How to Determine How Much to Pay for Your Rental Property

How to Determine How Much to Pay for Your Rental Property

If you are buying a house to sell it, then your calculations will be different. You should use sales comparables or sales “comps” to determine your purchase price.

However, if you plan is to rent the house, then sales comps are not all you will need to know. You must also use rental comparables, or rental “comps” to determine your purchase price on a rental property.

Why are you buying your property?

You want positive cash flow.

You need to find out your Net Operating Income or NOI.

How do you calculate that? You need to add up all of your monthly expenses and then subtract them from your monthly rent.

So, the first thing you need to know is what the property will rent for.

Now, how do you calculate your monthly expenses?

You can get a fairly accurate estimate by following these numbers:

·Vacancy/Loss Payment: 8-10%

·Insurance: Call an agent for an estimate

·Taxes: Look up in tax records

·Property Management: 8-10%

·Repairs and Maintenance: 5-10%

·Utilities: When property is vacant

·Capital Reserves: Varies based on age and condition

Now, let’s take these categories through an example of one of our properties (although I am changing the address for security reasons).

The property is located in Durham, NC, and let’s say the address is 100 Blue St. (a fictional address).

We will now run our numbers on the property to see what we should pay.

The market rent on this 4 bedroom house is between $900 and $1100, and we have rented it for $995.

Monthly income: $995

Vacancy: $80 @ 8% of rent (this is based on one month of vacancy per year)

Gross Operating Income/Net rent: $912

Expenses:

Property Management: $91 @ 10% of rent collected(even if you manage yourself, you need to be paid)

Insurance: $34.16 ($410 divided by 12)

Taxes: $135 ($1625 divided by 12; tax value @ $125,000)

Repairs and Maintenance: $49.75 @ 5% of rent (this can be more or less depending on the age of the house and the amount of work and money you put into fixing it up for rent)

Utilities: $5 (one month of utilities per year)

Total expenses and vacancy cost per month: $394.91

Net Operating Income:

This is calculated by subtracting Vacancy and Expenses from Gross Rent:

·Gross Scheduled Income/Rent: 995

·Vacancy/Expenses: -394.91

·NOI (Net Operating Income) = $600.09

The NOI is your key number. With this number you can pay your mortgage (principal and interest) and any return on your down payment and initial repair costs put into the property to get it rent ready.

Let’s start with just the mortgage. Let’s assume your interest rate is 6% on money borrowed from the bank, and let’s assume a 30-year fixed rate.

Using a financial calculator or an online mortgage calculator, you can discover that the house at this rent with these expenses can support a loan of about $106,000.

There are several ways to divide this up, but you need to make sure your calculations include your down payment money, your initial fix-up money, and the cost of the mortgage.

Now you can see that the most important number is not the sales comparables but the rental comparables.

Once you know what you can rent a property for, then you can calculate your maximum allowable offer for the property.

Doug Peterson