
If two properties are similar, the one which will produce the best first-year return may be the better short-term investment. To find out, you must determine the Cash Flow After Taxes.
For this example, we'll assume a CFAT of $11,000. The cash invested in acquiring the property, for instance as a down payment represents the next piece of the equation. Let's say the buyer put down $170,000. We must then divide the CFAT by the cash invest to calculate the return on equity:
$11,000 / $170,000 = .065 or 6.5%
You might use a real estate financial calculator to check the math for this and other calculations when buying a property.
Rental Property Investing - Not Just About the Numbers
Since the housing market and mortgage crash that began in late 2006, housing has recovered somewhat, though sales are still not at pre-crash levels. First-time home buyers are still out of the market for the most part. The economy and their job prospects are one reason. Another is that they're staying at home with their parents longer, even after graduation from college.
Baby boomers are not selling their homes at a historical rate, partially because they have their kids still in the house, but also because of the economy and high home prices due to low inventories.
Home prices are up, but mostly due to more buyers back in the market with low for sale inventories.
What does all of this mean? It means that there are a whole lot of renters out there. Rental demand has been growing, and rents have been rising at the same time. It's been a great market for rental property investors for the past few years, and it's still pretty good.
The biggest challenge now is to find bargains, especially if you want ready to rent properties.
The draw is still strong though, as rental property investing is a great tool to build wealth. The rental property investor wants two things primarily: 1) monthly positive cash flow, and 2) value and equity appreciation. If the new rental home buyer takes the time and effort to learn how to do it right, they can be on their way to a portfolio of homes that will fund a lavish retirement.
Cash Flow & Benefits
Real estate investment gets some advantages not afforded to the stock market or bond market investor. Mortgage interest, taxes, and insurance are deductible against rental income. You get an annual write-off for depreciation calculated over 27.5 years. The 1031 Tax Deferred Exchange can be used to push forward capital gains taxes if the rules are followed for selling one property at a profit and rolling the money into another property.
With the operating expenses also deductible, such as repairs, maintenance, trash collection, water and sewer, management fees, taxes, insurance and more, it's easy to see that rental property investing has some great advantages over other asset types.
So, the rental property investor buys right, gets the mortgage and expenses down below the monthly rent, and they have some cash to take to the bank every month. Interest rates rising doesn't bother them, as their mortgage is fixed, but it does bother potential buyers. So, they keep renting, good for the investors. In fact, as rental demand rises, increasing rents is possible, so better cash flow.
Equity and Debt Pay-down
Over the period of ownership, the odds are proven historically to tell us that there will be an increase in the value of the property. Other than a blip or two, over the long haul prices increase. Also, while you're paying your mortgage payment, you're building equity as well. When you decide it's time to sell, there should be a reward on that end as well.