First, you must accurately estimate the annual rent you may receive, as well as the expenses you’ll incur. Expenses can include real estate taxes, insurance, maintenance, and repairs, as well as legal fees if an eviction is required, advertising costs to get tenants, and repair costs if a tenant damages the property.
Do the Math: An Example of a Condo Investment
Let’s look at an example: You find a condo selling for $55,000, and you can pay cash. It will rent for $750 per month ($9,000 per year). At first glance, that represents a 16.4% yield ($9,000 divided by $55,000). But before you get too excited, you must factor in these expenses:
Real estate taxes are $1,000 per year. Insurance is $400 per year. You estimate about $300 per year in maintenance and repairs. The condo will be vacant about one month per year (at a cost of $750 per year). Each time it’s vacant, you’ll need to spend on advertising (at a cost of $150 per year). You estimate that one out of every five years, you might have a bad experience and incur legal costs and additional repair costs of about $5,000 (which would be about $1,000 per year).
Those costs total $3,600 per year (or about $300 a month). Your net rent is now $5,400 ($9,000 minus $3,600), which represents a net rental yield of 9.8%, which is still an attractive return. In addition to cash flow, you will get to participate in the appreciation of the value of the property. If you expected real estate to rise about 3% per year, in the first year your condo would appreciate from $55,000 to $56,650, for a gain of $1,650. If you cannot pay cash and must finance the property, you’ll also have to factor in the interest cost. For investment property, plan on putting 20–25% down to qualify for the loan. In the scenario above, let’s say you put 25% down ($13,750) and finance the remaining 75% ($41,250) at a 7% rate over 30 years. Your payment would be $274 a month. When you add your payment of $274 a month and the estimated expenses calculated above, of about $300 a month, you get $574 a month of estimated expenses. With expected rent of $750 a month, this property would still deliver positive cash flow, and based on these numbers would likely be a good investment.
Other Factors: Condo Assessment and Association Fees
You’ll also need to find out if the condo you’re considering has association fees and how often you may need to pay assessments, which are expenses incurred to cover the common areas of the condominium property. Assessments could include landscaping, parking lot and parking garage repairs and maintenance, improvements to the exterior of the building, and expenses associated with any common areas such as a main lobby or entranceway. These expenses should be factored into your expense estimate before you calculate the estimated return on your condo investment. Before making any real estate investment you must also assess how realistic your assumptions are. Here are some additional questions to consider in determining if a condo purchase will be a good investment:
Is your condo in an area where rental properties are in demand, such as near a college? Is it in an area that is getting less popular or more popular? Could a major employer in the area close down and cause rental demand to decline? Could a new condo development be built nearby, leaving yours in need of expensive improvements to compete?
