The Ultimate Guide to Purchase Price on Rental Properties

If you're looking to learn more about the purchase price on rental properties, then check out our Ultimate Guide to Purchase Price on Rental Properties.

Purchase price is the price you pay to buy a rental property.

Purchase Price to Improve Cash Flow

While the following video is not exclusively purchase price on rental properties, it does discuss some ideas related to purchase price and how it can impact improving cash flow.

In general, the lower your purchase price typically the better cash flow will be for a set amount of rent and other income on the property.

A general real estate investing rule of thumb is that for every $10,000 discount you can get on the property, you will save about $50 per month in payment (this varies a little with interest rate, but it is a close estimate for interest rates in the 4-6% range). That means if you're able to negotiate a $10,000 discount in price, you should expect your cash flow to increase by about $50 per month with a highly leveraged property.

Calculating Cap Rate

Purchase price is used to calculate Cap Rate as shown below.

Cap Rate

Annual Net Operating Income $16,791
÷ Purchase Price ÷ $261,142
Cap Rate = 6.43%

Let's walk through calculating Cap Rate for Typical 25% Down Payment Gainesville, Florida Rental Property.

Ultimately, we will need Net Operating Income and Purchase Price.

Purchase Price is easy since it is a primary input that does not require any real calculation.

So, let's focus on How to Calculate Net Operating Income.

To calculate Net Operating Income (often abbreviated NOI), we need to know the Gross Operating Income for the property and the Operating Expenses.

We'll start with the Gross Operating Income.

Gross Operating Income is really just the total Gross Potential Income for the property minus the vacancy allowance for the property.

That means we'll need to start with calculating Gross Potential Income based on all the income sources for the property: rent and anything else you might be getting income from on the property.

Annual Gross Potential Income

Annual Rent $27,720
+ Annual Other Income + $0
Annual Gross Potential Income = $27,720

Gross Potential Income is how much total income the property could possibly produce from all sources.

For Typical 25% Down Payment Gainesville, Florida Rental Property we take the total amount of rent they could collect and any additional income they might also get from the property.

The rent for Typical 25% Down Payment Gainesville, Florida Rental Property is estimated to be $2,310 per month or $27,720 per year. We'll use the annual amount of $27,720 for our calculation and we will, for now, ignore vacancies... we'll deal with vacancy when calculating Gross Operating Income.

We're estimating $0 in other income from the property.

Some common examples of other income might be: profits from on-site laundry (especially in multi-family), pet rent, renting out extra spaces on the property (like an extra garage or storage unit) or things like that.

That means that Typical 25% Down Payment Gainesville, Florida Rental Property has a Gross Potential Income of $27,720 per year.

But that does not consider the impact of vacancy. To do that, we'll look at Gross Operating Income next.

Annual Gross Operating Income

Annual Gross Potential Income $27,720
- Annual Vacancy Dollar - $832
Annual Gross Operating Income = $26,888

Gross Operating Income unlike Gross Potential Income does take into account the impact of vacancy on the property.

For Typical 25% Down Payment Gainesville, Florida Rental Property, we're estimating that the property is vacant 3% of the time. That means that we're not seeing $831.60 of the $27,720 that we thought we might get from the property.

Annual Gross Operating Income

Annual Gross Potential Income $27,720
- Annual Vacancy Dollar - $832
Annual Gross Operating Income = $26,888

But, what about all the other expenses? Well, those are called Operating Expenses.

Annual Operating Expenses

Annual Property Taxes $3,037
Annual Property Insurance $4,372
Annual Homeowner's Association Fees $0
Annual Landlord-Paid Utilities $0
Annual Other Expenses 1 $0
Annual Other Expenses 2 $0
Annual Property Maintenance $2,689
Annual Property Management $0
Annual Operating Expenses = $10,097

Operating Expenses are all the expenses of operating the property except vacancy and financing of the property.

