Real Estate Investment Analysis – Before entering or starting any new project, a real estate investor must conduct an investment analysis. A successful rental home investor may have a portfolio of dozens of properties. Real estate investing success is based on a number of elements. All of these must be taken into account. When you buy wisely, you can expect double-digit returns and a consistent cash flow for years. Alternatively, if you fail to conduct adequate due diligence, you may end up with a worthless investment property.
Net Operating Income
Understanding net operating income is the first step in any investment analysis (NOI). This figure represents the entire income your property earns minus any expenses. These expenses include the costs of property maintenance. To calculate your NOI, simply remove total expenses from total revenue. Divide the resulting number by 12 to determine your monthly NOI.
There is, however, one snag. Loan costs are not included in your overall expenses.
Your cash flow is what’s left after you subtract those loan expenses, which is usually your mortgage. When you eliminate debt service from NOI, you’re left with cash flow. This is the amount you’ll make.
The more money you borrow, the less money you have. If you pay cash for the property, your NOI will equal your cash flow.
Cash flow is, admittedly, a product of a slew of factors, each of which has the potential to alter and degrade — or enhance — a scenario. The market and the economy have an impact on some inputs. When a big local firm closes or relocates, the market for rental property might drop dramatically. The Federal Reserve has the ability to raise overnight interest rates, raising borrowing costs and affecting the broader real estate market. This shift could increase the cost of purchasing new properties and diminish your cash flow.
Things like this are beyond your control, but you may help to avoid them by completing your homework on the health and plans of local employers. Keep up with economic news and prepare for interest rate changes. If your properties are profitable and have recently had their leases renewed, you’re generally in good condition.
The Depreciation Factor
Naturally, the Internal Revenue Service (IRS) will demand a portion of any rental profits. Investing in real estate, on the other hand, comes with a slew of tax benefits. One of the flaws in the property depreciation deduction, is an important part of property valuation.
For those in high tax brackets, depreciation can even lower taxable gains from other investments. When the costs of maintaining and renting a property, including depreciation, exceed your taxable profit, you can typically utilize your residual losses against other investment income.
Because depreciation isn’t paid out of your pocket, it’s not a cash loss. It’s a computed figure that’s treated as a tax deduction. Even though you display an operational loss for tax reasons, you can nevertheless have a positive monthly cash flow.
If your company has rental property, you must pay property taxes, but you can deduct these costs from your taxable income. Businesses pay property taxes based on the assessed value of their real estate in the same manner that people do.
When real estate is sold within a taxation year, the tax is divided between the prior and new owners. This proportion is calculated by comparing how much of the year you possessed the property to how long the previous owners had it.
Landlord insurance is similar to normal homeowners insurance in that it helps to cover the value of the building. The policy will cover tenant damage as well as storm-related losses. If your home is in a high-risk location and is vulnerable to flood, earthquake, or wildfire, be sure you have the right insurance in place to protect your investment.
If you find yourself in a bind after a disaster, you can apply for a loan through the Small Business Administration’s (SBA) Disaster Assistance program to help you restore the damage.
1031 Tax Deferred Exchange
You can make a profit on a property and invest the proceeds in another without paying capital gains tax, but there are some extremely tight restrictions to follow. Title 26, Section 1031 of the Internal Revenue Code states:
“If property held for productive use in a trade or business or for investment is exchanged only for the property of like type to be kept either for productive use in a trade or company or for investment, no gain or loss shall be recognized.”
A “like-kind” property is one that is similar to another real estate or property. It does not, however, necessitate a land-for-land or office-for-office swap.
Rental real estate is unlike any other investing asset class or strategy. People require housing, and owning a home is not feasible or desirable for everyone.
Tax, investment, or financial services and advice are not provided by The Balance. The material is being provided without taking into account any specific investor’s investment objectives, risk tolerance, or financial circumstances, and may not be suitable for all investors. Past performance does not guarantee future outcomes. Investing entails risk, including the possibility of losing money.