While homebuyers search for affordable homes, real estate investors seek properties with high cash flow potential. In your local market, there are great investment opportunities if you know where and what to look for. This article will guide you through the process of analyzing cash flow real estate investment properties and help you find gems near you. We'll cover key concepts such as net operating income, capitalization rate, return on investment, and monthly cash flow.
Research Rental Comps
Before searching for cash flow properties, it's essential to understand your local rental market. Start by looking for rental comps of three-bedroom, two-bathroom, single-family homes that are 30 to 50 years old. Homes built in the 1970s to 1990s usually have functional floor plans and two-car garages, making them ideal for higher rental yields.
You can find rental comps on websites like Craigslist, Zillow, and Rentometer. Rental rates vary based on location, age, nearby amenities, and other factors. These factors influence what tenants are willing to pay in rent, so make sure to consider them when analyzing properties.
Narrow Your Search Using the Rental Multiplier
The Rental Multiplier is a useful tool to narrow down your search. Evaluate neighborhoods with higher rents and use the Rental Multiplier to determine the maximum price your investor can pay for a home while still achieving positive cash flow. The calculation is based on a traditional investor mortgage loan with a 20% down payment.
For example, if the average rental rate for a three-bedroom, two-bathroom home is $2,000 per month, you'll want to look for a home priced close to $260,000 ($2,000 x 130 = $260,000). You can use a maximum Rental Multiplier of 130, but adjust it based on your local market conditions.
Increase the Down Payment to Increase the Rental Multiplier Range
In some areas, it may be challenging to find properties with a Rental Multiplier below 130. If that's the case, your investor clients may need to increase the down payment to achieve the desired cash flow. Alternatively, you can explore other markets where properties have lower Rental Multipliers.
Americans working from home are relocating to suburban and rural areas, creating more opportunities for cash flow investing. If you're considering working with investors throughout the U.S., research reciprocity and portability laws in nearby states with better deals.
Calculate the Capitalization Rate
The capitalization rate, or CAP rate, is a crucial metric for assessing the potential return on an investment property. It allows investors to compare similar properties nationwide without considering individual financing details.
To calculate the CAP rate, divide the property's net operating income (NOI) by its asking price. The NOI is the income generated from the property after deducting all expenses. CAP rates tend to be lower in areas with high demand and are typically influenced by market conditions.
Calculate the Annual Cash-on-Cash Return
The cash-on-cash return, or return on investment (ROI), shows the potential annual return on your client's cash investment. It takes into account all the costs required to acquire the property, such as the down payment, closing costs, and inspection fees.
To calculate the ROI, divide the property's annual cash flow by the total out-of-pocket expenses. This will give you the annual rate of return for the investment. Remember to include all expenses and costs associated with acquiring the property.
How to Calculate Monthly Cash Flow
Monthly cash flow is the amount of money left over each month after all expenses and mortgage payments are made. Start with the NOI and subtract only the annual principal and interest payments on the mortgage. Then, divide it by 12 months to get the monthly cash flow.
Investors should pay attention to monthly cash flow, especially when financing larger multi-unit properties. Commercial financing often requires higher down payments and offers higher interest rates than single-family financing.
Other Factors to Consider
While CAP rate, cash flow, and ROI are important, other financial considerations come into play when analyzing investment properties. Real estate investment properties offer tax advantages, such as interest deductions and depreciation benefits. However, be aware of potential recapture of depreciation and capital gains taxes upon sale.
Use the Financials to Negotiate Your Offer
After narrowing down your search and calculating key financial metrics, use the rental multiplier, CAP rate, and ROI to recommend the best cash flow investment property to your investor clients. The financials can guide your client's offer price, ensuring it aligns with their goals. Remember, the right price doesn't always mean a low offer.
The Bottom Line
Knowing how to find and analyze profitable cash flow real estate investments is crucial for attracting investors and building another income stream in your real estate career. By understanding key financial metrics and evaluating properties based on cash flow potential, you can identify excellent investment opportunities for yourself and your clients.
