Norada Real Estate Investments

Is the Housing Crisis Over in America?

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Is the Housing Crisis Over in America?

The housing crisis is not over in the U.S. There is a shortage, or housing underproduction, in all corners of the country. The major coastal cities are known for their exorbitant real estate prices, which are driven by zoning restrictions and a scarcity of available housing. According to a new study, these issues are increasingly plaguing once-affordable towns and cities across the United States.

According to an analysis by the housing policy group Up For Growth, more than half of the nation's metropolitan regions had a housing shortage in 2019, a significant increase from one-third of cities in 2012. The country is short 3.8 million homes to meet its housing needs, which is double the number from 2012.

In recent years, rising raw material costs have exacerbated builders' woes, particularly during the pandemic, when lumber prices increased by more than 150%. But, given the large cohort of Millennials entering the housing market, one of the most significant reasons for this shortfall has been the severe underbuilding of entry-level homes, where the majority of the demand exists. Given the significance of this factor, we go into more detail about the entry-level labor shortage below.

According to an analysis published by Freddie Mac, long-term single-family home development declines have caused the housing shortage. Starter homes have decreased much further, exacerbating that trend. Between 1976 and 1979, 418,000 entry-level single-family homes were built annually, accounting for 34% of all new homes built. Mortgage rates rose from 8.9% to 12.7% in the 1980s.

As mortgage rates rose, housing became less affordable, decreasing demand and supply. In the 1980s, the entry-level housing supply dropped by nearly 100,000 units to 314,000 per year. The entry-level percentage of new single-family homes remained at 33%, similar to the late 1970s, showing that entry-level supply fell by the same amount as the entire new construction market.

According to another report published on the housing shortage by Fannie Mae, every city in the country has a housing supply problem, but each city's housing supply problem is quite unique. The research conducted by the firm found out that while the US has a nationwide affordable housing deficit, each state and city's approach to solving it is different, and the tools and techniques utilized to build needed new housing supply must be adjusted.

Tools to increase housing supply are accessible, although less so. Many towns oppose hard choices and reforms to increase housing for low- and moderate-income homeowners and renters. However, without those choices, the economic and social benefits of adequate housing supply will be wasted and the issues caused by its scarcity will deepen.

The housing supply shortage has well-known causes. After the Great Recession, housing development plummeted. The last decade saw the fewest new residences created since the 1960s. 3.8 million housing units were needed in 2019. The pandemic-induced materials and labor scarcity worsened the tendency, as shown by the 2021 rent and home price increases.

Rising mortgage interest rates have already dampened housing demand, particularly for new homes, and an economic recession could reduce demand further. Prices and rentals may stabilize or fall in some markets. The supply crisis will persist, hurting low- and moderate-income families. Fannie Mae ensures affordable housing for low- and moderate-income families by providing mortgage funding.

From 2019 through 2021, Fannie Mae sponsored almost 575,000 affordable units, according to their analysis. Their loans on newly built single-family houses bought by moderate-to-low-income households, funding to preserve affordable multifamily rental housing, and investments in low-income housing tax credits make up the majority of that amount.

If the housing supply is there, we can finance more. Nope. Families everywhere will continue to suffer with high housing costs until communities take concrete action to construct and preserve affordable housing stock where and how it is needed most. Fannie Mae economists Kim Betancourt, Stephen Gardner, and Mark Palim have issued a study report.

The authors compared the housing supply of the 75 largest U.S. urban markets to the housing needs of their residents. The housing supply problem is national, but solving it is local. Most housing-cost-burdened households are not just in coastal metros with high housing expenses. Fresno, Charlotte, and Las Vegas have high housing-cost-burdened household rates. Even smaller cities like El Paso and McAllen, TX, lack affordable housing.

Housing shortages necessitate localized solutions. According to the research paper, affordable multifamily rental units in Dallas and Atlanta could boost housing affordability. Some markets need new single-family houses, while others need to preserve multifamily housing. This analysis, based on 2019 data (the last pre-pandemic year with accessible housing cost burden data), shows that supply and affordability issues have worsened.

Even if home price growth has slowed and inflation and rising interest rates have reduced demand, working people have suffered from the rise in rents and housing prices since 2019. The supply dilemma can only be solved by building more housing and preserving affordable housing. While the economic drivers of housing costs—materials and labor inflation, supply chain disruptions, etc.—may take years to fix, states and municipalities may work with investors, builders, and lenders to make more homes available.

In several of the most cost-burdened states, zoning reform to encourage higher density and multifamily housing near transit and job hubs are working. Another option is to reduce or streamline regulatory barriers that hinder new development, particularly for manufactured houses and smaller starter homes that have all but gone in many large metro areas and made it hard for millions to buy their first home.

Federal low-income housing tax credits have been one of the most successful capital-generating mechanisms for affordable housing production and maintenance for over three decades and should be expanded and reinforced. Helping first-time homeowners and low-income renters could encourage the construction of additional affordable housing in areas of high demand.

