Capitalization

Well how now brown cow… I have much to learn.

ARRDPD has another interesting post that is worth writing about. This one is in regard to capitalization of a rental property. Basically, the gross income generated divided by the value of the property (similar to stock market capitalization). This is a measure I hadn’t considered yet, mostly because I was searching for properties that gave a good ROI for me. This is a similar measure, however, because my investment is a percentage of the house cost, and my income is the gross income minus expenses. However, I believe that both numbers are useful in analyzing properties as they will tell you different things (especially considering that interest expense varies month to month, thus changing ROI comparisons to prior acquisitions).

Anywho, let’s look at property #2 once more. The cap is 16%, ROI ~30%. My other property also generates a cap of 16%. The similarity is due to them both being 5-bedroom houses, rented by the room within 1km of each-other. ROI for each property does differ, however.

Cap varies significantly in my city. As you approach certain areas near the university, prices for comparable houses jump by $60k or more. One could raise rents slightly (say by 20%), but the cap would still drop to 11.7%.

However, one could also argue that these houses are still better investments than mine. Why, you ask? Because the area is somewhat nicer, the property values are higher, and because the houses are very close to the university, interested tenants are easier to find. Furthermore, if there is a downturn in the economy and enrollment drops, or more apartment buildings are built in the area around the university causing vacancy rates to raise… properties like these would ideally be easier to rent than similar properties located further away.

I am comfortable with my purchases right now. I plan to improve my properties as much as possible, making them more attractive, and because my cap and ROI are higher, I have room to lower rents and still maintain positive income/cash flow.

Anyway, enough rambling for one evening, I think.

 

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