I recommend that you retain a commercial Agent for your investment. Commercial Agents have been trained in real estate investments and can assist you in the calculations you are looking for. And, yes..there is a formula for making these types of calculations. The formula takes into consideration the price paid for the property,the yearly expenses, the rent collected etc
You will end up with a percentage, that will evaluate the IRR (internal rate of return).on your investment, .IE the difference between what your money would have made if put into the bank..as opposed to what you are making on this investment.
1. Depreciation. You can have two properties with the same number of units and with the same rents, same expenses and hence same NOIs having completely different cash flows because of depreciation. Depreciation is an accounting term that you reduce from the NOI to determine your taxable income. Obviously, if the depreciation is high your taxable income will be low, tax liability will be low and hence the Cash Flow After Taxes (CFAT) will be high. Depreciation in simpler terms is money that you do not get taxed on because you are setting it aside to pay for replacement of the structure after it's (and here is where the IRS lets you make money) "life" is over. The depreciation life and economic life are completely different. The IRS has determined that structures or improvements as they are called, for residential properties, depreciate over 27.5 years and for commercial properties depreciate over 39 years. As an example, if at the time you bought a triplex for say $400,000, the improvement value was $275,000, you can depreciate $10,000 each year that you hold the property. In other words, deduct $10,000 from the NOI before determining the taxable income. You may ask what happened to the balance $125,000 of the property ($400,000 minus $275,000). That was the value of land and the IRS does not allow you to depreciate land.
2. The other factors you need to consider are the kind of income you will have (IRS defines income as active, passive and portfolio), type of vesting, type of mortgage (another below the line item), discounted cash flow, basis at acquisition and change in basis during holding of property, tax rates, possible changes in capital gains and cost recovery (depreciation) rates and finally capital accumulation of wealth to determine annual growth rate.
It is not possible to deal with each and every item here. Suffice to say, investments are not all about CAP rates and GRMs - there are a number of factors that will affect your cash flow after taxes and you need to understand them.
My advice, get an agent who understands investment properties and has actually transacted a number of them. Get references, verify them and then proceed.
Certified Commercial Investment Member
United America Realty
A few details to always consider with this though: You always want to check, especially in this economy, to make sure the rents listed are accurate and not inflated. Find out what tenants are in a lease, which ones are month-month, find out if there would be any gain or loss if one or more of them moved out. A potential increase in rent due to low rent in a unit is usually called "upside potential".
Also, sometimes the agent will list "projected rents" when all or some units are vacant. Make sure and confirm these numbers are realistic because the rental market has not been immune to the economic downturn at all!
I am quite familiar with the intricacies of income properties and would be happy to answer more questions for you.
- Jeffrey White -
I think what you are doing is very financially intelligent. A lot of wealthy real estate investors got started with buying a 2-4 unit and living in one and renting out the others. Especially if the numbers work. Imagine one day having the other units pay 100% of your PITI and having NO housing payment! Basically living rent free. That is intelligent.