Fannie Mae and the thousands of mortgage lenders and investors they work with daily are ready to finance affordable homes. The US has a world-class housing finance system. It's time to equal the housing supply.

Will the Housing Crisis Worsen in 2023?

Many homeowners are still haunted by the 2008 housing market crash when property values plummeted and foreclosures increased dramatically. According to a new LendingTree survey, 41% of Americans now fear a housing crash in the next year, owing to the memory of a sudden disaster at a time when the real estate market was riding high. But NAR Chief Economist Lawrence Yun draws the distinctions between today’s real estate market and that of more than a decade ago.

“It’s a valid question,” Lawrence Yun, chief economist for the National Association of REALTORS®, said Tuesday at NAR’s Real Estate Forecast Summit. “People are remembering the crushing and painful foreclosure crisis. So, it has become a key question: Will home prices crash after the strong run-up in prices across the country over recent years?”

  1. The labor market remains strong.

  2. Less risky loans.

  3. Underbuilding and inventory shortages.

  4. Delinquency lows.

  5. Ultra-low foreclosure rates.

At the virtual conference, where leading housing economists offered their 2023 forecast for the real estate market, Yun offered assurance that current dynamics are nothing like during the Great Recession. He pointed to several key indicators of how this market differs.

Homes in foreclosure reached a rate of 4.6% during the last housing crash as homeowners who saw their property values plunge walked away from their loans. Today, the percentage of homes in foreclosure is 0.6%—also at historical lows, Yun said. He predicted foreclosures to remain at historical lows in 2023.

housing crisis or crash coming
Source: REALTOR® Magazine

Danushka Nanayakkara-Skillington, assistant vice president of forecasting and analysis at the National Association of Home Builders, said she expects housing starts to drop by double digits in 2023. Then, “as the economy improves in 2024, the housing market will gradually come out of this slump that is expected from the next year,” she added.

Builder confidence has fallen over the last 11 months as mortgage rates rose and buyer traffic slowed dramatically. Fifty-nine percent of builders have reported using incentives, like mortgage rate buydowns and price cuts, to try to win buyers back, Nanayakkara-Skillington said. Labor shortages combined with lot shortages, higher material costs, and lending issues for builders are all compounding factors preventing more construction.

And while lumber prices have eased from record highs, construction costs remain 14% higher due to shortages in other supplies, like gypsum and steel. “All of these issues will keep homebuilding down,” Nanayakkara-Skillington said. “We don’t see these issues being resolved in the near future either.”

Sources:

  • https://www.freddiemac.com/research/insight/20210507-housing-supply
  • https://www.cbsnews.com/news/real-estate-housing-shortage-crisis/
  • https://www.fanniemae.com/research-and-insights/perspectives/us-housing-shortage
  • https://www.nar.realtor/magazine/real-estate-news/2023-real-estate-forecast-market-to-regain-normalcy

What is Cash on Cash Return in Real Estate?

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Cash on Cash Return

Cash on cash return (CoC) is a measure of the cash flow from a real estate investment, expressed as a percentage of the initial cash investment. It is used to evaluate the profitability of a rental property or other real estate investment. A high cash-on-cash return indicates that the investment is generating a good return on the initial cash investment.

Low cash on cash return indicates that the investment is not generating as much cash flow as expected. The cash-on-cash return of an investment property is a measurement of its cash flow divided by the amount of capital you initially invested. This is usually calculated on the before-tax cash flow and is typically expressed as a percentage.

Cash-on-cash returns are most accurate when calculated on the first year's expected cash flow. It becomes less accurate and less useful when used in future years because this calculation does not take into account the time value of money (the principle that your money today will be worth less in the future). Therefore, the cash-on-cash return is not a powerful measurement, but it makes for an easy and popular “quick check” on a property to compare it against other investments.

For example, a property might give you a 7% cash return in the first year versus a 2.5% return on a bank CD. It's worth noting that cash on cash return is a short-term metric, it doesn't take into account the long-term appreciation of the property, and it doesn't include tax benefits. Therefore, it should be used in conjunction with other metrics, such as the cap rate, to evaluate the overall performance of a real estate investment.

The cash-on-cash return is calculated by dividing the annual cash flow by your cash invested:

       Annual Cash Flow / Cash Invested  =  Cash-on-Cash Return

The annual cash flow is the net income from the property, which is calculated by subtracting the annual operating expenses (such as mortgage payments, property taxes, insurance, and maintenance) from the annual rental income. The initial cash investment is the total amount of cash invested in the property, including the down payment, closing costs, and any other expenses.

Let's make sure we understand the two parts of this equation:

  1. The first-year cash flow (or annual cash flow) is the amount of money we expect the property to generate during its first year of operation. Again, this is usually cash flow before tax.

  2. The initial investment (or cash invested) is generally the down payment. However, some investors include their closing costs such as loan points, escrow and title fees, appraisal, and inspection costs.  The sum of which is also referred to as the cost of acquisition.

