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What return will you need to make an income property worthwhile? Here are two metrics to consider.
The cash-on-cash return looks at annual operating cash flows net of mortgage costs and compares them to your cash investment (your down payment). The capitalization rate ignores the mortgage payments and compares operating cash flows to the full purchase price. Look for a cap rate significantly higher than the interest rate on the mortgage, and higher than the returns on safer investments. Otherwise you’re not being compensated for the effort and risks associated with investing in real estate.
Rui Torrao’s 10% cap rate target is very difficult to find these days: a recent analysis by Boardwalk REIT found cap rates for high-quality large apartment buildings ranged from 3.75% to 4.75% in Vancouver and 5.75% to 6.75% in southwest Ontario. In this hypothetical example, we’ve assumed you put 50% down on a property valued at $300,000. We’ve also assumed the mortgage interest rate is 3.5%, amortized over 25 years.
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