How Much Income Will Your Property Generate?
Are you a residential income property investor, a real estate professional with investor clients, or a real estate pro wanting to do your own investing? If so, one of the biggest questions you’ll have is “How much return will I get for my investment?” Fortunately, there are ways to predict that before acquiring a property.
The buy and hold approach, as explained in the book HOLD: How to Find, Buy, and Rent Houses for Wealth, is a proven wealth-building strategy for residential real estate investors. But to build wealth using this strategy, you must be able to accurately project the income and cash flow that a property will generate for you or your investor clients.
To estimate a property’s income and cash flow, you must project the monthly and annual net rental income that the property will produce. If you’ve already done a property analysis that includes calculating the property’s optimal purchase price, you’re ready to project the rent for that property. Here are the basic steps:
Step 1: Gather the comps.
Find current rental values for comparable rental properties, or comps. Do this by using these four resources to find properties and their rental rates: Multiple Listing Service (MLS) to look for recently leased properties, local property managers, local newspaper and Internet listings, and “for rent” signs close to your property.
Step 2: List the comps.
Create a worksheet that lists each comp property. For each comp, enter its address, rent, square footage, rent per square foot (rent divided by square footage), number of bedrooms, number of bathrooms, number of stories, and year built.
Step 3: Determine average rent and square footage.
Using the information in your comps worksheet, first determine average monthly rental income and average square footage (the respective averages of the comps’ total monthly rents and total square footage).
Step 4: Calculate average rent per square foot.
Using the information obtained in the previous step, calculate the average rent per square foot by dividing the average monthly rental income by the average square footage.
Step 5: Project the annual rental income.
To project the annual rental income, multiply the total square footage of your property by the average rent per square foot. For example, if your property is 1,300 square feet and you calculated the average rent per square foot to be $1.15, $1,300 times $1.15 equals $1,495. Round up or down to the nearest $10 increment to get the monthly projected gross rental income — in this case, $1,500. Multiply this amount by 12 to get the annual projected gross rental income of $18,000.
Step 6: Account for vacancies.
You can use a 5% vacancy rate as a rule of thumb; however, actual vacancy rates depend on several factors, including your property’s condition, local vacancy rates, market competition, and even the time of year.
Step 7: Determine net projected income.
Multiply the monthly projected gross rental income amount by the vacancy rate (5%, or .05); then subtract this amount from the monthly gross rental income to get the net projected monthly rental income. To get the annual rate, multiply the net projected monthly rental by 12.
For example: $1500 × .05 = $75; then $1,500 − $75 = $1,425 (net projected monthly rental income)
$1,425 × 12 = $17,100 (net projected annual rental income)
An easier way
However, an easier, more convenient way for brokers and their investor clients to calculate projected rental income is to use the Real Estate Investment Planning (REIP) program, a cloud-based application based on the HOLD method of real estate investing. Simply plug in the comp numbers, and REIP handles the rest!