Let's look at an example. Let's say that your property's annual cash flow (before tax) is $3,000. And let's say that you made a 20% down payment equal to $30,000 to purchase the property. In this example, your cash-on-cash return would be 10%.

     $3,000 / $30,000  =  10%

Although the cash-on-cash return is quick and easy to calculate, it's not the best way to measure the performance and quality of a real estate investment. Future articles will introduce you to better ways to evaluate your real estate investments.

What is a Good Cash Cash Return in Real Estate?

There are no hard and fast rules for determining a specific figure that should be considered a good cash-on-cash return. Most investors, however, agree that a projected cash-on-cash return of 8% or higher is the ideal figure. It also relies on the investor, the local market, and your future value appreciation forecasts. Some real estate investors are happy with a safe and predictable CoC return of 7% – 10%, while others will only consider a property with a cash-on-cash return of at least 15%.

Cash on Cash Return Vs ROI

Cash on cash return (CoC) and return on investment (ROI) are both measures of the profitability of a real estate investment, but they are calculated differently and provide different information. Cash on cash return is a measure of the cash flow from a real estate investment, expressed as a percentage of the initial cash investment. It is used to evaluate the profitability of a rental property or other real estate investment.

Return on investment (ROI) is a measure of the overall profitability of an investment, expressed as a percentage of the total investment. It takes into account both the cash flow and the appreciation of the investment.

The formula for ROI is: (Net profit / Total investment) x 100

The net profit is the total return on the investment, which includes the cash flow, any appreciation, and any other income from the investment. The total investment is the initial cash investment plus any additional costs, such as closing costs, repairs, and improvements.

For example, if an investor purchases a property for $200,000 with a $40,000 down payment, the property generates $12,000 in annual cash flow and the investor sells the property for $220,000, the ROI would be: ($12,000 + $20,000 / $40,000) x 100 = 80%

Cash on cash return provides information on the short-term cash flow of the investment, while ROI provides information on the overall profitability of the investment, including both cash flow and appreciation. It's important to use both metrics to get a full picture of the investment's performance.

Cash on Cash Return Vs Cap Rate

Cash on cash return is a measure of the annual cash flow of a rental property as a percentage of the initial cash investment. The capitalization rate, or cap rate, is a measure of the rate of return on a real estate investment property based on the income that the property is expected to generate. While both measures are used to evaluate the performance of real estate investments, they are calculated differently and provide different information about the potential returns of a property.

Although there are many variations, the cap rate is generally calculated as the ratio between the annual rental income produced by a real estate asset to its current market value. Cap rates are measures used to estimate and compare the rates of return on multiple commercial or residential real estate properties. In contrast to the cap rate formula, which should only be used to compare similar properties in the same market, the cash-on-cash return formula can be used to compare potential cash returns across real estate markets.

To calculate the cap rate for a rental property, you will need to know the property's net operating income (NOI) and its purchase price or current market value. The formula for calculating the cap rate is:

Cap Rate = NOI / Purchase Price (or Market Value)

For example, let's say you are considering buying a rental property for $300,000 and the projected net operating income (NOI) is $30,000. To calculate the cap rate, you would divide the NOI by the purchase price:

Cap Rate = $30,000 / $300,000 = 0.1 or 10%

So in this example, the cap rate for the property is 10%. This means that the property's projected net operating income is 10% of its purchase price. A higher cap rate indicates a higher rate of return, so in this case, you would likely see the rental property as a good investment opportunity.

Investors Are Buying a Record Share of Homes

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Real estate is getting increasingly popular among investor groups. Investors bought more properties last year since home prices grew quickly and there were fewer homes for sale. They are eyeing growing prices because rental payments are also soaring, which encourages investors who want to rent out the houses they purchase. Many individuals who cannot locate a home to purchase are compelled to rent as a result of the housing supply constraint. In addition, investors who “flip” properties stand to make a substantial return as housing values increase.”

In the fourth quarter of the previous year, real estate investors acquired 18.4% of U.S. houses, according to Redfin. It was 12.6% a year ago and 17.4% in the third quarter. Although investor market share touched a record in the fourth quarter, the number of properties acquired by investors fell 9.1% from the third-quarter peak. In the fourth quarter, investors acquired 80,293 properties, up 43.9% year-over-year. Third-quarter investor house acquisitions were 75.3% cash. So, how are investors performing this year? Here's the summary of the latest Realtor.com® Investor Report for 2022.

Note: In their research, Realtor.com® analyzed deed data from January 2000 to April 2022 in 263 metro regions with more than 100 investor transactions in the year ending April 2022. They only considered single-family residences, condominiums, townhomes, and rowhomes, excluding multi-family buildings. They try to capture buy-and-hold investor purchases, excluding flippers. Some flipping activity is likely included as it is not always clear up-front whether an investor purchase is intended for a flip or buy-and-hold.

