Quickly scan the internet comment sections regarding housing prices and you will see a large number of folks commenting on the impending crash of prices and the fall of the capitalist system.
However, there is one simple calculation that will tell you if the sale price of houses is acceptable for the area. It’s not the only criteria but this method works well for most of the markets.
Remember back when I said there are 3 ways to value real estate? This method is based on the Income Method. It utilizes the relationship between the cost of ownership (principle, interest, taxes, maintenance, utilities) measured against the rental income.
This value is expressed as Net Operating Income and you will sometimes hear the term CAP Rate.
In simple terms, if the property can be rented out for an operating income which exceeds the expenses to own it (a net), the property is considered a good investment. How much net operating income varies based on the property. Older properties require higher CAP Rates because of maintenance and variable expenses. New properties can often sell for lower CAP Rates because of less maintenance.
At press time a variable rate mortgage is 3%. Buy a 4 bedroom house at $620,000 and put 20% down and your mortgage for $500k will be $2100 a month. Monthly Expenses? Taxes $300. Water $100. Insurance $150. Maintenance $200. Utilities are a wash as renters and owners both pay these. Total monthly cost is $2,750.
Three things to consider.
- About 40% of the mortgage payment pays down the principle so the entire mortgage is not an expense. About $800 a month in equity is building for the owner.
- A four bedroom house in my area rents between $2,500 and $3,500 a month. So, this house may be a good investment.
- Some people may create a 1 bedroom suite and rent it out for $800 to $1,100 in my area. Which, makes ownership of this home much less than rent!
Understanding Net Operating Income and CAP Rates will turn you into a savvy real estate investor in no time. In the short run ask your Realtor® for these stats and buy with confidence. Your home and investment are on solid financial footing.