The Well Informed Investor : Part 4: Crunching The Numbers

Posted on 23. Nov, 2011 by in General

Hey guys

A big welcome from a snowy, stormy Nova Scotia as we are brace ourselves for the first big storm of the season. It’s a perfect day to stay indoors and catch up with writing and blogging.

We’ve put together Part 4 of our beginner investor series for you. If you’ve been following the earlier series, you’ll now have a solid understanding of the economics affecting real estate investing, you’ve hopefully become a geographical specialist in your target area and you know how to identify at a glance whether a property cash flows or not.

Now is the time for the nitty gritty part, calculating the expenses to determine the net cash flow that the property will produce. 

It’s vital that you calculate every possible expense, forgetting to include one can result in a significant reduction in cash flow.  Even if math is not your favourite subject, you may want to spend time learning and improving as simple mistakes at this stage of the analysis will have big consequences.

What kind of operating expenses do you need to figure in your calculation? Things such as:

Heat  – bear in mind that the type of heat will vary in price quite considerably  (sometimes paid by tenant/other times by landlord)

Electricity (as above)

Water/sewer

Property Management Costs

Condo Fees (if applicable)

Property Taxes (you would be amazed by how many people forget this one in their analysis)

Insurance

Repairs and Maintenance

Garbage removal/snow removal/lawn care

The other expense you need to budget for is vacancy. This often gets overlooked but should be factored into your calculation.  Find out the vacancy rate for your local area, you can access this information from CMHC – Canada Mortgage and Housing Corporation. Once you have an idea of the figure, you can save a percentage of your rent in a reserve account to cover you in the event of a vacancy.  The vacancy rate here in Halifax is 3.0%  so we tend to budget just over 3%  from our monthly rent to cover these costs.

Fortunately, our Halifax properties have had zero vacancies, so that reserve fund is looking healthy – *but* vacancy is inevitable.We are certain that there will come a time when we will be thankful for this contingency fund :)

Next, take the total of the operating expenses (annually)  from the gross income (that’s the total annual rent) – this figure will be your net operating income (NOI) annually.

To determine cash flow  you now need to deduct the mortgage payment (principal plus interest). This figure is your CASH FLOW and it had better be positive, otherwise you are in for a world of pain! We know a few investors who have bought with a negative cash flow – but – if you want to save yourself HUGE headaches and avoid hedging your bets on the the property price appreciating, we would strongly advise buying for postive cash flow.

Hope this helps you understand the numbers, the calculation takes a bit of practice but once you’ve done it a few times, it becomes second nature.  The important thing is to work off an expense template – that way you won’t forget to deduct any of the crucial expenses!

Stay tuned for the 5th and final part of the Well Informed Investor Series next week.

Have a great week:)

Jane & Richard

 

 

 

 

 

 

 

 

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