Investors Bought a Record-High Share of Houses in Spring of Last Year

Investor buyer trends 2022
Source: Realtor.com®

Realtor.com® defines an investor as a buyer or seller that was/is an absentee owner and that has a name that includes the following: LLP, LP, LLC, GP, or TRUST. According to their spring 2022 report, the investor proportion of house sales has declined significantly from its all-time peak in February 2022 but is about double its 2014/2015 level. After dropping in the early months of the pandemic, investors' proportion of house purchases has increased over the past two years, exceeding non-investors' growth and reaching a new high of 9.7 percent in February 2022.

Nonetheless, investor purchases have declined substantially in tandem with non-investor purchases since February 2022, bringing their entire buy percentage to 9.5%. However, the current proportion of investment purchasers is approximately double the proportion at the same stage in 2014/2015. In April, investors bought 9.5% of properties sold, up 2.8% from the same period last year but down from February's 9.7% peak.

After months of surpassing non-investor purchasers, investor behavior has paralleled non-investor behavior since February. 2021 investor house purchases surged 64% over 2020 when the COVID-19 outbreak hurt investor activity. 2021 purchasing was up 39% from 2019 before the epidemic. While investor purchases were down in January and February, they were up 31% in April and 64% over the same period in 2019, while total sales were down 8% and up just 7%.

Investors' percentage in house purchases is near record highs. In April, investors bought 9.5% of properties, down from 9.7% in February but up by 2.8% year-over-year. This high percentage is driven by both investor purchases and non-investor purchasers, who bought 11% fewer properties in April than a year earlier. The investor proportion of house purchases is almost double what it was in April 2015 (4.8%), but its growth pace has slowed compared to February after 19 straight months of increase.

Their data shows investor purchases under a corporate name. Cash purchases are overrepresented in the statistics because small investor activity under individual names isn't included. Pre-pandemic standards for investors buying properties with cash have changed. In September 2021, 78 percent of investors bought with cash, comparable to 2009 to 2015.

Larger investors with greater equity may have increased demand. Another is greater iBuying activity during this time. Since September, investors' cash purchases have fallen while mortgage purchases have risen. With borrowing rates so high, this pattern may alter in the coming months.

Larger Investors Grew Their Share of Purchases in 2021 to 35%

Despite the fact that smaller investors continue to acquire the highest proportion of properties among the group of investors we've found, bigger investors have overtaken smaller investors in terms of activity increase over the past year. Smaller investors, defined as those who have acquired 10 or fewer properties since their data collection began in 2001, accounted for 64 percent of investor-purchased homes in July 2020, just after the commencement of the COVID-19 epidemic.

Nevertheless, as housing demand surged and rents climbed over the last year, bigger investors, defined as those who have acquired more than 50 properties since 2001, raised their proportion of investment purchases from 18 percent in July 2020 to 42 percent in August 2021. Since August, demand from bigger investors has decreased to 32 percent in April, but their sales share has stabilized above historical norms, grabbing market share from both small and medium-sized investors.

Large home investor sale increase is attributable to Opendoor, Offerpad, and Zillow iBuyer activity (prior to their exit from iBuying). iBuyer's significant investor stake was 30% in 2021. In 2022's first four months, it was 22%. Large investor purchases fell from 32% to 27% in April when iBuyer data was removed. Among non-iBuyer big investors, demand peaked in August and has subsequently decelerated.

While investors are buying a record number of properties, the margin between their buying and selling has shrunk since August. August 2021 saw investors buying 14,000 more properties than selling. By 2022, the margin was 2,300 dwellings. While investor purchasing surpassed selling in March and April, investor selling is up 24 percent from April 2018 and 28 percent from April 2019.

real estate investor contribution 2022
Source: Realtor.com®

Charlotte Saw Greatest Growth in Investor Interest

Southern metros saw the most investment activity last year, followed by the West. Larger investors raised their purchases more than medium or smaller investors in the South and West. Investors bought 20% of Charlotte-Concord-Gastonia properties in the year ending April 2022. Branson, MO (19.5%), Birmingham-Hoover, AL (18.9%), Summit Park, UT (18.6%), and Memphis, TN (18.5%) had the highest investment activity.

Three of the top five metros where investors bought the most homes were in the South, which experienced the most investor interest and the most increase over the last year. In eight of the top 10 metros, investors paid less than the median price in April 2022. Summit Park, UT, and Branson, MO were outliers. In these eight metros, investors bought properties for 16% less. The median investor purchase price was $295,000 in April, 15% less than the median selling price overall and 10% less than the median investor house sold. In all 10 areas, investors bought more houses than they sold in April, vying with purchasers for limited inventory.

