Every once in a while, the financial services industry on Wall Street stirs from its pile of sludge and trots out “proof” that investing in stocks is better than real estate. What is real estate anyway? That term is way too generalized. It would be like someone asking you where you live and you say, “In the universe.” While true, it’s not exactly valuable information.
Is your home an investment? No. Your vacation condo? Probably not. Your vacant lot downtown? No. As followers of Empowered Investor Network (PPIN), you probably realize that the term real estate actually means nothing. We need to narrow it down.
Investing is the process of creating value over time. In our opinion, if something does not produce income, it is not an investment. Following that logic, that means the only way you can participate in real estate investing is to own rental income property. Furthermore, these properties must make sense the day you buy them.
How can you tell if they make sense?
Thought you’d never ask. A quick rule of thumb to evaluate and screen potential properties to add to your portfolio is the RV Ratio. This stands for rent to value ratio and it works like this. Say you’re looking at a $100,000 property and it rents for $700 a month. That’s great! It comes in right on the nose of our ideal metric, which is an RV Ratio of .7%. Anything above is even better. You would still be okay going down to .5%, which we would call acceptable. Anything lower is a poor risk from a cash flow perspective and will not be sustainable as an investment.
The RV Ratio gives you a quick look into the feasibility of a deal and helps you manage your cash flow. Put it in your income property tool bag and don’t forget to take it out when you’re in the property buying mood.
Flickr / danielmoyle
