You must be able to obtain suitable financing on the property for it to be a good deal. The type of financing available, specifically to you, can make the property more or less desirable. What may be a good deal for someone else may be a bad deal for you. This is usually determined by the type of financing that you are able to obtain to purchase the property. Do not accept financing that is so expensive that it will produce a negative cash flow just because it is the only financing that you can qualify for. If you can afford the negative cash flow and are sure that you will be able to qualify for a more reasonable loan that will allow the property to produce a positive cash flow in the near future, the purchase may not be such a bad idea. The main point is, if you cannot hold on to the property with financial comfort, whether or not it would be a great deal for someone else who can obtain better financing, it is not a good deal for you. The next section will go into detail on some of the best ways to finance rental properties. The type of financing you are able to obtain will also affect your ROI, or return on investment. The ROI determines the rate of return an investor will earn on the amount he was required to put down in order to obtain the property. This rate is calculated by dividing the property's annual net income by the investor's down payment. For example, if a property's net income is $4,000 per year and the investor puts down $2,000 to acquire the property, then his ROI is 200 percent, ($4,000 / $2000 = 200). If he did not have to come in with a down payment in order to acquire the property, then the return on his investment is infinite. You cannot get this type of return by placing $2,000 into a savings account at your bank. The investment that offers the highest ROI without significant risk is the best place an investor can put his money. The higher your ROI, the greater your positive cash flow. In real estate, there are two types of ROIs: Simple ROI: This is when the ROI is determined by taking into consideration the annual cash flow that the property produces without taking into consideration the property's appreciation, average annual rent increase, and principal payments being paid from the tenants' rents. Complex ROI: This ROI does include a property's appreciation, rent increase and principal payments, as well as the property's annual cash flow. To fund this, you add the dollar amount of the average annual appreciation, average annual rent increase and average annual principal payments into the net income before dividing the property's annual net income by the investor's down payment. The average annual appreciation and rent increase depends on the area. You can find out what these averages are through the area demographics often found on the Internet, in local real estate offices and at property management companies. Once you have these percentages, multiply the appreciation rate by the purchase price of the property to determine the property's amount of annual appreciation; then multiply the rent increase percentage by the property's gross annual rents to determine the amount of annual rent increase. To determine the average annual principal payments, just divide the entire loan amount by the number of years it will take before the loan is paid off. Now you are ready to calculate the Complex ROI. For example, if the property's annual net income is $4,000, its average annual appreciation is another $4,000, the average annual rent increase is $320 and the average annual principal being paid off is $3,333 then the ROI is $11,653 ($4,000 + $4,000 + $320 + $3,333) divided by $2,000 (the down payment) = 582.6 percent per year. Wow! This is the most accurate determination of an investor's return on investment. |