Metro Average Investor Purchase Shares and Change in Shares

Region Average of 12 Months End April 2021 Average of 12 Months End April 2022 Average of yy percentage point change
Midwest 5.9% 7.6% 1.7%
Northeast 4.3% 5.7% 1.4%
South 6.6% 9.5% 3.0%
West 4.6% 6.8% 2.1%
Overall Average 5.7% 8.1% 2.3%

Not all major investor markets showed increased interest in the last year. Charlotte-Concord-Gastonia, NC-SC (+0.7%), Jacksonville, FL (+10.2%), and Birmingham-Hoover, AL (+8.8%) witnessed the most investor market share growth. Eight of the top 10 metros with the biggest growth in investor purchases over the past year are very cheap South metros with median list prices as or more reasonable than the typical home nationally.

The average April 2022 listing price in the top 10 metros where investors are rising was $372,000, compared to $450,000 nationally. Investors bought cheaper properties in all 10 markets. They bought properties 13 percent lower than April's median price. Except for Danville, VA, investors acquired more properties in April than they sold.

Source: https://www.realtor.com/research/investor-report-april-2022/

11 Ways to Determine Rent for an Upcoming Vacancy

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How to Determine Rent for an Upcoming Vacancy

The challenge of setting the appropriate rent price for a home that is currently unoccupied can be a hard one for landlords and property managers. Setting the rent too high can lead to longer vacancy periods and missed rental income while setting the rent too low can lead to less profit and underestimating the value of the property. On the one hand, setting the rent too high can lead to longer vacancy periods and missed rental income.

It is essential to have a strong awareness of the local rental market as well as the elements that influence rental prices in order to avoid these errors and make the most out of your income. In this piece, we will discuss several efficient methods for determining the rent for an upcoming vacancy, such as completing market research, studying the attributes of the property, and evaluating the level of competition in the market.

11 Ways to Determine Rent for an Upcoming Vacancy

1.) If the vacating tenant has been a long-term tenant, and you had a good relationship, simply ask him. I bet over the years he's followed the neighborhood and knows from friends and fellow renters. He can tell you if he thinks you should charge more or less. Feedback from your vacating residents should be ONE piece of the info you assemble to determine.

2.) The quickest way to figure out the market rent is to put your tenant's “shopping” hat on and start looking. I observe area rentals (signs, newspapers, etc.), see how they are priced, and watch to see how long they stay vacant. Many times, I'll even stop by to get up close to see the condition of the . In every case, one that is priced right and sits for very long has “issues”.

3.) Another resource is a property manager with local rentals (and a website) who knows what they're doing. They make the most money by pricing at the top of the market and usually have little interest in discounting unless a property sits vacant for too long.  I usually price mine 2% to 5% below their prices.

The caveat with property managers is that some have owners that force them to overprice. That happens fairly often, but it is usually pretty obvious.

4.) Be careful not to use an apartment as a comparable (“comp”) for a single-family home (or visa versa). Instead, I'd try to find another single-family home in the same neighborhood as your .

5.) Maybe, there aren't any single-family homes on the market to serve as comps. But, were there any in the past few months or years? Is there a way you could track those down by reviewing old newspapers or more importantly, your notes on what homes have been rented for?

6.) Check comps on www.craigslist.org.

7.) Do you feel that your current long-term tenant was paying the market rate when he moved in? I believe that a general guide to rental increase should be 3% to 5% per year. Use this amount as a starting point. (This rule of thumb may not apply in cities experiencing a large number of lay-offs.)

8.) Take a property manager to lunch. Maybe, if you said the right things in the right way over lunch, a property manager could give you her opinion — and maybe even back it up with some comps on properties she manages.

9.) A trick I have used is to always set the rent a little too high. If the phone does not ring with decent quality renters, I quickly lower it to $50 or $75, or so. If the phone starts ringing then, you can be pretty sure that you have the right amount.

If you find someone terrific and they tell you they would love your house but can only pay $50 less than what you're asking, you can always say yes. Be flexible and listen to market feedback.

10.) The key for me is not to wait until you get notice to vacate to begin your pricing research. Go through the rental ads from good sources weekly. That way you'll be on top of things when the time comes.

11.) Don't be overly concerned with the best rent amount. More importantly, keep turnover to a minimum. Lost time is more valuable than a slightly higher rental amount. This money can never be recouped. One lost month can cost more than leaving the rent too low.

Advertising, curb appeal, repairs, and even some paint can all be done during the current lease. It should only take a day or two maximum for cleaning and painting once they leave.

Play up the return of their deposit for super cleanliness at move-out. Remind your current tenant their lease ends August 31, not September 1. Your new lease should start September 1.

Bonus Tip: How to Build Value When Showing Rentals

When showing properties to prospective tenants, you must build value in the eyes of the prospect. Three ways you can build value are:

  1. Building interest or excitement in the property,
  2. Building trust in you, the landlord or property manager, and
  3. Building a connection between the prospect and the property.

If you focus on each of these points, you WILL rent your property faster.

– – –

Known to thousands as “Mr. Landlord”, Jeffrey Taylor is the author of a dozen publications, books, and reports on various aspects of rental property management.

