Many people know that real estate can be an excellent investment in order to generate wealth. However, most people do not know what is required to analyze a single family rental properly. The good news is, you don’t have to be particularly good at math or finance in order to look into a property’s investment potential. If you follow the steps below, you should have a good idea of whether or not the property you are interested in purchasing would make a good investment.
1. Figure Out the Total Monthly Income (Gross Rent)
There are two options when figuring out the monthly gross rent. The first is if you purchase a property with a current tenant already paying rent. This is certainly the more easy of the two options. Most of the time, when purchasing a property, the new owner has to honor the current lease that is in place until it expires. So, if you are purchasing a property with an existing tenant and lease, keep in mind that their current rent amount will carry over.
If the property you are buying has no current tenants then you must calculate the fair market rent. This can be done in a variety of ways. The first would be to use online tools such as rentometer.com that will use their advanced calculation techniques to calculate a suggested rental amount. The second way would be to visit a variety of online property rental websites to get an idea of what other similar properties in the area are being rented for. Once you get an idea, you can use these numbers to create a competitive monthly rental price for yourself. The third option would be to consult a professional property manager or real estate agent who deals in investment properties. They should be able to use their knowledge and professional experience to give you an accurate rental amount. This last option will more than likely give you the most realistic number out of the three.
2. Calculate the Expenses You Will Have Every Month
Every property is different, but you will surely have monthly operating expenses for your investment. This may include insurance, taxes, property management fees, a monthly mortgage payment, and homeowners association fees. In addition, you should also consider vacancy and future repairs!
Here’s how to estimate these expenses:
- Property taxes: You can visit your county’s tax collector website to get the most up to date property taxes for your property.
- Insurance: Get a quote from a trusted insurance provider.
- Property management fee: This fee is usually around 10% of the monthly rent.
- Mortgage Payment: You can consult a trusted mortgage lender that specializes in investment property loans. If you need, we can provide you with an excellent reference for a lender.
- Vacancy: I would recommend estimating about 8-10% of the monthly rent toward vacancy expenses. This highly depends on the desirability of the home and the area it is located in. However, this should give you a safe estimate.
- Repairs: Again, this is dependent on the property, but I would recommend somewhere from 5-8% of the monthly rent.
- HOA: You can contact the HOA of a community or ask your real estate agent.
Once you add all these expenses up, you can move on to the next step.
3. Subtract the Monthly Expenses (Step 2) From the Monthly Rent (Step 1) to Get Your Monthly Profit
This is how you can obtain your monthly net income; or what’s known as your cash flow. This should be a positive number. Otherwise, it is time to reconsider this particular property.
4. Calculate Your returns
There are two numbers that you are ultimately looking to find out in order to see if the property is a good investment:
Capitalization rate (cap rate):
This gives you an idea of whether the property is a good deal. It is an analysis of the return on investment in relation to the purchase price.
Here is the full equation:
Monthly Profit(from previous step) X 12(months)= Net Operating Income(NOI)
NOI ÷ purchase price = Cap Rate
Cash-on-cash return:
This number indicates how much return you are getting on the actual money you invest. If you pay all cash for a property, this number will be the same as the cap rate. However, if you are using financing, this number is the most accurate way to see the true return on investment. This is because, when using financing, you are only putting in the down payment from your own funds.
Here is the formula:
Net Operating Income ÷ total cash invested = cash-on-cash return
As you can see, running a proper rental property analysis can be done without being a math or finance expert. Just right down your list of expenses, fill in the numbers, and calculate your cash flow. With these steps listed above, you are well on the way to analyzing a potential investment property. Of course, you can also consult with our team to get an even better idea of whether or not the property you are considering is a good investment!