Are you thinking about investing in real estate to earn rental property income? Whether you invest in a residential or commercial building, there are several things to consider to make sure the property will generate a profit. Here’s what you need to take into account to determine how profitable an income property will be.
Figuring out how much profit you can expect after buying a rental property with no more than four units or a building with five or more units involves much more than just subtracting expenses from income. Since this is a long-term investment, several factors will influence (positively, we hope) your building’s market value over time:
There are several ways to determine your profit on income property.
This is the simplest way to determine how profitable a building is. Just subtract all your annual expenses, such as mortgage payments, utilities, municipal and property taxes, maintenance costs, and insurance, from the total annual rent.
If income equals 125% of expenses, meaning you earn $125 in income for every $100 of expenses, the profit will be acceptable.
Bear in mind that this is merely a guide. Talk with an expert to make sure the building will generate enough profit.
The gross income multiplier (GIM) is a quick way to calculate rental property income.
The formula is simple: divide the building’s purchase price by annual gross income.
While simple, this ratio is not the most accurate because it doesn’t take all of your building-related expenses into account. However, it’s an easy way to compare similar buildings in different areas.
We recommend using the discount rate for commercial buildings and buildings with 12 or more residential units.
This is another simple calculation: divide the net income generated by the building by its market value.
The discount rate is used a lot for comparison purposes. For example, you can compare your desired building’s discount rate with market discount rates by building type and location.
To make a rental property more profitable, you have to analyze your costs and operations first, and all the available options second. For example:
Let’s talk first about raising the rent. This might be an option, but it might make some of your long-term tenants move out. In addition, rent increases must comply with applicable law, be reasonable, and must respect tenants’ rights. Rent increases are warranted and easier to justify if you’ve renovated the units and maintain the building properly.
Doing work to improve the building’s energy efficiency, such as replacing doors and windows, might reduce your energy bills. That can help you increase your net income from the building.
Reducing your administrative costs can be another way to increase profitability. Review all your expenses, such as snow clearing, landscaping, and concierge or building manager costs. You may find budget items where you can cut costs and increase revenues.
By adding services or making the units more luxurious, such as by providing Internet, a garage, or even a carport, you might be able to raise rents.
Taking the long view will also help you generate rental property income. For this type of property, supply, demand, and sales remain constant over time. Year after year your building should increase in value, giving you a return on investment when you sell.
Are you thinking about buying a rental property? We’re here to answer your questions.
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