ROI in Real Estate: A Beginner’s Guide to Maximizing Returns

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ROI in Real Estate

Real estate investment is a popular way for beginners to make money and build wealth. One important metric to consider when investing in real estate is the return on investment (ROI). How do you know if you are getting a good return on your real estate investment? Calculating the ROI on your investment property is critical to know how your investment is performing, or when comparing one investment to another.

In this beginner's guide, we will cover everything you need to know about ROI investment in real estate.

Understanding ROI in Real Estate

ROI is a measure of the return on an investment, calculated as a percentage of the initial investment. It is important in real estate investing because it helps investors to compare different investment opportunities and choose the most profitable one.

There are different types of real estate investments that generate ROI, including rental properties, fix-and-flip properties, commercial real estate, and real estate investment trusts (REITs). Each type of investment has its own advantages and disadvantages, and the ROI can vary depending on the type of investment.

Several factors impact the ROI in real estate, such as location, property condition, rental income and expenses, financing and leverage, taxes, and depreciation. These factors will be discussed in detail in the next section.

Calculating ROI in Real Estate

To calculate ROI in real estate, you need to use a formula that takes into account the amount of money you invested, the amount of money you earned from the investment, and the duration of the investment. The formula for calculating ROI is:

ROI = (Gain from Investment – Cost of Investment) / Cost of Investment

For example, if you purchased a rental property for $200,000, rented it out for a year, and earned $20,000 in rental income, your ROI would be:

ROI = ($20,000 – $200,000) / $200,000 = -90%

This result may seem alarming, but it's important to note that ROI is not always a perfect measure of performance. The example above does not take into account the property's value appreciation, which can significantly impact the ROI over the long term.

Limitations of ROI as a performance metric include its failure to account for factors such as taxes, property appreciation, and loan pay-downs. It's important to keep in mind that ROI is only one measure of performance and should be considered in conjunction with other metrics when evaluating an investment.

In order to successfully decide whether a property is worth buying, an investor must run the numbers to calculate two types of returns: Cash-on-cash return on investment, and total return on investment.

Cash on Cash Return on Investment

The cash-on-cash return on investment is the before-tax cash flow (BTCF) divided by your initial cash investment. The formula looks like this:
Cash on Cash Return on Investment  =  BTCF / Initial Cash Investment

Your before-tax cash flow is calculated by subtracting your annual mortgage payment from your net operating income (NOI). The net operating income is simply the total income from the property minus the total expenses.

Let's take a look at an example using a $150,000 income property purchased with a 20% down payment of $30,000. Let's assume your mortgage of $120,000 is fixed for 30 years at a 7 percent interest rate.

Let's assume your BTCF is $3,000 per year ($250 per month):
Cash on Cash ROI  =  $3,000 / $30,000  =  10.0%

Through the "magic" of leverage using financing to purchase your property, you have created a cash on cash ROI of 10%. This would be quite attractive to most investors in today's market.

The cash on cash ROI is a good measure of a property's first year financial performance. However, it does not include the additional benefits achieved through real estate such as the amortization of the mortgage and any future appreciation. The total return on investment addresses that.

Total Return on Investment

The total return on investment (TROI) provides a better and more complete measure of a property's financial performance. That is because it factors in amortization and appreciation gained over time.
Total ROI  =  (BTCF + Net Sales Proceeds - Initial Cash Investment) / Initial Cash Investment

In order to calculate the total return on investment, one must project the BTCF for each year of expected ownership as well as the net sales proceeds from the sale of the property.

Let's take our example above and assume that we plan to sell it in five years with an average annual appreciation rate of 4% per year. After five years our $150,000 property would be worth $182,498, and our mortgage balance would be $111,665. Let's also assume that our selling expenses total 5% of the sales price, or $9,125.

Using the figures above, our net sales proceeds from the sale of the property in year five would be $61,708 ($182,498 - $111,665 - $9,125). Additionally, our before tax cash flow after five years would total $15,000 assuming no annual increase in rents or cash flow. Now our formula looks like this:
Total Return on Investment  =  ($15,000 + $61,708 - $30,000) / $30,000  =  156%

Note that some investors calculate their TROI using their after-tax cash flow (ATCF) instead of the BTCF. This can provide a deeper "bottom line" measure of the return on investment; however, it does not provide a good measure to compare one investment to another since tax liabilities will vary between individual investors. Calculating the TROI using ATCF is best suited for investor specific use.

By projecting a property's future cash flows and appreciation, you can calculate the potential gains on your initial cash invested (down payment). Assuming the property is not declining in value, the TROI should increase in each successive year.

However, total return on investment can be a little shortsighted when used in isolation. This is because total return on investment does not measure the property's financial performance as it relates to its equity. For this we must calculate the property's return on equity (ROE). Similar to the TROI, the return on equity calculation replaces the initial cash invested with the properties equity in a given year.

Factors That Impact ROI in Real Estate

Location and neighborhood: The location and neighborhood of a property play a critical role in determining its ROI. Properties located in desirable areas with good schools, low crime rates, and proximity to amenities like shops and restaurants tend to generate higher ROI than those in less desirable areas.

