The recent financial crisis has indicated that investment in the real estate sector can be real challenging if a person ignores a few aspects of investment. It should be noted that learning these investment aspects are not the panacea to overcoming the challenges of the real estate market. They only act as educational titbits to make real estate investment less risky and more profitable.
Loan-to-Value Ratio (LTV)
It is important to understand that once the market returns to normal conditions, the LTV tends to show the same trend by offering loans that are of 60-80% on the overall value of a property. However, such a high LTV from major financial institutions should not be interpreted as an indicator for high profit margins, as this is a fresh lesson from the recent financial meltdowns. The actual value of a property plummets when LTVs are high, forcing an investor to bear the burden of a loan along with high investment risks for their property.
Debt Coverage Ratio (DCR)
An investor must calculate the ratio of Net Operating Income and the NOI’s Annual Debt Services, so the actual value of the property can be determined. In real life, a lender may not be willing to loan to a property which has a NOI that falls behind its Annual Debt Services. This is a problem because if an investor fails to generate reasonable profit out of a real estate property, there is no point in risking a large amount of money to buy it. While buying any property, it would be prudent to check if the DCR stands at 1.20, as this is said to be adequate for meeting the criterion of a good investment.
Capitalization Rate can be expressed as the ratio of Net Operating Income and a property’s value. One should calculate the Capitalization Rate before making the decision to invest in the real estate sector. The ratio tends to determine the value of a property through undertaking variables of the prevailing rate of return in the market and the time value of money. Because of this, the ratio determines the value of an investment if it is generating an income of 10% in today’s market. For investments such as this, the Capitalization Rate will measure the value of the investment in comparison to historical rates and in comparison to its purchase time. Overall, the capitalization rate acts as a mathematical tool that you must remember.
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