VALUING YOUR INVESTMENT, Pt. 1: Before you Buy
Before buying a student rental - or any investment property - it’s essential to understand how it will actually make you money.
This post synthesizes some key financial tools investors use before purchase to evaluate potential returns, model different outcomes, and decide whether a deal is worth pursuing. A follow-up post will cover how to track and manage performance after you own the asset.
Cashflow v. Appreciation
Generating Return on Investment (ROI) occurs through 2 main avenues:
Cashflow is the passive income investors often talk about. It is what's left of rental income after operating expenses and mortgage payments are accounted for. It can be steady, recurring, and provides liquidity while holding the property.
Appreciation is the increase in a property's value over time. It represents the lump sum gain realized when you sell the property for more than you originally paid.
Cash Flow offers consistent income throughout the holding period, helping cover debt service and expenses. It's often more predictable and can be stabilized early with strong management. Investors focused on income tend to prioritize cash flow-heavy deals. Appreciation is more speculative and market-dependent. It requires a longer-term horizon and can be driven by neighborhood growth, property improvements, or favorable market shifts. Investors looking for large payoffs down the line often lean more toward appreciation.
Most real estate investments include both elements, but your strategy (and risk profile) will dictate which one you lean on more. Smart use of leverage can magnify both cash flow and appreciation returns - but it also introduces risk. In a following blog post, we’ll explore how using borrowed money impacts your return, and how Return on Equity (ROE) helps evaluate how efficiently your invested capital is generating more money for you.
Financial Forecasting
Before you buy, you need to know if the deal pencils out - not just today, but over time. The following 2 tools are a great place to begin for forecasting real estate investment performance.
Net Present Value (NPV) calculates how much an investment is worth today by adjusting future cash flows for the time value of money, using a discount rate.
It answers, "Do the future profits, adjusted for time, justify the initial cost?" A positive NPV suggests the investment could be profitable, while a negative NPV indicates it may not be. The discount rate reflects the required rate of return or cost of capital, and is essential for calculating NPV.
The Time Value of Money (TVM) means that money today is worth more than money tomorrow - accounting for potential investment returns and inflation.
NPV helps you figure out if future cash flows justify the initial investment.
Internal Rate of Return (IRR) is the discount rate at which NPV = 0. It reflects the minimum return you want from an investment.
In simple terms, it reflects the annualized (projected) return the deal would produce after accounting for expenses. If the IRR is higher than your required rate of return, the investment could be a good fit. If it’s lower, seek a lower purchase price, or perhaps it might not meet your goals altogether. IRR is especially helpful for comparing multiple investment opportunities on equal footing.
Additional Tools
Once you’ve estimated returns, it’s smart to pressure-test the deal.
Break-Even Analysis helps you identify the point at which your rental income just covers all expenses — no profit, no loss. Knowing this number gives you a clear sense of your margin for error and helps answer, “How much vacancy or capital expenditure can I withstand before this stops making money?”
Sensitivity Analysis helps you understand how your investment might preform under various market fluctuations: interest rates, occupancy, rental income, maintenance & repairs... This approach reveals risk scenarios and helps you make decisions based on what could happen, not just what you hope will happen.