Most of us, when initially looking to purchase a rental property, are scanning what I still call the MLS, now Realtor.ca. We may see up to a hundred potential properties in our area that seem like they could generate rental income. But which ones do we make an appointment to see? How do we weed out the ones that aren’t worth our time?
Two things ultimately matter for the investor: time and return on your investment. Time is something that, when spent, is gone forever so I’d like to tell you formula to quickly figure out if a property will provide you with positive cash flow and if it’s worth your time (and your Realtor’s time) to see it and get more details.
This easy cash flow formula I’m about to explain is not new. I learned it from the Real Estate Investment Network and have used it countless times to weed out the properties that aren’t worth looking at. I should mention that this analysis tool is not applicable to properties with 4 or more suites in them.
Now assuming you have already chosen a good town or area to invest in, there are two key questions that you need to ask your realtor or the seller to determine if you’ll spend more time looking into this property. The questions are:
- What is the asking price?
- What is it currently rented for?
There is a possible third question to ask your Realtor if you are looking at a condo, and that is: Does the Strata allow rentals?
Once you have the answers to these questions, the calculation is pretty simple:
(Total annual rents divided by selling price) x 100 = ___________%
If the above number is 8% or more, this property is worth looking into. This is just a rule of thumb though. It doesn’t mean it will end up being a good investment, and vice versa. It’s just a quick formula to weed out the properties that will likely not have positive cash flow.
- Property #1 is selling for $400,000
- The upper suite rents for $1,700
- The lower suite rents for $1,300
- Total monthly rents: $3,000 x 12 months = $36,000 ÷ Price $400,000 = 0.09 x 100 = 9.0%
- This property is definitely worth looking into and doing a detailed cash flow analysis which I will discuss in another article.
- Property #2 is selling for $250,000
- It currently rents for $1,500
- Formula: $1,500 x 12 months = $18,000 ÷ Price $250,000 = 0.072 x 100 = 7.2%
- This property is not worth looking into, generally speaking. Again, this is just a rule of thumb. For example, if the Realtor told you that it is rented for less than market value rent, and that the current tenant has given written notice that they are moving, it may be worth looking into.