Financing investment properties needs a close look as investors again venture into the market in increasing numbers. As always, cash flow is king. However, how much cash flow you have is highly affected by how you go about financing investment properties.
Financing Investment Properties Has Changed
Gone are the days from 2004, 2005, and 2006 when you could pay almost any price for a house and hold it for a few months to take a profit by selling it for rapidly increasing appreciation. Today, you must plan for modest appreciation and plan to hold the property for several years. That means the house has to have decent positive cash flow.
Experienced investors know it’s important to use conservative numbers when looking at options for financing investment properties. That means slightly underestimating the rent that will come in and overestimating the interest rate that will be paid for financing investment property.
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Financing Investment Properties – A Look at the Numbers
The reason investors get into bad deals is because they don’t go through the financing investment in detail. They make off the cuff assumptions that don’t pan out. They over estimate rent and underestimate expenses. Failing to correctly estimate a financing investment is the primary cause of investors getting into negative cash flow financing investments instead of ones that cash flow positive.
Let’s take a $100,000 house. You’ll make an initial financing investment of $36,000. That covers a 20% down payment, closing costs, and $10,000 for some repairs. Your financing investment will cost you $479.64 with a 6% loan. Homeowner’s insurance, property taxes, and other operating expenses brings your monthly expenses to $652.97 or $7,835.64 per year.
You are able to rent the house for $800 per month. Your monthly profit is $147.03 or $1,764.36 per year. That’s positive cash flow from your financing investment. Not great but at least it’s positive. Now divide your annual positive cash flow by your initial investment.
$1,763.36 / $36,000 = 4.90%. That is your cash on cash rate of return. Again not great but better than what the banks are paying and you’ll also be earning appreciation. However, knowing that number enables you to compare it to other opportunities in the real estate market.
The financing investment numbers will be different for each property you consider. By reducing them to the cash on cash percentage, you can easily see the best opportunity for financing investments of all types.
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