Commercial property requires more evaluation
If you’re purchasing a multifamily, retail, office, or industrial property as an investment, appreciation is a factor, but the property’s value is determined by the income it produces, or can produce when performing optimally.
In addition to cash-on-cash return, you’ll want to look at the capitalization rate, which is essentially the rate of return on your money as it would be if you had paid all cash for the property. The capitalization rate (cap rate) of the property is determined by dividing your net operating income (NOI) by the current market value of the property.
The NOI is factored by taking your gross annual rents and subtracting your expenses, including mortgage interest if there is any, but not mortgage principal (so you need to break out your payments).
If you bought an apartment building for $1 million with $50,000 NOI, your cap rate would be 5% and your cash-on-cash return, if you put $250,000 in the deal and mortgaged the property, would be a whopping 50% annually.
Turn your home into an investment
Most people don’t think this way when buying a piece of real estate for personal use, and that could be a mistake, especially if we see an ugly recession occur again, or if you need or want to move to a new home or city. One of the claims to fame by Robert Kiyosaki, a real estate mogul author of the bestselling book, Rich Dad, Poor Dad, was that your primary residence is not an asset. It’s a liability. That’s because it doesn’t make you money; it only costs you money to upkeep and maintain. Sure, your home will likely appreciate a lot over the long haul, but Kiyosaki claims appreciation should be the icing on the cake, not the primary reason for buying a home or property.
If you’re interested in learning about investing in real estate but don’t yet have the capital to purchase an investment property or if you’re not sure you want to be a landlord, you could turn your home, or a portion of it, into an investment property in one of the following ways:
- Purchase a home with advantageous owner-occupied financing terms, such as putting just 3% down and living in it for a couple of years before moving out and renting it to tenants. You can keep doing this as much you want, and eventually build a portfolio of homes in markets you know inside and out because you’ve lived in them. If this might be your plan for when you buy the home initially, check to see whether market rents would cover your mortgage and other expenses.
- Purchase a home with a basement apartment or the ability to create a separate living space for you to rent out. Then, you can see what it’s like to be a landlord, and bring in income that covers part or most of your living expenses. If you ever move out, you can rent out both units separately to increase your cash flow.
Considering these factors even when buying property for your personal use can help you make a good and potentially profitable choice.