I once met a family who was considering whether to turn their home into a rental or sell it and look for new investment properties after moving to Lexington from another state. The first question they had was whether the rental prices in Lexington were actually worth investing in.

The average home value in Lexington is around $336,762, which has increased by 3.0 percent compared to the previous year. The average rental price in the area is reported to be $1,383 per month. Dividing the annual rental income of $16,596 by the purchase price gives a total return of about 4.9 percent. The next question that arises is how much the property tax will be.

The effective property tax rate in Fayette County, where Lexington is located, is about 0.87 percent, which is relatively low even within Kentucky. For a home valued at $336,762, the annual property tax would be around $2,900. If the previous state had a much higher property tax rate, moving to Lexington could result in significant savings each year.

According to the 1 percent rule, a property valued at $336,762 should have a monthly rent of $3,368, but the actual average rent of $1,383 falls far short of this benchmark. However, since this family's goal was stable living and long-term holding rather than short-term cash flow, they placed more emphasis on property tax burden and school district stability than on the 1 percent rule.

So how should net operating income be calculated? When factoring in insurance, maintenance costs, management fees, and vacancy losses, the net operating income based on the 50 percent rule would be around $8,300 annually, and the cap rate would drop to about 2.5 percent. Compared to the total return, this represents a significant reduction, but this trend is common across all regions when accounting for operating costs rather than being unique to Lexington.

If long-term holding is assumed, the perspective of total returns becomes more important. Even with a low cap rate, the gradual repayment of the loan principal each month, combined with steady but modest price appreciation like in Lexington, can lead to much better results over 10 or 20 years than the initially calculated cap rate. Of course, this is not a guarantee that prices will continue to rise, but rather a possibility to consider.

During discussions with this family, the most important point highlighted was the cash-on-cash return. The perceived return can vary significantly depending on how much cash is actually invested through the down payment and closing costs. Depending on how much is borrowed and the interest rate terms, the cash-on-cash return could be higher than the cap rate or vice versa.

Lexington has several school districts that are preferred by Korean families, leading to families considering both living and investment options. However, school district boundaries tend to change frequently, so it seems wise to double-check the assigned school for the address before purchasing. When coming from another state, not only the property tax but also the insurance rates may differ from the previous residence, so it's important to keep that in mind as well.

Tax benefits from depreciation should also be included in the total income calculation. By spreading the building value over 27.5 years for cost recovery, taxable income can be reduced each year, and in areas like Lexington with low property tax rates, the impact of this depreciation effect can feel relatively significant in the overall after-tax income.

I compared the scenarios of converting the home to a rental versus selling and reinvesting. Keeping the home as a rental saves on transaction costs but creates new management burdens, while selling and reinvesting incurs initial costs but allows for selecting properties that better fit investment goals.

When reviewing properties, it's also good to consider the lease duration and renewal conditions. Kentucky is often cited as a state with relatively landlord-friendly regulations, but specific clauses can vary from contract to contract, so it's necessary to verify before finalizing any agreements.

Tax and rental-related conditions can vary by county, and this article does not constitute investment or legal advice. Please consult with real estate and accounting professionals before finalizing any agreements.