If you’re looking to invest in Toronto real estate, understanding the math behind your investment – and how much money you stand to make (or lose) is critical.
Understanding Real Estate Investment Math
Investment, Income and Expenses
When evaluating whether or not to buy a particular investment property, you’ll need to estimate:
Your Investment
You need to have a good understanding of all the costs that make up the initial purchase price – that’s the real amount of your investment. Your investment includes:
Your downpayment
Land transfer taxes
Immediate repairs and renovations
Home inspection cost
Financing costs (eg appraisal)
Legal costs to purchase the property
Income
To help you decide if a property is a good investment, you need to forecast the potential income. Your REALTOR should be able to estimate potential rent, based on how much similar nearby properties are renting for. Make sure to include the following in your income calculations:
Rental income for the apartment
Any additional possible income – for example, additional rent from parking spots or garages or money earned from coin-operated laundry
You should also estimate a vacancy allowance, to account for times when the property isn’t occupied or rent isn’t being paid.
Expenses
You won’t know if something is a good investment until you estimate all of the potential costs. Make sure to include these operating and financing costs:
Financing costs (ie, the amount of the mortgage payment)
Heating
Electricity
City services (garbage, water)
Property taxes
Condo fees (if applicable)
Insurance
Property management
Repairs and maintenance
Snow removal and yard maintenance
Pest Control
Key Investment Metrics
While experienced property investors have their own favourite ways of evaluating investment properties, the metrics they usually use include:
Cash Flow
The difference between the income and the expenses
Capitalization or CAP Rate
Estimates an investor’s potential return on a property
Cap Rate=Annual Net Operating Income / Property Cost
Debt Coverage Ratio (DCR)
DCR is the ability of the projected rent (after operating expenses) to cover the mortgage obligations
Debt Coverage Ratio = Net Operating Income / Annual Debt Service
A DCR of less than 1 indicates a negative cash flow
Yield
Annual income from the investment expressed as a percentage of the investment’s total cost
Gross Yield = Total Rents / Purchase Price
Net Yield = (Total Rents – Operating Expenses) / Purchase Price
Return On Investment (ROI)
A property’s Return on Investment or ROI is a combination of:
Cash on Cash Return
Calculates the cash income earned on the cash invested in the property
Cash on Cash Return = Cash Flow (before taxes) / Investment
Mortgage Paydown
Every month, part of the principal of the mortgage is paid down by the rent
Mortgage Paydown = Mortgage Paydown /Investment
Appreciation
If home prices increase, that increase in value is part of the ROI when you sell it
