When commercial real estate professionals and institutional investors calculate their return on investment, they rely on net operating income (NOI) to help them determine if a project is profitable. Essentially, NOI is what you get from an investment property after all the expenses. A positive NOI means that the property generates enough income to cover the expenses. The same logic applies to individual investors like you. A property that generates negative cash flow is not going to be a good investment for you. After all, with all the money we put in, who does not want to see positive results? But, how do you know if the property you purchased is generating positive cash flow? What needs to be done to ensure success? Rest assured, as we at RealtyHop has put together a list of things you should do as a smart investor. Let us take a look!
1. Become educated with the landlord-tenant laws in your jurisdiction.
The first step for you to become a landlord and an investor profiting from your rental property is, of course, something legal. After all, you might end up losing everything and paying hundreds of thousands of dollars back to your tenant if you violate the law. Be sure to go through the state rental laws, tenants’ rights, and the eviction process. Many states have security deposit limits as well as deadlines, and as a landlord, you do not want to go to the court just because you forget to check the regulations.
2. Keep track of your income and the market rental rate
Basically, how much cash your property can generate. Is $4,000 per month enough to cover your mortgage repayments? Should you raise the rent? Is the rent way above the market rate, making it hard for you to lower the vacancies? If your rent is already below the market rate and you still have trouble leasing it up, perhaps it is time for you to renovate the property. In addition to the monthly rent, you can also charge your tenant additional fees to cover your cost, such as pet fees, parking fees, etc. The additional income can be really helpful if you do it properly!
3. Keep track of your expenses.
Indeed, we all know how much you can make is important, but at the same time, how much you spend is also crucial in determining if your rental property brings in enough cash for you. Some common expenses include property taxes, mortgage repayments, insurance, utilities, pest control, commissions (if you work with a broker to find tenants), marketing and advertising, as well as trash removal. Of course, if you own a condo or co-op unit, many of these will be taken care of with a simple maintenance fee. That does not mean, however, that you don’t need to keep track of how much you’ve put in for maintenance.
4. Cap rate is still key, especially if you are looking to re-sell soon.
Once you have figured out how much you actually make (in other words, your net operating income), then you can look at the cap rate. To refresh your memory, the capitalization rate, commonly known as the cap rate, is a rate real estate professionals and investors, especially those in the commercial real estate sector, use when evaluating a real estate investment. If you are looking to re-sell the property in the near future, the cap rate can be very helpful. With the NOI you calculated, the cap rate helps you determine your asset value. If the cap rate for residential properties in your city is around 5%, and you are generating $60,000 a year through your rental property, then you know you can potentially sell the property for $1.2 million.
5. Set up a contingency fund for emergencies.
Let’s face it, no matter how good you are at managing your investment property, sh*t happens. Maybe your contractor decides to charge you more for fixing the stove, maybe your pipes break because of the cold weather, or maybe the trade tariffs make materials more expensive. As a smart investor, it is crucial that you set up a contingency fund for the unexpected. Without a contingency fund, you might need to rely on credit and eventually end up deeper in debt.
6. Find the right contractors.
Most institutional real estate investors have long-term contractual partners they work with when it comes to repairs, maintenance, and improvements. Many of them even have a dedicated team set up. While it is impossible for you, an individual investor, to have the same resources and scale, you can still save a lot of money by finding the right contractors. Ask your neighbors, friends, or even the original seller to see if they know anyone. If you are in a condo/co-op building, chances are the handymen will have time to take on extra work at a discounted rate.
7. Refinancing is always an option if you want to invest in another property.
Let’s say now you’ve proven that the property does generate positive cash flow and your investing strategy works, what you need to think about, then, is the possibility of replicating your success. But what do you do if you do not have enough cash to buy additional properties? Well, the answer, of course, is, refinancing. Refinancing your investment property allows you to lower your monthly mortgage payment, and also purchase additional properties using the equity. However, keep in mind that the lenders do treat loans for investment properties differently than loans for primary residences. You should expect a lower LTV ratio and a higher interest rate.