To make all of this worthwhile, the rental property should yield a good return; otherwise, there would be no point in investing all this money.
The One Percent Rule
The One Percent Rule is one of the general rules of thumb used by investors to determine if a rental property is performing as it should. It simply states that the rent before expenses – in other words, the gross monthly rent – must be equal to at least one percent of the purchase price. This means that the gross revenue of the property would be 12 percent of the purchase price each year, although after expenses, the net revenue is actually closer to 6 to 8 percent.
Some investors also consider it a good return when the monthly rent of a property is 2 percent or more of the purchase price plus repairs.
The capitalization rate
Working out the capitalization rate of a property, also called the CAP rate, is another way to determine whether you are getting a good return on rental property. The higher the cap rate is, the better the annual return on your investment will be. Of course, you should bear in mind that cap rates differ from city to city and even across neighborhoods.
To determine the CAP rate, divide the net income of the property by its price. Whether a CAP rate is good or bad will depend on your investment goals, with some investors happy if their CAP rate is as low as seven percent and others aiming for nothing less than ten percent.
Gross rent multiplier
A gross rent multiplier is another rule of thumb for measuring whether you are getting a good return on rental property for a certain area compared to the other properties nearby. It is calculated by dividing the price or value of the property by the gross rent. The lower the resulting gross rent multiplier is, the better the investment. However, this method doesn’t take into account other expenses and is more of a general way to compare rental returns.
These rent-to-purchase-price rules are useful for evaluating whether a property is achieving a good return, but they are all subject to a myriad of external factors that can influence their accuracy. Factors such as the type of property, location and amount of financing all play a big role when it comes to returns, so always look at the bigger picture.
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