There are three main factors that one must consider when attempting to determine the financial viability of an investment property. These are referred to as the “3 Course Meal” of property investment, because they each add some level of future or immediate benefit to you as an owner, and when viewed as a whole form a significant incentive to potential buyers.
The Appetizer – Cash Flow
The total amount that you have left over each month after all expenses have been paid is what you call “cash flow.” This is usually the first benefit that investors have the chance to reap from their hard work, and it is an incentive that helps to justify an investment in property during times of uncertainty. You can almost always expect to benefit in the form of quick cash that comes at the end of each month. (realestate.about.com).
Here is a basic formula that can help you to determine what your investment property’s “cash flow” will look like. Simply take the amount that you will bring in from rent, and subtract any expenses, such as loan or mortgage payments, utility bills, renovations, or vacancy. It should look something like this: Rent income – Payments – Expenses – Vacancy Loss = Cash Flow
The Main Course – Equity
The “main course” factor is what ensures future financial security, and drives investors to commit to their property long term. Let’s say that you bought an investment property for $300,000, and every month your payment takes off some of the interest and some of the principle from your loan. Perhaps $1000 of that payment each month goes directly to the amount you owe, and at the end of each year you will have paid down $12,000 paid from Tenant’s rent.
After ten years, you will have invested $120,000, on top of whatever you originally used for a down payment. If you were to sell the property right then and there for the original $300,000 that you bought it for, the $120,000 would be yours to keep, and the rest could pay off the loan. This is how you make money in investment property over the extended periods without falling victim to short-term market fluctuations.
The Dessert – Market Increase
Here’s another imaginary scenario: Let’s say you purchase a property for $350,000 with a 10% down payment. That means your initial investment is $35,000 to own an asset currently valued at $350,000. If prices were to remain stable and housing appreciation maintains historic levels—2% per year—then your net equity after 10 years would be as follows not including maintenance and utility costs (moneysense.ca):
|Year 1 $313,294.00||Year 1 $43,706.00|
|Year 2 $304,989.00||Year 2 $59,151.00|
|Year 3 $296,376.00||Year 3 $75,046.80|
|Year 4 $287,442.00||Year 4 $83,980.80|
|Year 5 $278,174.00||Year 5 $108,254.28|
|Year 6 $268,562.00||Year 6 $125,594.85|
|Year 7 $258,592.00||Year 7 $143,447.98|
|Year 8 $248,251.00||Year 8 $161,829.78|
|Year 9 $237,524.00||Year 9 $170,031.40|
|Year 10 $226,398.00||Year 10 $200,250.05|
The equity in your home would amount to just over $200,000 after 10 years (once again not accounting for maintenance and utility costs). That’s why we call the final course the dessert. It is pretty much the icing on the cake that makes long term property investment such an enticing and profitable endeavor (moneysense.ca).
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