Investing for a return is a simple concept when it comes to real estate.
1) In the case of income generating rental properties, a basic evaluation metric is to look at the property’s overall RETURN ON INVESTMENT (ROI). If we are considering the purchase of a ‘fully occupied 3 unit plaza’- at a purchase price of $300,000 and a net operating annual income of $30,000 - the RETURN on the property is projected to be 10%.
In other words, an investment of $300,000 will bring an annual ROI of 10%. Pretty impressive in today’s low rate environment.
2) But what happens to the return, when we look to arrange financing (a.k.a. mortgage) to buy this property? Using the same example – say we arrange a new first mortgage at $200,000 @ a rate of 4% on a 20 year amortization. Monthly mortgage payments are projected at $1208.50 per month ($14,502 per year). The Net Income (after Debt Service) is now reduced to $15,498, but so is our upfront cash investment (a.k.a downpayment) , to $100,000. The ROI calculation now looks like this - $15,498 / $100,000 = 15.49%.
Welcome to the world of LEVERAGE!
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| Source: 16:10 Financial |
When analyzing the return potential of a property, these are the first two metrics to review. In considering the financing options, it’s important do your homework on what is realistic and obtainable in your market. Key factors to consider include - downpayment requirements, interest rates, amortization periods, commitment periods, preferred property types, open vs. closed mortgages, and upfront costs to arrange a new mortgage.
Ensure you are dealing with qualified COMMERCIAL MORTGAGE SPECIALISTS, as you assess all factors relating to financing the property.
In Windsor-Essex over the past 4-5 years, rates of return (aka Cap Rates) have compressed significantly – in some cases +2%. But the market has responded by accepting lower rates of return and the lenders have adjusted accordingly. The key element for both investors and their lenders, remains the quality and sustainability of the cash flow.
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