Evaluating Real Estate Investment Properties: A Comprehensive Guide

Are you looking to invest in real estate but don't know where to start? Evaluating real estate investment properties can be a daunting task, but it doesn't have to be. In this comprehensive guide, we'll cover the top metrics every real estate investor should know and how to use them to make informed decisions. When deciding if a property is a good investment, there are several factors to consider. These include rental income, monthly mortgage payments, property taxes, mortgage insurance, and additional expenses.

For a standard owner-occupied home, lenders typically prefer a total debt-to-income ratio of 36%, but some will rise to 45% depending on other qualifying factors such as your credit rating and cash reserves. This ratio compares your total gross monthly income with your monthly debt repayment obligations. For housing payments, lenders prefer gross income over total housing payment of 28% to 33%, depending on other factors. For an investment property, Freddie Mac's guidelines say that the maximum debt-to-income ratio is 45%.

None of the down payment or closing expenses for an investment property can come from gift funds. Individual lenders will determine how much you must deposit to qualify for a loan based on your debt-to-income ratio, your credit rating, the price of the property, and your likely rent. When looking at a potential investment, consider the relationships you have with the people involved. If there are strained relationships, this may not be the right investment for you. Since it depends so much on how you interact with others, it can literally be worthwhile to have good relationship and negotiation skills.

The Top 10 Metrics Every Real Estate Investor Should Know

Whether you're a new investor or one with twenty years of experience who needs a review, these are the top ten real estate investment metrics you should know:
  • Price/Income Ratio: This metric measures the price of a home relative to the median income in an area.

    The national average is 26%.

  • Cap Rate: This metric divides your net operating income (NOI) by the value of the asset. When you are in the acquisition phase, this will be the selling price of the property. Later, you can use your local realtor, broker, or the estimated value on real estate websites like Zillow.
  • Internal Rate of Return (IRR): This metric measures the rate of return on an investment over time. You can calculate this metric yourself or let Stessa do it for you.

    When calculating the IRR, set the net present value (NPV) of the property to zero and use the projected cash flows for each year you plan to maintain the building.

  • Net Cash Flow: This metric measures how much money is left after all expenses are paid. If it's negative, you won't be able to pay your bills or make a profit. A negative cash flow could also indicate that you're spending too much on the property and you should examine your associated expenses.
  • Cash-on-Cash Return: This metric tells you the total return on the money you have invested in your real estate investment. Simply put, it's the amount of money you make with the cash you invest.
  • Loan-to-Value Ratio (LTV): This metric expresses how much of the total purchase price lenders are willing to finance in a loan.

    Typical A and B lenders require a LTV in the range of 80-90%.

  • Debt Service Coverage Ratio (DSCR): This metric measures how much additional income is generated after paying off debt. A DSCR of 1.25-1.5 is desirable and could help lower your interest rate.
  • Vacancy Rate: This metric gives you the percentage of vacant units compared to total available units. It's easy to calculate: take the number of unoccupied units, multiply it by 100 and divide it by total number of units.
  • Cash-versus-Cash Return: This metric helps you choose between potential investments and can help forecast returns during years when capital expenditures are expected.
  • Population: The population of an area will determine its local economy and thus affect returns from your property.

Making Your Purchase

After identifying potential investment properties, the next step will be to make a purchase. Buying a home is a huge investment, and not many people buy a home with money out of their pocket.

There are many financing options to choose from when paying for a home, such as taking out a mortgage or looking into other financing options like lenders with a lot of money or private investors.

Harvey Billa
Harvey Billa

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