For Typical 25% Down Payment Gainesville, Florida Rental Property we used the following:

  • Property Taxes - These are the property taxes paid for the property. For Typical 25% Down Payment Gainesville, Florida Rental Property, we've estimated they are $3,037.08 per year.
  • Property Insurance - This is the insurance policy to cover the property from perils like fires and liability from injuries on the property. Your specific policy will define what hazards you're covered for. This policy typically does not cover the personal property of tenants; they should get their own renter's insurance policy to cover that. For Typical 25% Down Payment Gainesville, Florida Rental Property, we've estimated the cost of this insurance policy to be $4,371.52 per year.
  • Homeowner's Association Fees - This is usually the cost for the homeowner's association (HOA) where the property is located. What the HOA coverages varies widely between different HOAs so be sure to check with the HOA to find out what is included for your HOA fee. For Typical 25% Down Payment Gainesville, Florida Rental Property, we've estimated the cost of the homeowner's association fees to be $0 per year.
  • Landlord-Paid Utilities - With many single family homes... and to a slightly lesser extend... duplexes, triplexes adn fourplexes... the tenants all pay individually metered utilities. However, in some cases... especially for larger multi-family properties... the landlord is responsbile for some shared (or in some cases... all) utilities. This is just for the utilities that the landlord is responsbile for paying. Tenant-paid utilities should not be included here. It is not uncommon to have this be equal to zero especially for smaller properties. For Typical 25% Down Payment Gainesville, Florida Rental Property, we've estimated the cost of the landlord-paid utilities to be $0 per year.
  • Other Expenses - Sometimes a property will have an extra expenses associated with it. Some examples might include lawn service, snow removal, common area cleaning, etc. For smaller properties, it is not uncommon to have these extra expenses be equal to zero. For Typical 25% Down Payment Gainesville, Florida Rental Property, we've estimated the annual cost of these extra expenses to be:
    • Other Expenses 1: $0
    • Other Expenses 2: $0
  • Maintenance - With many properties... especially residential properties... the landlord will be responsible for maintaining the properties and should set aside money to pay for on-going maintenance. For Typical 25% Down Payment Gainesville, Florida Rental Property, we've estimated the cost of maintenance, on average, to be $2,688.84 per year.
    • There is some debate over whether you should include some or all of the Capital Expenses in the Operating Expenses or if they should be capital improvements to the property and not including in Operating Expenses. You can choose to include them by increasing the maintenance percentage or choose to include them elsewhere by excluding them from Maintenance.
  • Property Management - With most properties, there will be an expense to managing the properties either in the form a professional property management fee or the... much lower hard costs... of managing the property yourself. For Typical 25% Down Payment Gainesville, Florida Rental Property, we've estimated the cost of property management to be 0% of the rent or $0 per year.

If we add up all of these expenses for Typical 25% Down Payment Gainesville, Florida Rental Property, we're estimating the Annual Operating Expenses to be $10,097.44.

Annual Operating Expenses

Annual Property Taxes $3,037
Annual Property Insurance $4,372
Annual Homeowner's Association Fees $0
Annual Landlord-Paid Utilities $0
Annual Other Expenses 1 $0
Annual Other Expenses 2 $0
Annual Property Maintenance $2,689
Annual Property Management $0
Annual Operating Expenses = $10,097

Now that we know the Gross Potential Income and the Operating Expenses for the property, we can calculate the Net Operating Income.

Annual Net Operating Income

Annual Gross Operating Income $26,888
- Annual Operating Expenses - $10,097
Annual Net Operating Income = $16,791

Net Operating Income is how much money you're making from the property after vacancy and all the Operating Expenses except for the financing expenses on the property (like the mortgage payment and, if applicable, private mortgage insurance).

For Typical 25% Down Payment Gainesville, Florida Rental Property we would use the Gross Operating Income of $26,888.40 per year and subtract out all the Operating Expenses of $10,097.44 for the year.

That would result in a Net Operating Income of $16,790.96 per year or $1,399.25 per month.

Annual Net Operating Income

Annual Gross Operating Income $26,888
- Annual Operating Expenses - $10,097
Annual Net Operating Income = $16,791

And, finally, with a Net Operating Income of $16,790.96 per year and a Purchase Price of $261,142, we can calculate the Cap Rate.

Cap Rate

Annual Net Operating Income $16,791
÷ Purchase Price ÷ $261,142
Cap Rate = 6.43%

That means that Typical 25% Down Payment Gainesville, Florida Rental Property has a Cap Rate of 6.43%.

Primary Input

Purchase Price/Value Primary is considered a primary input in the Hierarchy of Real Estate Metrics.

It is used to calculate Cap Rate.

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