Hello everyone!

I’ve been learning how to analyze properties and I wanted to post on how to do a full, if basic, property analysis. My hope is both to help other investors out by distilling things I've learned while getting input from experienced investors who I hope will let me know where I am incorrect. So please, any comments are welcome! Especially anywhere that I am wrong. The goal is to learn!

This analysis is aimed at single family buy and hold rentals, but much of it applies to short term rentals and multi-family or apartments as well. I’m afraid I have no experience with flips so I won’t be touching on that subject.

Analyzing a deal seems daunting at first, but ultimately it consists of finding the answers to three questions and crunching numbers. These questions are "What is the monthly rent likely to be?", "What are the monthly expenses?", and "What is an acceptable/expected Cap Rate?". Once you have these pegged, it's just some simple calculations to arrive at an initial offer price.


Expected monthly rent
Determining the potential monthly rent consists of doing some research and talking to people knowledgeable in your desired market. Online resources include Zillow and Realtor.com and other websites that show properties for rent. Do some simple comparisons of similar properties, noting condition, square footage, bedrooms, bathrooms, and other major factors. I also recommend talking to property managers and investment savvy real estate agents. They will help you identify factors that affect rent, give you an idea what your prospective property will rent for, and what improvements will increase the rent most efficiently. Ultimately your mindset should be “what property will cash flow the best” not “do I want to live in this property.”

Determining Expenses
I break these into initial expenses (one time costs associated with buying and fixing up the property) and monthly expenses (recurring costs associated with operating the property).

Initial Costs
1. Down Payment - the percentage of the purchase price you bring to the table. Talk to local banks. For a rental property these are usually 25%.
2. Advertising Fees - the costs associated with advertising for tenants. Talk to local advertising agencies your property manager.
3. Initial Cleaning Fees - professional cleaning prior to tenants moving in. Talk to local cleaning agencies or your property manager.
4. Closing Costs - costs associated with closing on the house. Talk to your real estate agent or local title companies.
5. Due Diligence Inspection Fees - costs associated with pre-purchase inspections and research. Talk to your real estate agent or local inspection agencies.
6. Initial Repair Costs - how much the property will cost to get into rental shape? This one varies greatly between properties, but scheduling a walk through with a good local general contractor will get you an estimate. Note that you may need to pay for their time, which is another initial cost item.
7. Any other initial setup costs - do some research and talk to your real estate agent, property manager, or other local investors to determine any other initial costs that may be associated with the property.

Monthly Costs
1. Property Taxes - you can get these from the county assessor's office. Use the expected taxes for the coming year. Note that these will likely increase as you increase the home’s value.
2. Insurance Premiums - talk to your insurance company for an estimate on landlord insurance for the property. Convert the annual premium to a monthly cost (divide it by 12).
3. Property Management Fees - what the property manager will charge each month. Talk to your property manager for their rate and multiply it by the expected rent. Generally, it’s 8-12% of the rent.
4. Vacancy - the percentage of the year that the property will be between tenants. Talk to your property manager and/or real estate agent. Multiply this percentage by the rent to get a dollar amount.
5. Any other operating costs (utilities if paid by owner, HOA fees if applicable, etc) - do some research and talk to your real estate agent, property manager, or other local investors to determine any other monthly costs that may be associated with the property.
6. Loan Principal and Interest Payments - you'll get this after determining your offer price, but prep now by asking your lender what interest rate you can expect. Once you have the offer price, plug the down payment percentage, interest rate, and offer price into a loan amortization calculator to get the monthly loan cost (there are many online).
7. Capital Expenditures or CapEx - This is one that causes much analysis paralysis. One way is to break down all the major parts of the home (roof, plumbing, flooring, appliances, drywall, etc) and get a cost to replace each verses expected lifespan of each and use that to get a monthly dollar amount to set aside. This varies wildly by location and construction material. A simpler approach is to ask other investors and see what they use as a monthly CapEx cost for your market. For now, I look at my insurance copay and figure on one major expense per year, so I take that copay and divide by 12 to get my CapEx expense. I'm not sure if this is valid, so comments are welcome.

Cap Rate
The Cap Rate is related to two other values that I'll discuss in a moment - your Net Operating Income (NOI) and your purchase price. Cap Rate = NOI / Purchase Price. It is essentially a percentage that tells you "How good of an investment is this?" In the context of deal analysis it is best used as a tool to get to that offer price. By rearranging (math!!), we get Offer Price = NOI / Cap Rate.

Each market has an expected cap rate, one that you can determine by talking to other investors and investor savvy real estate agents in that market. Alternatively, once you have more experience you can pick what an acceptable cap rate is for you and use it to analyze deals.


The Analysis
Ok, now you have a bunch of numbers. Nothing to do but crunch them! But don't worry, the math is quite easy. Getting the correct numbers was the hard part.

The first thing we want to do is calculate our Net Operating Income. NOI is your annual income minus the annual operating expenses. Your annual income is the expected monthly rent (not your profit but the total rent coming in) times 12. The operating expenses are all of the above expenses added together EXCEPT your loan payments (principal and interest of all loans associated with the property) and your CapEx. Think of the NOI as how much it costs to operate the property itself on an annual basis, barring catastrophic expenses.

Now that you have your NOI and your Cap Rate, just plug it into the formula Offer Price = NOI / Cap Rate. Congratulations! You have a sensible initial offer price based on what the property is actually worth as an investment. However, we aren't quite done yet.

How much money will I make? What is my return?
There are two other useful quantities to consider: your annual profit and your cash-on-cash return. Profit is your income minus all expenses. Take the monthly rent and subtract out all monthly expenses. Multiply by 12 and you get your annual profit.

Cash-on-cash return is a common way of analyzing how good an investment is. Where Return on Investment speaks to the full lifetime of the investment, Cash-on-cash return looks at how it does on an annual basis. To get this, you take your annual profit and divide by the total money you put into the property. This is another area I would like someone to check me on, but this includes all initial costs (and not just down payment). This is why using other people’s money is amazing because any investment deal that you have no money down on but still cash flows even a little bit yields an infinite cash-on-cash return for you.

The different quantities we get are used for different things. NOI and Cap Rate help you arrive at an offer price. Annual profit is the total cash flow you stand to get each year. Cash-on-cash return is how good the investment is relative to what you put into it. All three of these are important to know before going in. If any of them are not acceptable to you, then the property may not be a good investment.

I know this was a bit of a long post, but if you read it all, thank you! I welcome any and all feedback!