Are you thinking of becoming a real estate investor and investing in residential rental property in Long Beach, CA? How do you know if it’s a good deal?
Successful real estate investors know how to identify rental properties that make good financial sense. Numbers that every experienced property investor wants to know are:
· Purchase Price
· Rental Income
· Net Operating Income
· Capital Gains
Whether you’re looking for a single-family or multi-family real estate investment property, these considerations will help you make an informed decision.
Rental Property Purchase Price
Of course, the first consideration is the investment property’s purchase price. This will give you an idea of how much money you’ll need to put down and how much your mortgage payment will be.
Remember that the purchase price is not always the same as the property’s market value. The market value is what the property is worth on the open market, and the purchase price is what you and the seller agree upon.
If you finance your investment property, most mortgage companies will request a 25% down payment. For a $500,000 property, that’s a down payment of $125,000. You’ll also want to factor in closing costs, which are typically 2-5% of the purchase price.
Expected Rental Income
The next thing you need to consider in real estate investing is rental property income. This is the amount you can expect from renting out your property. To calculate rental income, you must find the average rent for comparable properties in the same area.
Once you have that information, multiply it by 12 to get an annual estimate. For example, if the average rent for a two-bedroom house in a specific neighborhood in Long Beach, CA, is $4,200, your annual rental income would be $50,400.
A security deposit is money a tenant gives to a landlord to ensure they do not damage the property. If the tenant does damage the property, then the landlord can use this money to fix it. Security deposits, typically one month’s rent, are refundable and not considered income.
Vacancy expense is the percentage of time that an income property is empty and not generating rental income. This can happen for many reasons, such as a tenant moving out or you having difficulty finding a renter.
Calculating Vacancy Expense
It’s important to factor in vacancy expense when calculating rental property income because it will reduce the amount of money you bring in. Some investors use 5%, which in our example would mean:
- To calculate: $50,400 x 5% = $2,520 vacancy expense. Gross rental income is $47,880.
Net Operating Income (NOI)
The next thing you need to consider is how much the rental property will cost to own and operate.
- Mortgage payments*
- Property taxes
- Insurance
- Screening and placing tenants
- Utilities (common for tenants to pay this expense)
- Pest control
- HOA fees (if applicable)
- Management fees (if you plan on hiring a property management company)
- Repairs and maintenance: a rule of thumb for repair costs is to budget 1% of the property value each year
*Mortgage payments are not technically operating costs, but need to be included in any preliminary rental property income calculations.
Even if the property has no historical rental income or expense, you can still estimate these costs before you purchase a property. A good rule of thumb is to estimate 1-2% of the purchase price for operating expenses.
For example, let’s say you’re considering buying a rental property for $500,000, and your annual rental income is $47,880. Your estimated annual operating costs would be:
- Mortgage (6% interest after 25% down payment) = $ 2,248
- Property taxes (1.25% of purchase price) = $6,250
- Insurance (varies depending on location and type of property) = $1,200
- Managing the property = $4,000
- Utilities (typically tenant pays) =$0
- HOA fees (if applicable) = $0
- Repairs (1% of purchase price) = $5,000
Total estimated annual operating costs = $18,698
This number subtracted from your annual rental property income is your rental property’s net operating income.
Rental Property Cash Flow
Now that we’ve looked at the purchase price, rental income, and operating costs, let’s calculate the cash flow.
Cash flow is the difference between the rental property’s gross income and the month-to-month variance in operating costs.
A positive cash flow means that the rental property generates more income than it costs to operate, while a negative cash flow means spending more money to operate the property than it’s generating.
Simply subtract the operating costs from the rental income to calculate cash flow. In our example, the cash flow would be:
- $47,880 (annual rental income) – $18,698 (annual operating costs) = $29,182
This rental property has an annual positive cash flow (net operating income) of $29,182. Or, $2,431 a month.
Factoring in Renovations
Running the numbers on a turnkey Long Beach investment property ready to generate income is one thing, but what if you’re considering a fixer-upper? In this case, you’ll need to factor in the cost of repairs and renovations.
These costs can add up quickly and you might run into budget issues, so it’s important to get a realistic estimate (which we can help with) of how much they will cost.
After determining the budget, a good rule of thumb is for the amount of rent you can charge to be at least 1% of the total upfront costs (total purchase cost + renovation costs).
For example, a $150,000 investment property that needs $25,000 in upgrades should rent for at least $1,750.
Anticipated Capital Gains
In addition to cash flow, you also need to consider potential capital gains. Capital gains are the profits you make when you sell your rental property.
To calculate capital gains, subtract how much you paid for the investment property from the sale price. For example, if you bought a rental property for $500,000 and sold it for $600,000, your capital gains would be $100,000.
Capital gains are taxed up to 15% so you’ll need to learn about your tax bracket and any other additional taxes you might owe at the sale of your investment property.
Evaluating a Rental Property’s Value
These are four of the most important factors when initially calculating the income potential of a residential investment property. Other numbers you might want to consider are:
- Gross rental yield
- Price-to-rent ratio
- Capitalization rate
- Cash on cash returns
- Gross rent multiplier
- Debt service coverage ratio
By crunching the numbers and doing your research, you can calculate potential rental income and make an informed decision about whether owning rental property is right for you.
If you have questions about how to calculate any of these numbers, we’d be glad to help.
Residential Investment Property Valuation in Long Beach, CA
Need help evaluating a Long Beach rental property? CMC Realty & Property Management is one of the most experienced and successful investment property firms in all of Long Beach and Southern California.
If you’re buying your first or your next investment property, we can guide you through the process, help you run the numbers on a rental property, and ensure that you’re getting the most bang for your buck.
Our team of expert property managers will help you find the right income property, evaluate its long-term value, and negotiate the best price.
We will also help you with the due diligence process to make sure that the rental property is up to your standards.
And, once you’ve purchased the investment property, we can help you find quality tenants and manage the property so you achieve truly passive income.
If you’re ready to get started on your real estate investment journey, contact us today! We would be more than happy to help you find the perfect income property and get you started on your path to success.