Not all investments will turn out to be profitable, but there are many ways to determine profitability before you get dug in too deep. Real estate investing is an excellent opportunity to generate income. It involves the purchase, ownership, management, rental, and sale of real estate properties for profit. It’s the kind of investment that’s very much involved and hands-on, as there are many moving parts when it comes to real estate. Investing in real estate may not always be profitable, and it depends largely on the behavior of the market. However, there are metrics you can use to determine the profitability of an investment property, and one such metric is the equity dividend rate.
In the simplest terms, an equity dividend rate is the cash flow an investment property makes annually. It is calculated as the percentage of the initial cash invested on the property. Equity dividend rate is also commonly referred to as cash-on-cash return. It deals specifically with the actual cash invested on a property and not the final purchase price. It does not take into account any loans that might have been acquired to purchase a property.
How to use
If you were a real estate investor looking for profitability measures on a particular investment, this would be the tool for you to use. Just remember that the rate of one property has to be treated separately from another—if you were to calculate profits from several investments. A high equity dividend rate result means that your cash investment is generating a greater return. You want this number to be high and remain high as long as you are dealing with that particular investment property. In order to keep your investment profitable, it’s highly advisable that investors check an investment’s equity dividend rate every year. Having a record of where your returns are each year will allow you to see what areas need to be changed in order to be more profitable or just general ways you can maintain positive returns. It’s an easy equation that investors can even do quickly to get estimated numbers. To get exact equity dividend rates, however, investors will need to perform specific calculations.
How to calculate
To begin calculation of an investment property’s equity dividend rate, the first step is to add up all the income generated by the property through an entire year of operation or through a sale. Remember to include all sources of income and not just rental income. For example, other sources of income might include cash received from parking services, laundry services, maintenance services, and more. This total number would be your investment property’s gross income. The next number to calculate would be the property’s operating expenses. It’s important to be as thorough as possible when calculating both income and expenses because any missed input will give you an inaccurate equity dividend rate. Some examples of expenses to add up would include maintenance expenses, employee salaries or wages, utilities, insurance, property taxes, and more.
Once you have both the gross income and expense numbers, you can proceed to calculate the net operating income or NOI. You’d simply need to get the difference between the income and expense to get an accurate NOI. The next step is just as important. Once you’ve arrived at the NOI, you’ll need to subtract any mortgage payments or other debt services you might have from your NOI number. The result will give you the investment property’s pre-tax cash flow. Now, go back to the beginning and think about the cash you initially invested into the property. This could be any cash amount you might have put up in order to acquire the property, and it could include any closing costs, down payments, renovations, or any other initial investments. Divide the pre-tax cash flow by the initial cash investment. Multiply the amount by 100 to get to a percentage, which will be the equity dividend rate of the investment property.
Here’s an example. Think of an investment property that will cost you $1,000,000—an old beach house. You end up putting in $200,000 as down payment, and you spent $50,000 on repairs, renovations, and all other cash expenses. That total of $250,000 is the initial cash investment. Your property is up and running, and it starts to generate rental income that adds up to $100,000 within the first year. Your property also racked up $35,000 in total operating expenses. By subtracting $35,000 from $100,000, you get an NOI of $75,000 for the first year.
The next step is to figure out any mortgage and debt. Let’s say that the mortgage on the beach house added up to $50,000. By subtracting that debt from the $75,000 NOI, you get a pre-tax cash flow amount of $25,000. Dividing $25,000 by the initial cash investment of $250,000 and multiplying it by 100 will give you the percentage of 10. This means that the equity dividend rate on the property is 10%. An equity dividend rate of 10% is considered a low return in real estate investing. Remember that the higher the equity dividend rate percentage–the higher the actual cash return will be. Generally, equity dividend rates of 35% to 55% are considered to be ideal for any investor. For some investments, it might take a couple of years or more before a property becomes profitable. It’s up to the investor to decide whether a property is worth investing in or not. There are several variables an investor can take into consideration in order to create a more accurate picture of how an investment property will perform over time. In any case, using the equity dividend rate metric will allow an investor to stay on top of investments—no matter how profitable they are or not.