Get real about your real estate returns

What return will you need to make an income property worthwhile? Here are two metrics to consider.

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by

From the June 2013 issue of the magazine.

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The cash-on-cash return looks at annual operating cash flows net of mortgage costs and compares them to your cash investment (your down payment). The capitalization rate ignores the mortgage payments and compares operating cash flows to the full purchase price. Look for a cap rate significantly higher than the interest rate on the mortgage, and higher than the returns on safer investments. Otherwise you’re not being compensated for the effort and risks associated with investing in real estate.

Rui Torrao’s 10% cap rate target is very difficult to find these days: a recent analysis by Boardwalk REIT found cap rates for high-quality large apartment buildings ranged from 3.75% to 4.75% in Vancouver and 5.75% to 6.75% in southwest Ontario. In this hypothetical example, we’ve assumed you put 50% down on a property valued at $300,000. We’ve also assumed the mortgage interest rate is 3.5%, amortized over 25 years.

7 comments on “Get real about your real estate returns

  1. What a ridiculous analysis–where can you find a $300K property that rents for $33K a year — almost $3,000 a month??? I know it's hypothetical but at least use something remotely realistic rather than pumping up expectations –or is that the goal–fuel buyers?

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  2. You're kidding, right???
    Where can you pay $300k for a rental property that churns out $2750 per month???
    Get real please.

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  3. Wouldn't the return on equity be a more relevant calculation? E.g. If I run my own rental property figures through your calculations I get 32% and 67% respectively. Sounds fantastic! BUT, if I take net rental income as a percentage of the net proceeds I'd get if I sold it I am only making 3%! Much different picture isn't it. That is why I'm planning to sell and invest my equity elsewhere.

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  4. Must be GTA or Vancouver posters?

    My latest buy was just over 600K purchase price and has gross rent of around 150K a year, netting around 90K (not including mortgage payments). At 10% cap rate it's value is around 900K worked the other way. This is with onsite management, numbers would be even higher if I was more involved. Id rather spend my time looking for more buildings however!

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  5. Who would ever pay $2750 rent on a place they could bye for $1800 a month?

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    • A few commenters have noted that the rental rates in the example are not realistic: Depending on the property type and location, they most certainly are. We purchased a condominium in Florida for both vacation rental and personal use. Purchase price was $405,000 (oceanfront is expensive). Gross rents so far in 2014 are $55,000. Direct expenses amount to about $15,000 per year, including property taxes, condo fees, etc. We’re running very close to a 10% cap rate, and may exceed that depending on the remaining rental weeks.

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  6. Why wouldn’t you use rational numbers? Under no circumstance would anyone put a 150000 dollar down payment on a $300000 house. This contradicts a lot of your other articles. Plus what type of person has that kind of money to blow on a down payment. It would make more sense to put your money into investment propertys with 20% down payments or invest some because of low mortgage interest rates.

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