Property condition and maintenance: The condition and maintenance of a property can impact its ROI by affecting its resale value and the cost of ongoing maintenance. It's important to budget for repairs and maintenance when calculating the ROI of a property.

Rental income and expenses: The rental income and expenses associated with a property are important factors in determining its ROI. Rental income can be maximized by setting competitive rental rates, marketing the property effectively, and keeping the property occupied with reliable tenants. Expenses such as property taxes, insurance, and maintenance costs can eat into the ROI, so it's important to keep these costs in mind when calculating the ROI.

Financing and leverage: Financing and leverage can impact the ROI of a property by affecting the amount of money required to purchase the property and the ongoing cost of financing. Using leverage can increase the ROI of a property, but it also comes with added risk, such as the potential for foreclosure if payments cannot be made.

Taxes and depreciation: Taxes and depreciation can impact the ROI of a property by reducing the amount of taxable income generated by the investment. It's important to consult with a tax professional to understand the tax implications of real estate investing.

Strategies to Maximize ROI in Real Estate

While there are many factors that impact the ROI in real estate, there are several strategies that beginners can use to maximize their returns. Here are some of the most effective strategies to consider:

Property value appreciation: One of the most common ways to increase ROI is to invest in properties that are likely to appreciate in value over time. This can be achieved by choosing properties in up-and-coming neighborhoods, areas with new developments or infrastructure, or areas where property values are expected to rise.

It's important to note that property value appreciation is not guaranteed, and it's important to conduct thorough research and due diligence before making an investment. It's also important to keep in mind that appreciation is a long-term strategy, and it may take several years before the property value increases significantly.

Rental income optimization: Rental income is one of the most important sources of ROI for real estate investors, and there are several strategies to maximize rental income. One strategy is to set competitive rents that are in line with the market rate in the area. This will help to attract high-quality tenants and minimize vacancies.

Another strategy is to provide additional amenities or services that can increase the value of the rental property, such as laundry facilities, parking, or cleaning services. It's also important to maintain the property in good condition and respond quickly to tenant requests or concerns, as this can help to retain tenants and reduce turnover.

Renovation and improvements: Renovating and improving a property can be an effective way to increase its value and rental income, and it can also help to attract higher-quality tenants. This can be achieved by upgrading the property's features and amenities, such as the kitchen, bathrooms, or flooring. It can also involve adding additional space, such as a bedroom or bathroom, or converting unused space into a rental unit.

It's important to carefully consider the cost of renovations and improvements and to ensure that they are likely to generate a return on investment. Beginners should also work with experienced contractors and designers to ensure that the renovations are done correctly and to a high standard.

Tax planning and mitigation: Real estate investing can have significant tax benefits, and it's important to understand how to optimize these benefits to maximize ROI. This can involve strategies such as taking advantage of depreciation, which allows investors to deduct a portion of the property's value from their taxable income each year.

It can also involve utilizing tax credits, such as those available for energy-efficient upgrades or investments in low-income housing. Beginners should work with experienced tax professionals to ensure that they are taking advantage of all available tax benefits and to avoid any potential tax liabilities.

Risks and Challenges of ROI in Real Estate

Real estate investing can offer high returns, but it also involves risks and challenges. Before investing in real estate, beginners must evaluate and understand these risks to mitigate them effectively.

Market volatility and unpredictability: Real estate markets are subject to economic and political changes that can impact property values, rental demand, and financing. Recessions, interest rate hikes, and regulatory changes can all impact real estate investments. Investors need to have a long-term investment strategy and plan for market fluctuations to ride out any potential economic downturns.

Property management and tenant issues: Real estate investing involves managing properties and tenants. Managing property requires time, resources, and expertise. Landlords must maintain the property, ensure tenants pay rent on time, and handle tenant requests and complaints. Landlords must also find new tenants when old ones move out. A bad tenant can damage the property and cause legal problems, so screening tenants is critical.

Financing and liquidity risks: Real estate investments require substantial amounts of capital, and financing is often necessary to purchase the property. Investors may use their own funds or borrow from banks or other financial institutions. Loans have interest rates and must be repaid, which can affect the ROI. In addition, real estate investments can be illiquid, meaning it can be challenging to sell the property quickly if needed.

Legal and regulatory compliance: Real estate investing is subject to various legal and regulatory requirements that investors must adhere to. Regulations may include zoning laws, building codes, tenant protection laws, and tax regulations. Investors need to be aware of these requirements to avoid legal issues and penalties.

Summary: ROI in Real Estate

Real estate investing offers a potentially lucrative investment opportunity for beginners. ROI investment in real estate can be a profitable and rewarding experience if they understand the key factors that impact ROI, calculate ROI accurately, and employ strategies to maximize ROI. However, it is important to recognize and mitigate the risks and challenges associated with real estate investing to achieve long-term success.

