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Financial Analysis of Income Properties |
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Written by J.S.Carpenter
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Mar 27, 2008 at 06:41 PM |
Purchasing and managing income properties is a financial game. The only way to know if you are winning is to check the score from time-to-time. During times of intense real estate appreciation, scorekeeping is presumed to consist of watching comparable sales in the neighborhood, and subtracting your purchase price. The fact is that during times of appreciation, depreciation, or flat values, knowing the financial score requires a formal
analysis of your cash flow, and after-tax return on invested capital. Smart investors will take time each year, perhaps while dealing with taxes, to analyze each property.
The goal of any income property owner should be to achieve a return on invested capital that beats a one-year CD. Why? Because it makes no sense to expose yourself to the risks of property ownership for the same return you could achieve in a non-managed account.
There are two fundamental analytical values that provide basic scorekeeping:
Capitalization Rate: This is calculated by dividing Net Operating Income by the Purchase Price or current Market Value. Dividing your Net Operating Income by the Cap Rate that current buyers are achieving will give you an appraisal of your property value. Ask a realtor for the Cap Rate most recent buyers are achieving.
Example: Net Operating Income / Capitalization Rate = Market Value
$50,000 / 5% = $1,000,000
After-Tax Cash-on-Cash: Many investors used bank financing and benefit from interest and depreciation tax deductions. After Tax Cash-on-Cash evaluates your return after these tax benefits. To calculate, divide your after-tax cash flow by your total invested capital. If resulting percentage does not surpass a one-year CD, you should be looking for a solution.
Example: After Tax Cash Flow / Invested Capital = After Tax Cash-on-Cash Return
$8,000 / $200,000 = 4% |
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