Equations for St. Louis Investment Property Profit
Purchasing a St. Louis investment property may not have the same sentimentality as purchasing a residential property, but if you are unsure of whether or not you can turn a profit, purchasing a St. Louis investment property can wreak just as much havoc on your nerves! Luckily, there are some well-known measurements you can use to calculate your chance of turning a profit.
Use these equations to feel confident in your St. Louis investments:
Value appreciation
Value appreciation is a powerful but slow-burning return on your St. Louis investment property. As the real estate market grows over time, most properties do appreciate in value. However, if you are relying solely on value appreciation to turn a profit on a property, you are in for a disappointment. Most properties require at least five years to generate enough value appreciation to compensate for the transaction costs of buying and selling. During that time, you may also experience negative cash flow through property taxes, insurance, and home owner’s association fees, so in order to see profit, your property must also appreciate in value more than you pay to maintain it.
Cash-on-cash return
To calculate cash-on-cash return, estimate your cash flow (rental income minus homeowner expenses) and divide by your cash equity (the amount of money you take out of your bank account to pay for a home, including your down payment, transaction costs, and mortgage).
Example: You purchase a property for $46,000 and generate $3,200 in one year of cash flow. Your cash-on-cash return is 6.95%, which is pretty good!
Internal rate of return and net present value
Internal rate of return and net present value are both common tools to evaluate a real estate investment. Because these two calculations can be rather gnarly, they are generally calculated by brokers or lenders and used to influence your decision about purchasing a property. Most investors do not perform these calculations themselves.
The weakness of internal rate of return and net present value is their reliance on estimation. Both are based on an estimated value for the future sale of the property. This value may or may not come to fruition. The same goes for your investment return.
Gross rents multiplier
To calculate gross rents multiplier (GRM), take your property price and divide it by the gross rents the property can generate.
Example: a property’s price is $200,000. The annual rental income is $20,000. The GRM is 10.
GRMs give you a quick and easy way to compare properties in a similar area. While handy, GRMs do let some details slip through the cracks. GRM does not take into account the fact that different properties have different expenses. Consider two properties with a GRM score of 10. One is a $100,000 and can generate $10,000 of rental income per year. The other is $40,000 and can generate $4,000 of rental income per year. On the surface, these properties appear to be equally good investments. What you may not realize with a GRM comparison is that the $40,000 property will require $6,000 worth of renovations before any tenant would agree to live there. Your profit has just taken a serious hit.
As a St. Louis investor, you should carefully consider which tools you want to use to evaluate potential investments. You might be comfortable with only one tool, or you might want to use all tools before you lay your money down. Regardless, the more you know about your potential return on a St. Louis investment property, the more confidently you will invest.