Disclaimer: This information is for general knowledge and guidance only. It does not constitute financial or investment advice.

Should you just build for the sake of it? When it comes to investing in rental properties, we all want to make money but the question is: Is building a block of flats on a 20×30 plot profitable?. There are several ways to determine this. In this short article we are going to examine one way of determining whether you are getting a good return on your investment. This is called Capitalization Rate or Cap Rate. Let’s use an example of a block of flats in Chalala, Lusaka. Grab a pen and paper.

STEP 1. Calculate your Projected Annual Rental Income (ARI)

Determine Monthly Rent (R):

• Research comparable rentals in the area to set a competitive market rate. Be realistic.
• Consider factors like size, amenities (e.g., parking, appliances), and property condition.
• Rent in Chalala 2 by 2 bedroom house R = 5,500 x 2 = 11,000 per month

Calculate Annual Income (ARI):

• Multiply monthly rent by 12 months.
• Account for potential vacancy periods (e.g., between tenants). 
• ARI= 11,000*12= K132,000

STEP 2. Determine Annual Operating Expenses (AOE)

Add up all the annual operating expenses you expect for example:

• Mortgage Payments: Include principal and interest.
• Property Taxes: Give to Caesar what belongs to Caesar. Caesar is Zambia Revenue Authority, Ministry of Lands etc.
• Insurance: Many people in Zambia don’t take this seriously but please insure your house.
• Utilities: (If you pay any)
• Maintenance and Repairs: (Estimate for routine and unexpected costs)
• Property Management Fees: (If applicable)
• Vacancy Costs: (Estimate potential lost income during vacant periods)
• Total Annual Operating Expenses AOE= K90,000 (just an example factoring in all the above, K7,500/month )

STEP 3. Calculate Net Operating Income (NOI)

Formula: NOI = ARI – AOE

NOI = Annual Rental Income – Annual Operating Expenses

= 132,000 – 90,000

Net Operating Income -NOI = K42,000

STEP 4. Calculate Return on Investment (ROI) 

Capitalization Rate (Cap Rate):

• Focus: Property’s purchase/construction price. Let’s assume you bought the flats at K1,000,000
• Formula: (NOI / Purchase Price) x 100

• Our Cap Rate = 42,000/1,000,000= 4.2%

A Higher Cap Rate: Generally indicates higher potential return. However, it can also signal higher risk. Example: A higher cap rate might suggest a lower property value or higher vacancy rates. If our house in Chalala was 500,000 the cap rate would have been 8.4%.

Lower Cap Rate: May suggest a more stable and less risky investment, but with lower potential returns. Example: A lower cap rate could indicate a more desirable location or higher property value.

IMPORTANT: ANALYZE AND COMPARE

• Compare your calculated ROI with other investment options.
• Consider your risk tolerance and investment goals.

• Accurate Estimates: Use realistic figures for all income and expenses.
• Have a long-Term View: ROI can fluctuate over time. Consider long-term appreciation potential.
• Market Conditions: Research local rental markets for trends and potential challenges. Sometimes the project can yield better results in a different town.
• Professional Guidance: Consult with a real estate professional or financial advisor for personalized advice. Seek professional advice from a financial advisor or real estate investor. The above are just my opinion.

Even if your property does not yield good results after this calculation, there are still other ways you can gain a benefit. We will discuss this in another article. I hope this gave you a better understanding.

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