Rent, minus every cost, divided by the cash you put in. That is your return, and there is no fourth step.
The arithmetic takes ten minutes. Getting the cost side right is the part people skip, and around here one line does most of the damage.
What are the two numbers investors use?
Cap rate is your yearly net income divided by the price. Net income means rent after every cost except the mortgage.
Cash on cash is the money left in your pocket each year divided by the cash you put in. This one counts the mortgage, and it is the number that tells you whether the deal feeds you or eats you.
Cap rate compares two properties. Cash on cash tells you what you personally earn on the money you handed over.
How does the math work?
Use round numbers to see the shape of it. These are for the arithmetic, not a quote on any street in Kane County.
Take a house at $300,000 that leases for $2,400 a month. Gross rent for the year is $28,800.
Now subtract. Say $7,500 in property taxes, $1,600 for insurance, $1,200 for repairs, and eight percent of rent for vacancy, which is about $2,300. Net income comes to $16,200.
Divide $16,200 by $300,000 and your cap rate is 5.4 percent. Then put a mortgage against it, subtract the payments, and whatever survives is your cash flow.
Which costs do people forget?
Six of them, and every one is checkable before you write an offer.
Property taxes. The biggest line in Illinois by a wide margin, and it is knowable to the dollar. Pull the bill for the parcel before you offer.
Vacancy. A unit between tenants earns nothing. Budget for it every year, not just the years it happens.
Turnover. Paint, cleaning, a new carpet and a few weeks of nobody paying. This costs more than most first time investors expect.
Big ticket items. A roof, a furnace, a water heater and a driveway all have a lifespan. Put money aside monthly so the bill does not land on your credit card.
Management. Hiring it out commonly costs eight to ten percent of collected rent, plus a leasing fee. Doing it yourself is free in dollars and expensive in Saturdays.
Insurance. A rental needs a landlord policy, and it costs more than the homeowners policy on the same building.
The Illinois line that changes the answer
Here is the one nobody tells you. The general homestead exemption applies to property somebody occupies as their principal residence.
Buy that same house as a rental and the exemption comes off. Your taxable value goes up and your bill goes up. The tax figure printed on the current owner’s bill is no longer the figure you will pay.
So never underwrite a rental off the seller’s tax bill. Work out the value without the exemption, then apply the composite rate.
Our post on Kane County property tax rates lists that rate by district. Our post on the Illinois equalized assessed value shows how the value math works.
How do you find out what it will lease for?
Ask what comparable units leased for, not what they were listed at. Listed rent is what somebody hoped for. Leased rent is what a tenant signed.
Dale can pull recent leased comparables from the MLS for the specific block you are looking at. That takes a few minutes and it beats every rent estimate on the internet, because the internet does not know your unit has one bathroom.
Walk the street too. A property two blocks from a Metra station leases differently from one that needs a car for everything. The Fox Valley has stations at Elgin, Geneva, Elburn and Aurora.
Does the one percent rule work here?
The old screen says monthly rent should reach one percent of the purchase price. On a $300,000 house that means $3,000 a month.
Use it as a quick filter and nothing more. It came out of a different era of prices and interest rates. A property that misses it can work once you put your own numbers in.
The full arithmetic beats any shortcut. It takes ten minutes and it is specific to you, your loan and your tax bill.
What should you do next?
Pick three properties you like and do the math on all three before you fall for any of them. Get the tax bill, get the leased comparables, and price the insurance.
If two of them fail, that is the process working. A property that fails on paper fails in your bank account twelve months later, and the paper version costs nothing to find out.
Our real estate investing page covers how we work with investors here, from the first walkthrough to the tenant. Send Dale an address at (630) 940-7016 and he will send back the tax figure and the leased comparables for it.
