Real Estate Investing for Beginners: How to Identify A Good Investment.
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Real Estate Investing for Beginners
Identifying a Good Investment
Every real estate investor was a beginner at one point.
Whether you’re thinking about real estate as a way to build long term wealth or as more of a full time career that will allow you to dictate your own hours and be present and available for your family, one of the first skills you’ll need to develop is identifying a good investment.
Of course, situations are always unique, and there are variables in every real estate transaction, but we’re going to look at the basic math involved in calculating a potential investment. Bottom line, if the math doesn’t make sense, the investment doesn’t make sense.
How to Calculate A Potential Buy & Hold Real Estate Investment
Let’s talk about calculating a potential buy-and-hold real estate investment. In a buy-and-hold situation, you might be planning on renting out the property on an annual lease. The potential income from the rental should cover your mortgage payment and all expenses while still leaving you with a positive cashflow. That’s simplifying it down to your one main goal.
In this article I will explain the basic math involved in calculating a buy-and-hold real estate investment. If math is not your strength, don’t panic. This is very basic!
Determining Potential Rental Income
Real Estate Investing for Beginners
The first step in calculating a potential return on investment for a rental property is to determine the rental income the property can generate.
You can identify this number by researching the local rental market to find the average rental rates for properties similar to the one you are considering.
*Similar means similar; same area, same amenities, close to same year built and comparable square footage.
I like to use the lowest possible number when I’m calculating potential rental income. It’s better not to pad your numbers with “likely potential.” If you keep your predicted rental income on the low end and the numbers still look good, you may have a winner.
Ok, let’s keep going…
Property Expenses
Once you have a rough estimate of the rental income, you’ll need to factor in any expenses associated with the property, such as property taxes, insurance, and maintenance costs.
Subtract these annual expenses from the annual projected rental income. This will give you a net operating income (NOI) for the property.
Pretty straightforward, right?
Check out our helpful 2024 guide to Buying a Home in Florida. Understanding the Home Buying / Home Selling process is your first step to real estate success!
Finding Your Net Operating Income
Real Estate Investing for Beginners
Net Operating Income
The formula for NOI (that we just used above) is as follows:
Net Operating Income = (Gross Operating Income + Other Property Income) – Operating Expenses
The final number you’re looking for is the potential cash flow from the property. This is calculated by subtracting the mortgage payment, including principal and interest, from the NOI. If the property is not financed with a mortgage, then the NOI is the cash flow.
Other Expenses You May Have Missed
What if the property needs some work before it can be rented out?
What percentage should you factor in for vacancies?
Will you pay any of the utilities?
These are all things to consider. For example, you may require your tenants to pay their own electric, but you’ll still need to keep the electricity on to show the home as well as during any vacant time, so I would suggest inluding at least two months of average electricity costs as a potential expense.
The chart above is calculated at $1500 monthly rent with deductions for utilities, vacant time, and other expenses.
Keep in mind that these calculations should be revisited as you continue to gather information about your potential real estate investment, especially right after your home inspection. Besides cosmetics like paint and cleaning, there may be roofing repairs, plumbing repairs, or an upcoming AC unit replacement. This additional information will help you better assess positive cash flow.
Real Estate Investing for Beginners
How to Calculate Your Return on Investment
Real Estate Investing for Beginners
To calculate the potential return on investment (ROI) for an investment property, use the following formula:
ROI = (NOI / Total Investment) x 100
Total Investment = Down Payment + Closing Costs + Annual Mortgage Payment
Let’s say the annual mortgage payment comes to $12,000 (for the sake of nice round numbers), the down payment was $50,000 and the closing costs were $5,000.
Then, the Total Investment will be:
Total Investment = $50,000 + $5,000 + $12,000 = $67,000
Now, we can calculate the ROI using the formula:
ROI = (NOI / Total Investment) x 100
ROI = ($10,433 / $67,000) x 100 = 15.63%
Real Estate Investing for Beginners
Once you begin using this formula to calculate potential ROI, you’ll be able to determine whether a potential investment property is likely to work for you or not. A higher NOI indicates a higher potential for cash flow and a higher ROI, while a lower NOI indicates a lower potential for cash flow and a lower ROI.
Overall, understanding and using NOI is essential for real estate investors to make informed decisions and maximize potential returns on investment.
Tackling Real Estate Investing Myths
Real Estate Investing for Beginners
Let’s cover a couple of fun real estate investing myths in this guide to Real Estate Investing for Beginners. I love being a myth-buster!
First, have you ever heard anyone say, “It’s better to buy than waste your money on rent?” When you actually crunch the numbers, you’ll often discover that renting can be superior to buying. It just depends on where the market is currently.
Second. Some people believe you need to be a homeowner before you start investing in rental properties. This statement, of course, is completely false. Many investors buy and rent properties while they are living in a rental property themselves.
The road to successful real estate investing for beginners is an exciting journey. It also has a few myths that need to be dispelled along the way, but I’m here for all of it with you!
Houses for Sale in Fort Myers, Florida
Fort Myers Houses for Sale
Hope you enjoyed reading Real Estate Investing for Beginners. Are you ready to take a tour of some of the available homes in Fort Myers?
Contact me today! I’m here for you every step of the way.
