Have you every wanted to buy a rental property, but were not sure how to figure out how much a mortgage the property could support and still before becoming negative cash flow (meaning that the rents pay for everything)? Check out this simple example showing how to calculate this number.
Samantha is interested in purchasing a rental property as part of her retirement plan. She finds a nice 4-plex with gross rents of $4,000/month. She assumes a 50% expense ratio for the property (meaning that 50% of the gross rents will be accounted towards taxes, insurance, repairs, utilities, vacancies, evictions, etc.), thereby leaving Samantha $2,000 of rent to pay the mortgage.
Assuming that Samantha can get a fully amortized mortgage with terms of 30 years (360 months) at 5 percent interest, how large of a mortgage can the property support?
Answer: Here are the following key strokes to punch into your HP10bii financial calculator (if you don't have one, no worries, simply follow along)
- N (number of months) = 360 (the mortgage is 30 years/360 months)
- I/YR (interest rate/year) = 5 (the interest rate of the mortgage)
- PV (present value) = ??? (this is what we are solving, the starting value of the mortgage)
- PMT (payments per months) = ($2,000) (these are the monthly payments that the property can afford, please note that this number is negative as Samantha has to pay this out every month)
- FV (future value)= 0 (the loan is fully amortized, which means that it will be paid off at the end of the 360 months)
After entering the above number and solving for PV, the answer is $372,563.23, meaning that the property can support a $372,563.23 mortgage and not become cash flow negative.