Income Property Analysis - Quick & Dirty

By: Kevin Chan

Income Property Analysis - Quick & Dirty

Tags: Cap Rate, CAsh on CAsh, CCR, ROI, Income property, Investment Property

 

Through my years as a Realtor I have seen investors make purchase decisions based on nothing more than the price of the property and speculative future value. A few key metrics can quickly help an investor compare properties or assess it's viability as an investment.  

The Greater Toronto Area property market has seen consistent price increases for years therefore it is easy to fall in to the trap of making a speculative income property purchase. 



One may speculate buying any property may eventually yield a return.   I commonly ask my buyers, "Would you take your investment capital to the Casino OR would you ask your bank avisor to show investment products with metrics of past returns, expense ratios, market risks and possibly future return?" The obvious answer to most buyers would be the latter. 

The financial properties of each income property are unique however, the returns have a certain level of predictbility, similar to mutual funds, GICs, bonds or dividend paying stocks.  

Here are a few Quick & Dirty metrics one can use to help compare one income property to the next. 

1. Captilization Rate or Cap Rate(Like Dividends yields in your stock portfolio)
Typically this metric is used in commercial real estate analysis and can also be used to normalize and compare one income property to the next. 

Cap Rate = Annual Net Operating Income / Purchase Price of the Property

Annual Net Operating Income: Necessary expenses subtraced from the total revenue earned from the property

Including: Utilities not paid by tenants, property tax, Property management fees, General Maintenance, Insurance, professional fees (ie. legal/Accounting)

Excluding: capital debt service, income taxes and interest payments

The Cap rate can represent return an investor can expect from an all cash purchase. 

2. Cash on Cash Return or CCR (Similar to 1st year % yield on your bonds) 

This metric includes debt servicing and gives you an idea of the expected returns on the cash invested in to your income property in the first year of operation.  It does not give you the big picture of the returns year over year which would require analysis of the cash flows over several years. 

CCR = 1st year Cash Flow / Initial Down Payment

1st year Cash Flow = NOI + Captial Debt Service (mortgage payments)

This metric includes debt servicing and gives you an idea of the expected returns on the cash invested in to your income property in the first year of operation.  It does not give you the big picture of the returns year over year which would require analysis of the cash flows over several years. 

NOTE: this is not the same as ROI which utilizes the equity in the property to calculate returns and assumes the disposition of the property. 

3. The other metrics, who cares for now: ROI, Gross Rent Yields, DSR, LTV, Price to Rent Ratios etc.
There are a plethora of metrics to be considered to analyze and income property.  Quite simply I take each property and calculate the Cap Rate and CCR then line them up in a spreadsheet.  I pick the property that shows the most potential before calculating the other metrics. 



At a very high level one can quickly see none of these properties perform very well.  The spreadsheet quickly calculates and offers a quick snapshot of CAP Rate, CCR, NOI & Cash Flow, thus taking out the speculative purchase decision.  It helps to quickly identify the potential of the property and perhaps where certain operating efficiencies can be improved thus possibly improving income or possibly the liabilities and risks pertaining to each property.  Gains in property value as seen in the TREBB MLS trend lines become a bonus and no longer speculation.