Metrics Explained: Return on Investment

ROI, Return on investment, Business and financial concept., real estate investment

ROI, Return on investment, Business and financial concept, Real estate investment

In our series “Metrics Explained”, we will dive into two concepts that are commonplace to any seasoned real estate investor. This article about ROI is part-one of a two-part series.

Return on Investment, or ROI, is one of the best-known measurements of how much money or profit is made on a given investment. It is a ratio between net profit and cost of investment that can be stated as follows:

ROI = Gain – Cost / Cost

Though it is a simple concept, there are a number of variables you must account for to render an accurate measurement. For example, when calculating gains, you should be mindful of the time your rental property stays vacant, such as transitions between tenants, as the lack of income during that period will affect the ROI. When it comes to costs, be sure to include repair and preventative maintenance expenses, property taxes and insurance costs on top of down payments and mortgage payments.

Because the ROI is a snapshot in time of profitability, appreciation of (and sometimes depreciation) the real estate value along with tax advantages of rental can have an impact on your returns. Additionally, rents will typically go up with inflation while your mortgage payments stay the same, all of which can increase your ROI.

The 203(k) FHA Loan: Adding on Your Rehab Costs to Your Loan

5 little red houses, The 203(k) FHA Loan: Adding on Your Rehab Costs to Your LoanAn 203(k) FHA Loan, sometimes called a Rehab loan or FHA Construction Loan, allows you to buy or refinance a home that needs work. With this FHA loan, you can include in your mortgage the dollar value needed to repair or upgrade the home. Your loan will then cover the purchase or refinance price and the cost of upgrades, allowing you to pay for the renovations over time as you pay down the mortgage. This is a superb financing tool that may allow you to get into an area where turn-key homes are more expensive. It is important to remember that in order for a lender to approve financing, the home must meet certain safety and livability standards. As 203(k) loans are insured by the Federal Housing Administration, lenders may be able to offer more lenient qualification requirements than other type of renovation loans.

The process for an FHA 203(k) loan is quite similar to that of regular home buying, but with a few extra steps:

  1. Apply with a 203(k) approved lender
  2. Get approval for the loan
  3. Select a contractor for your renovation project
  4. Get estimates for the project
  5. Close the loan
  6. Complete the repairs
  7. Move into your new home

Are you interested in a 203(k) loan or would you like more information? RLG has the tools and resources at its disposal to get you on your way. Call us today to experience firsthand the dedicated, personalized customer service and undivided attention that RLG has to offer!

What is Cap Rate?

Business, finance, saving money, property ladder or mortgage loan concept : Wood house model, coins and financial statement or saving account book on desk table, cap rateThe capitalization rate (or cap rate, in short) is a metric used in real estate to indicate the potential rate of return from an investment property. It is calculated based on the net income the property is expected to generate. The formula is spelled as follows:

Capitalization Rate = Net Operating Income / Current Market Value

The Net Operating Income is essentially the difference between revenue and operating expenses. It does not include principal and interest payments on loans or capital expenditures. Assuming you own a rental property that pulls in $100,000 in total annual revenue and incurs $65,000 in maintenance costs and taxes, your NOI will be $35,000.

To calculate your cap rate, you will divide the $65,000 by the property’s current value. Supposing the property is valued at $500,000, then the cap rate will be 0.07 or 7%. This percentage is used as an indicator of the return you can expect on an investment. In contrast, if the cap rate on a similar rental property is only 2%, that means that the one projected at 7% would be more profitable and produce the highest return.

In addition to profit, the rate also indicates the duration of time it will take to recover the invested amount in a property. For instance, with a property whose cap rate is 10%, you would divide 100 by the cap rate. In this case, it would amount to a 10-year payback period.

While a higher cap rate may seem like the obvious choice, it is also understood as a measure of risk. With higher cap rates, there is a greater risk of not getting the return you expect, and perhaps not getting your investment back. As a best practice, use this metric to gauge comparable homes in a same neighborhood and beware of cap rates that are irresistibly high.

Do you like our content? Subscribe to our YouTube channel and stay on top of all the real estate trends. Are you ready to invest? Call us today to learn more and experience firsthand the dedicated, personalized customer service and undivided attention that RLG has to offer!

Breaking Down the BRRR Method

Investment Lending Concept, BRRR Method

Investment Lending Concept, BRRR MethodThe BRRR Method, which stands for Buy, Rehab, Rent, Refinance, is one of these buzzwords that are often thrown around in the real estate industry. Notwithstanding the hype, this strategy can yield great returns on investment. Simply put, the BRRR boils down to adding enough value to a property to recover the money you invested in it. This, in turn, allows you to take the money and use it to buy more properties. Over time, you will be able to build a real estate portfolio that gives you complete financial independence.

Let’s dive into each step of this multipronged method:

  1. Buy

Finding a good deal is one of the most important aspects of the BRRR method. To implement this strategy successfully, you need to buy properties under the market value and never invest more than 70 to 75% of the property’s after repair value (ARV).

Most lenders use the ARV to determine how much money you can borrow and typically offer loan-to-value (LTV) rates ranging from 60 to 75%. Keep in mind that your lender is likely to request their own appraisal as part of their due diligence to compare with the ARV that you present, so it’s important to make yours as accurate as possible.

  1. Rehab

Rehabbing a house comes with a myriad of challenges. Your focus should be on making the house functional and livable. Any aesthetic improvements should make sense financially so the value added exceeds the costs. A finished basement or garage and basement, on one hand, are rarely worth the expenses. New tiles and new light fixtures, on the other hand, can have a positive effect on rent while keeping the costs low.

  1. Rent

It will be a lot easier to refinance your investment property when it is occupied by renters as properties that stay vacant for an extended period of time send out the wrong signals to lenders. Make sure to screen tenants diligently. Checking the tenant’s background, verifying their job and income, and contacting previous landlords are some measures you can take in anticipation of a lease agreement.

Try to maintain an open communication line with your tenants and work hard to keep the good ones by being responsive and attentive to maintenance faults.

  1. Refinance

The next step is to recoup the initial equity with a cash-out refinance so you can repeat the process and build out your real estate portfolio. The goal is to get as high of an appraised value as you possibly can. The typical cash out financing is done after 6 months of owning the property, based on ARV. This wait period is called the seasoning term and can vary from lender to lender.

Are you interested in going the BRRR route? RLG has the tools and resources at its disposal to get you on your way. Call us today to learn more and experience firsthand the dedicated, personalized customer service and undivided attention that RLG has to offer!

The FHA Loan: Putting as Little as 3.5% Down

FHA Loan, investment lending

FHA Loan, investment lending

FHA loans are mortgages insured by the Federal Housing Administration (FHA), which can be issued by any FHA-approved lender in the United States. Unlike conventional loans, FHA loans are government-backed, which protects lenders against defaults. This in turn allows lenders to offer prospective borrowers more competitive rates.

The biggest obstacle to most new homebuyers is the feared down payment. But did you know that FHA loans allow down payments as small as 3.5%?

On a $250,000 home, a 3.5% down payment translates to $8,750 – quite a contrast to a traditional 20% down payment of $50,000.

To qualify for a 3.5% down payment with a FHA loan, your credit score needs to be at least 580. If your score is lower than this, you will need to put at least 10% down.

Contact RLG today to see if you qualify!