(I really hate the title of this post. It’s clunky and lacks wit, but I guess it gets the job done. Anyway, sorry about that. And overall, this is going to be low on entertainment value…but sky high in information! So keep reading. I’ll try to make this as painless as possible.)
When my grandfather died, he left my dad some money. My parents used some of it to pay off their mortgage, then used the rest to buy a house at the New Jersey shore (or “down the shore,” as we like to say). He said buying shore property was a good investment, because they can’t build more shore.
The same can be said of New York City–they can’t really build more of it. Sure, they can continue to build up and try to find other ways to squeeze tiny residences onto our little island, but it’s a good bet that there will always be more people trying to live here than decent homes available (and if there is a time when people don’t want to live in New York, well, that probably means something really bad has happened and we may all have bigger problems than our rent). That means that New York real estate can also be a good investment. But when you’re shopping for a possible investment property, how do you know if you’re getting a good deal? Let’s think through this.
Bad news! Remember that old lady you used to cat sit for years ago when you first moved to New York? I’m sorry to tell you that she has shaken loose from this mortal coil. Good news! You’re her sole heir and it turns out that she had several million tucked away under her mattress.
Okay, you’ve used some of it to buy your own dream apartment, but now you have some leftover and you’d like to do more with it than have it just sit and rot in your savings account. You decide to buy a condo so you can earn some income from renting it out.
Here’s a good looking deal. It’s a one bedroom in a prime West Village location for $900,000 with monthly charges of just $900 (note: this is based on a real listing but numbers have been rounded for easy math purposes). Is it a good investment.
Step 1: How much do you think you can charge for rent? A quick look at rental listings in the same area show that you should be able to get at least $3,000 a month in rent. You may be able to get more–after all, the West Village is a super popular location–but let’s go with the low end of things.
Yearly income from rental: 3,000 x 12 = $36,000
Step 2: Now you have to figure out your expenses for maintaining this apartment. This means your common charges and real estate taxes for the apartment. We already said they are $900 a month (let’s say $400 for common charges and $500 for real estate taxes if you’re interested).
Yearly expenses: $900 x 12 = $10,800
a) If you want to be super careful you could always tack on a little bit more to your yearly expenses to account for any unforeseen repairs or other issues that might come up, but for now, let’s just keep it simple and stay with the basic monthly charge expense.
b) If you didn’t inherit money and you have a mortgage on the apartment, then you should include your mortgage payments in your monthly expenses. Yes, that mans you’re going to have to get more in rental income to make this worthwhile.
Step 3: Subtract the yearly expenses from your yearly income:
$36,000 – $10,800 = $25,200
That $25,200 is your “net operating income.” Yay!! We learned something new today (okay, not new if you’re a financial pro, but if you are, why are you reading this?).
Step 4: Now we are going to find out your capitalization rate, or cap rate, because no one wants to say capitalization all the time. To do this, you divide your net operating income by the amount you paid for the apartment.
$25,200 / $900,000 = 0.028 (I used a calculator for this part–congratulations if you don’t need to)
Let’s round that to the hundredths place:
0.03, or 3%
Your cap rate is 3%!
Is 3% a good cap rate? It’s acceptable for New York City, but it’s not a wow number. If you could get 4% or 5% that’s more impressive; 6% would be the wow. But what do you care? You’re already rich from Kindly Cat Lady and 3% is probably better than what you’d get parking that $900,000 in your savings account.
So there you go! Your first steps towards being a New York real estate mogul, explained. Questions? Problems? Ask me at firstname.lastname@example.org