Strategy for Your Investment Property?
There are many reasons why someone would buy an investment property. Some of these
reasons are for long-term capital growth, positive cash flow, or adding value. In this article,
we will briefly discuss all three, and how to quickly analyze a property with potential to see if
it is worth spending more time and energy on.
Let’s start with long-term capital growth. The definition of long-term capital growth is the
appreciation of the value of an asset over a period of time. It is measured by comparing the
asset’s current value with how much it originally cost. One Benefit to this strategy is the
potential to generate long term capital growth as the value of the property increase over
time. Another benefit this strategy brings, is the ability to draw out equity or borrow against
the property to expand your investment portfolio. There are also tax benefits and deductions
that may be claimed from depreciation, certain kinds of out-of-pocket expenses, and losses
associated with the property. This type of strategy works for someone looking to build a nest
The next reason someone might buy an investment property is for positive cash flow. Let’s
start by defining cash flow as all of the revenue produced by an investment property minus all
the expenses incurred by the investment property. Basically, gross revenue minus expenses
equals cash flow (when the revenue is greater than the expenses it is called positive cash
flow). The major benefit with positive cash flow is the cash goes directly into the owner’s
pocket. Another benefit is positive cash flow can be used to increase the value of the real
estate investment, or it can be used to fund and maintain other investment properties. In
many cases, real estate investors are able to achieve passive income from their properties,
particularly triple net properties (we will discuss triple net properties in a different article).
This type of strategy works for someone looking for an immediate return on their investment.
The last reason we will discuss why someone might buy an investment property is for
value-add opportunity. Value-add properties are defined as investment properties that need
some type of corrective action to fully realize their full value. For example, an investment
property might be under performing due to lack of up keep, which causes the rents to be
cheaper. If you renovate the property, you will be able to charge more to rent, which should
increase your total net operating income (net operating income will be discussed in another
article), which increases the overall value of your property. Value-add properties have a
higher degree of risk reward potential then other type of investment properties.
No matter what your reason for investing in real estate, a good quick way to analyze a
potential deal is by looking at cap rates. By definition, cap rate is the rate of return on an
investment property based on the income it generates. Market cap rates vary by area, an A+
location will command a lower cap rate compared to a C+ area which will command a much
higher cap rate. In short, the riskier the property, the higher the cap rate. The formula for
finding the cap rate is NOI divided by current market value equals cap rate. When you find a
property you are interested in find out from the owner, what price they are asking and what is
the current NOI for the property. Then, plug the number into the cap rate formula to see if
the cap rate for this property is similar to other investment properties in the area. If the cap
rate is similar, you can spend more time analyzing the property in greater detail, if the cap
rate is much lower than similar properties in the area you just walk away from the property,
saving you time and energy.