We get a lot of people looking for a great rate of return on an investment properties. These are hard properties to find in little Northern Michigan, but not impossible. I think sometimes people are seduced by national advertising campaigns that show how easy it is to buy homes with no money down and start making tens of thousands of dollars a month. The investors that are able to achieve this kind of success are few and far between and most of those opportunities are going to be in larger markets with much more population and turnover.
So, what’s a good rate of return for an investment property locally and how do you calculate that rate when evaluating properties?
Having sold many of these properties in Northern Michigan I have often used the timeless evaluation formula called Capitalization Rate.
Capitalization rate (or “Cap Rate”) is a real estate valuation measure used to compare different real estate investments. Although there are many variations, a cap rate is often calculated as the ratio between the net operating income produced by an asset and the original capital cost (the price paid to buy the asset).
A simple example:
Yearly gross annual rent ($12,000) minus yearly expenses ($4000) for taxes, insurance, maintenance) = ($8000) in net operating income.
Cost of property ($100,000)
($8,000) divided by ($100,000) = A cap Rate of .08 or 8%.
Is 8% a good cap rate? The short answer is yes for Northern Michigan, anywhere above 5,5% (depending on scale) is respectable. Now there are many other factors at play not mentioned here such as long term investment considerations and cash flow but for the purpose of evaluating if you should or should not buy a property, this is the scientific method we use at Gaslight Group Properties to assist our clients when buying investment properties and tell people all the time “the math doesn’t lie”.
Call us, email us, or stop in and see us in at 215 Howard Street next to Chandler’s where we refreshingly put our clients agenda first and will aggressively assist you with commercial or residential investments, the buying or selling of your year round or vacation home, or with vacation rentals at Gaslight Group Rentals.
Michael “Mac” McCarthy