In this article, I’ll be discussing some techniques you can use in evaluating if a foreclosed property is a good deal or not, specifically for those who are planning on using it to generate rental income. Note than when browsing listings, only basic information are given such as address, lot area, floor area, price, and minimum downpayment. There is no indication on the property’s current state or if previous owners are still residing there. Furthermore, you will not have an idea if the foreclosed property is really selling at a discounted price – you will have to research the current market value of properties in the area to get an idea.
After getting firsthand data, the first thing you need to check is the monthly cashflow that the property will generate. While on mortgage, your net cash flow will be the difference between rental income and your monthly amortization. But how will you determince the monthly rent?
The easiest and fastest way to determine monthly rent is to talk to the people around, especially those who also own properties for rent. This is actually easier for lofts or condominium units since you simply have to approach their office.
After getting the projected monthly rental income, you need to determine how much your monthly amortization would be. This can easily be computed using an amortization calculator, which is readily available in many websites.
Next, compute for the return on investment (ROI). Yes, just like in any business, the ROI shows how effectively the money you used in acquiring the property generated returns for you. The ROI can be computed using the formula below:
To help you better understand the concept, let’s illustrate using an example. Suppose you read about a foreclosed 5-door apartment 5 miles from your residence. The selling price is $61,000 with a minimum required downpayment of 20%. The balance is payable up to 15 years and the interest rate is 10% per annum.
To compute the ROI, you must first determine the monthly cashflow that the apartment will generate. The cashflow is the net monthly rent you’ll get after deducting the monthly amortization. Simply enter the information above to the monthly amortization calculator to get the needed figure.
The monthly amortization is $524. Now suppose after talking to people in the neighborhood, you found that the going rental rate for similar units is at $150/unit per month. The monthly total rental income from the 5-door apartment is therefore equal to $750. Subtracting the $524/month amortization, the monthly cashflow is $226.
The ROI is therefore equal to the monthly cashlow time 12 months, divided by the downpayment:
Comparing against the S&P 500′s 15-20% average annual gain over the past decades, the property therefore seems like a good investment.
Just like in any company, the ROI is a significant gauge of how effectively you are rewarded for your investment.