In a previous article (“Which Areas Will Have The Greatest Appreciation?”), we covered the factors you need to consider when investing in real estate for appreciation.
Now we’ll look at investing for cash flow, and how to discover the most promising areas in the Bay Area.
In real estate terms, cash flow is the byproduct of owning a property and leasing it to tenants for a monthly rental income. The higher the net cash return, the better the return on your investment. The rental income must cover your total expenses and reap a surplus of cash as extra income to deem a rental property profitable.
Cash-On-Cash (CoC) Return
The most popular metric used in real estate investing is the cash-on-cash return (CoC). Also called the equity dividend rate, the CoC return is calculated by dividing the cash flow (net operating rental income, before tax) by the amount of cash invested.
The CoC return is calculated in the following way:
Annual Pre-Tax Cash Flow
Total Cash Invested
Because pre-tax cash flow is used in the calculation, you should be aware of the tax treatment of your investment. If the CoC return is low, high taxes may erase any potential investment returns.
Capitalization (Cap) Rate
This calculation is also very important because it is the purest form of understanding a property’s returns. The cap rate reveals the investment return of a property independent of its financing. Therefore, this number indicates the return as if the property was already paid for.
The cap rate is calculated by dividing the net operating income by the property’s price.
(Click here for more on how to analyze an investment property and determine its quality and/or estimating its profitability through calculating the property’s cash flow.)
Mashadvisor offers an interactive investment property calculator that not only gives returns based on what is entered, but also provides insights by using predictive, comparative data and algorithms. The tool also gives investors an understanding of an overall neighborhood by providing data on the neighborhood’s average median home price, traditional rental income, and Airbnb rental income and occupancy rate.
Trends To Observes
Honing down on a good location and neighborhood for attracting the right tenants and maintaining high rental demand requires patience and meticulous analysis. While CoC returns and cap rates allow you to determine a property’s profitability in present terms, you also need to consider long-term trends which will sustain those returns during the lifetime of your investment.
- Look for areas where properties are comparatively more affordable based on their price-to-rent ratio, a simple metric that measures the ratio between property prices in a particular area and annual rent. Zillow offers a searchable database for estimated median market rate rents by housing type across a given region.
As earlier reported, the 10 Bay Area cities with the fastest housing appreciation over the past five years aren’t traditionally the most sought-after communities and have seen housing prices grow by more than 15 percent over the time period. Cities like Richmond, Pittsburg, and Antioch have seen some of the highest increases regionally yet still have median home prices under $500,000.
- Look for areas which are experiencing comparatively higher rates of population growth which will underpin rents in the future. Make sure the property is located in an area where the job market is robust. Job and income growth are key when deciding where to invest.
According to the US Census Bureau’s 2017 population growth estimates, the 10 fastest-growing cities and towns in the Bay Area between 2016 and 2017 were:
|
Jurisdiction |
Percent Increase |
|
Rio Vista |
4.3% |
|
Gilroy |
4.1% |
|
Newark |
3.5% |
|
Brentwood |
2.9% |
|
Oakley |
2.4% |
|
Dublin |
2.1% |
|
Dixon |
2.0% |
|
Albany |
1.9% |
|
San Carlos |
1.8% |
|
Pittsburg |
1.8% |
- Look for areas which have future development plans likely to attract more residents, such as transport links to major job hubs, new schools, shopping centers, restaurants, amenities, etc.
- As environmental consciousness continues to grow, especially among millennials, look for cities leading the pack in sustainable living. A recent nationwide study done by SmartAsset shows nine Bay Area’s cities among the top 25.
The highest-ranked city is Mountain View. Not too far behind, at #9, is San Francisco. The other cities which made it to the 25 Best Green Cities For Families are:
Sunnyvale
South San Francisco
Alameda
Berkeley
San Mateo
Palo Alto
Whether you are investing in real estate for appreciation or cash flow, hiring a professional real estate agent is key. A real estate agent has the right knowledge and expertise to identify the most promising income properties, help you conduct the proper analysis and assessment, and, most importantly, negotiating for the right price.
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