While real estate investment can generate income and capital appreciation, no two projects or investment opportunities are going to be exactly alike. As an investor, it’s up to you to evaluate a property and make a business plan that aligns with your long-term goals, as well as the realistic and feasible opportunities the property offers. Going into a project with a clearly laid out plan and strategy can be the difference maker between turning a profit and defaulting on your loan (or going into bankruptcy).
But before we reach the property, let’s begin with seeking out that loan and what five calculations any investor should make before sitting down with a lender.
Are you meeting loan-to-value (LTV) requirements?
Testing the debt service coverage ratio (DSCR) will let any investor know if it meets their LTV requirements before sitting down with a lender and answering any potentially hard questions. DSCR is calculated by dividing the annual gross rent (income) by the annual loan payments, including any property taxes, insurance or HOA dues/assessments (PITIA). If the number is1.25x or greater, you will likely qualify for financing at 80% LTV. If the number is less than 1.25x, the lender could still sign on to finance the project, but if they do, they’ll finance at a lower LTV rate, such as 75% LTV.
Are you following the 50% rule?
If you compile the annual gross rent on your investment property, and then divide it in half, you’ll have an estimate for your expense load. While expenses might amount to less, it will still cover whatever additional expenses lenders typically consider as a conservative measure. Why50 percent as opposed to 30 percent? You’re simplifying your math and erring on the side of caution.
Have you calculated the annual PITIA payment?
The annual PITI payment – standing for principal, interest, taxes, insurance and Association Dues – allows you to get a rough idea of what your property’s annual payments would amount to. How do you calculate your estimated loan amount? Take the estimated value for the property and multiply it by 0.80 (80%) Plug that number into the PMT function in Excel and it’ll bean easy way to calculate your annual loan payment. Remember to add in the amounts for property taxes, insurance and association dues(if applicable) to get your total payments. Still confused on the payment, your lender will be happy to calculate it for you.
What is your capitalization rate?
Your cap rate will tell you the rate of return on your investment (your net operating income (NOI) divided by the asset value).Often, a higher cap rate indicates a higher risk while a lower cap rate indicates a lower risk. Knowing the market you intend to invest in (is it an up and coming neighborhood or town, or is it a safe bet with assumed returns?) is the first step in getting an idea of where your cap rate will fall.
What is your cash flow?
Cash flow is a healthy indicator of how well your property is (or isn’t) doing. If monthly rent in your building is $2,000 and all monthly costs are $1,200, then your property is cash flow positive, and your monthly net per unit is $800. Keeping a pulse on the monthly numbers will let you know if your business is succeeding, and if not, how you can pivot to make sure you stay in the black.
If you have crunched your numbers and are ready to meet with a lender to discuss your real estate investment plans, contact Temple View today.