By following the guidelines in this guide, beginners can set themselves up for success and make informed decisions when investing in real estate. While investing in real estate involves risks, those who understand the market, manage their properties well, and plan for challenges will likely reap the benefits of this investment option.

Absorption Rate and Months of Inventory in Real Estate

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Absorption rates and months of inventory in real estate. What are they, and why are they significant? This information is useful since it represents the liquidity of a market. As a real estate investor, you can help maximize your profits by knowing the liquidity of a given real estate market. By knowing the liquidity of a market, you will better understand that market and therefore be able to take advantage of the various buying strategies afforded by it.

One of the measurements frequently used to gauge the liquidity of a given market is the absorption rate. This is basically the rate at which a specific segment of a real estate market sells in a given time frame. These segments are usually categorized by price range but may also be categorized by property type. The absorption rate can assist sellers to determine the optimal price for a property. The absorption rate is useful information for buyers as well because it indicates the extent to which a seller may be willing to lower their asking price or make other concessions.

Absorption Rate Formula

The easiest way to understand absorption is to put it in more tangible terms and measure it in “Months of Inventory”. In other words, we take the number of active listings and divide it by the total number of sold transactions within the same month to give us the months of inventory.

To calculate the months of inventory for any given market:

  • Find the total number of active listings on the market last month.
  • Find the total number of sold transactions for last month.
  • Divide the number of active listings by the number of sales to determine the number of months of inventory remaining.

Supply-DemandAs a general rule, 5 to 6 months of inventory is considered to be a normal or balanced market. Over 6 months of inventory and we have a buyer’s market. If it is less than 5 months and we have a seller’s market. The smaller the available inventory, the tighter the market is. Keep in mind that these are simply guidelines and will differ from market to market.

For example, let’s say there were 8,000 active listings last month and 1,000 closed transactions. That leaves us 8 months of inventory remaining on the market and also tells us that we are in a buyer’s market.

If you are in the market looking to buy, calculating the months of inventory can give you an indication of how negotiable sellers might be. A large number, say 12 months or more, would mean that sellers have a high level of competition and will probably be more flexible on their sales price and terms.

On the other hand, if you are a seller trying to sell your property, the months of inventory will give you an indication of the level of competition you will face. Selling in a buyer’s market will require you to put some serious thought into your pricing strategy and any incentives you may want to offer.

8 Tips To Becoming A Successful Landlord

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How To Become A LandlordHow To Become A Landlord

The ultimate goal of investing in rental property is to turn a profit.  To ensure that you achieve that goal it is essential that you follow several critical guidelines. Most of us dream of becoming a landlord but it an easy or a difficult job? Before you start searching for a home to rent, you should think about the responsibility that comes with being a landlord to your tenants. If you’re interested in investing in real estate, the single-family rental market might be a good option. Being a landlord can be a profitable venture that provides a steady income stream while your property appreciates in value. You might also be able to enjoy certain tax advantages while you build equity in the home.

Here are 8 valuable tips for becoming a successful landlord and start a rental property business.

1. Screen Your Tenants

First, always make sure that you check tenant references. This is the first step of becoming a successful landlord. This can be a burdensome step and many landlords overlook it because they feel as though they have good instinct when they meet with the tenant.  But not checking references can lead to a number of problems later on.  You will uncover a wealth of information about potential problems before you rent to a prospective tenant. It’s also worth the time to do a background and credit check on all potential tenants. There are several online tenant-screening services available, and you should be sure to check potential tenants’ credit scores. You should also conduct an interview to make sure you’re comfortable interacting with them, and check references, especially from employers or past landlords.

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National Economic Outlook (September 2013)

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The rate of annual job growth in August, 1.7 percent, was basically the same as in previous months. We had better get used to the idea that this is the new normal, because there probably won't be much help from the lagging government and construction sectors.

Budget difficulties will prevent any meaningful increase in government spending, even though local and state revenues are now in better shape. The recession revealed the extent of unfunded pension liabilities for public employees, which will absorb any extra dollars.

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National Economic Outlook (August 2013)

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The pace of job growth in July was unchanged from the 1.7 percent annual rate of previous months, but the details suggest an economy that will do modestly better for the rest of the year. Most importantly, jobs in business services were up 3.5 percent from last year.

Business services is one of the largest sectors of the economy, on a par with health care and government, and bigger than retail or manufacturing. Earlier this year it was growing at a 3 percent rate, in the last few months around 3.5 percent; it seems only a small increase but it means that businesses are expanding again.

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National Economic Outlook (June 2013)

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The economic recession only lasted a year, but there wasn't a recovery for homes because prices had climbed much too high and builders had built way too many of them. Prices had to fall, not just back to a “normal” level, but to an even lower level so that the large inventory of excess homes could be moved – a sort of clearance sale. We're not yet done with that sale – see the large number of mortgages still delinquent – but enough has been cleared out so that prices can drift up to a more normal level.

 

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