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How Do You Know If an Investment Property Is Worth Buying or Not?

how to calculate the rate of return of an investment property
How To Tell If An Investment Property Is A Good Buy

With housing prices at record-high levels, is it still worth it to buy an investment property?

As the real estate market is booming, many of my friends have asked me whether it’s still worth it to buy a house as an investment.

At any time, it is worth buying as long as the rate of return on the investment property is considerable.

So how to calculate the rate of return on an investment property?

There are many ways to do it, but ordinary investors only need to know one method.

We need to compare the expected rate of return on our real estate investment return with the potential return on other types of investments, such as stocks and fixed-income deposits, to see which one is more cost-effective.

For example, when I bought one of my investment houses, the price was $230,000. With a 20% down payment and other renovation costs, the total investment was $51,000.

At that time, the rent for the house was $1,800––it’s risen to $2,050 now––and the monthly mortgage payment was $1065 including property tax and insurance. Assuming there is a one-month vacancy period every year plus the usual maintenance costs, the investment had an annual net profit of $6,346. On a total investment of $51,000, that’s a 12.44% return.

I invested about $50,000 dollars and the annual rate of return was 12%. That was a good deal for me. Investing returns from stocks are unstable, and the interest rate of fixed-income deposits is close to zero. So this investment property was worth buying.

Moreover, we have to look at things in the long term. The rent of this house has been slowly rising since I bought it, and has now reached $2,050 per month. Later on, I refinanced the mortgage and the interest rate dropped a little. Now the rate of return is even higher.

The second way to calculate is to count the principal of the mortgage as returns as well; and the third way is to include the house’s price appreciation every year. Both methods would make the rate of investment return even higher. But the third calculation is a bit unrealistic, because people don’t usually buy and sell their investment properties very often due to the high transaction costs.

Some might ask, if I am only buying a house for my own use, does it mean I don’t need to calculate the rate of return?

The answer is no. When buying a house, you need to calculate the rate of return not only for an investment property, but also for the house for your own use. Because you’ll never know how long you will live in the house. You might not live there for your lifetime, and maybe have to rent it out in a few years.

Recently, there have been some adjustments to the financing policy of real estate investment. The mortgage interest rate has risen a lot and could sometimes vary widely among different mortgage companies and banks. Sometimes the rate quotes given by mortgage brokers could differ by up to 0.75%.

If you plan to purchase an investment property or refinance, you need to go to the websites that compare the mortgage rates among different providers. These websites usually recommend several mortgage brokers with the best interest rates to help you find the best deal quickly.

There are a lot of things to learn when making a real estate investment: How to find your first house, how to renovate a property, how to choose tenants, how to manage tenants, and so on.

If you are interested in real estate investment, please subscribe to our blog. We will talk more about the topic in the future.


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