Real Estate Analysis Will Make or Break your Investment
Real Estate Analysis is a process that must be completed thoroughly at all levels of real estate investing. This process will be your safeguard against buying a “hell-house” and must be completed thoroughly!
Rules of Thumb
I utilize these rules of thumb to quickly weed out properties before I waste time performing real estate analysis on them. With practice and market familiarization, you will be able to take one look at a property and decide if it is worth looking through photos or moving on. The idea here is to avoid wasting your valuable time scrolling through pictures of homes that aren’t even worth visiting.
If a property doesn’t meet these three rules I will kick it to the curb and find something else! Don’t look at pictures, or emotions will start to get involved, and definitely, don’t go look at the property in person! Profit is made when you buy, not when you sell!
1. GMR x 12 x 7 rule
In this rule of thumb, I take the gross monthly rent (GMR) total and multiply it by 12 to get the gross annual rent. Then we multiply that number by 7 (not entirely sure why 7, but it works!). The answer is the highest allowable offer to purchase the property.
I will multiply this total number by 0.90 if the project needs a little work, but generally, this rule of thumb is pretty spot on. If a property piques my interest I will run it through this formula first, and if the asking price is higher than what my formula says I immediately move on to another property.
2. 1% rule
This rule states that gross monthly rent should equal about 1% of purchase price. This number will fluctuate a little based on your local market. In my primary market, it is closer to 1.2/1.3 percent for duplexes. I would be wary that anything over 2% most likely has a lot of issues.
3. 50% rule
This rule states that in a worst case scenario all expenses (minus principle/interest from mortgage) will equal no more than 50% of gross monthly rents. So if the property rents for $1,000 a month, expenses will be $500 or less. Subtract your mortgage from the difference and that should equal your cash flow.
When we discuss income we want to consider all of the possible ways a property can earn you money. I analyze everything based on the gross monthly income for residential properties.
Gross Monthly Rent
This is the monthly rent due every month. Be sure to run your analysis based on current numbers, and if you can increase rents later that is a bonus. Don’t factor that into your purchasing decisions. A useful tool to verify if the current rents are above or below market value is rentometer.com
Any Additional Income
This can include coin laundry machines, parking space fee’s, pet fee’s, and vending machines. Additional income is limited only by your imagination and is one way to add value to a property that is often overlooked. I have coin laundry machines in my 10-plex, and easily they generate 30-40 extra dollars a month!
Expenses are the most critical, and overlooked, part of real estate analysis. When we discuss expenses it is critical that you consider every possible expense that could take place. Ensure that you ask for an income/expense report for every property in order to see what the expenses looked like over the last few years. Keep in mind these numbers could be fudged and it is always a good idea to double-check their records. Expenses are the most important piece of the puzzle in real estate analysis, don’t skimp on this.
The Mortgage is your monthly payment to the bank for whatever portion of the purchase they funded. This includes the principal (original amount loaned) and interest on the loan.
It is important to note that mortgages are paid using amortization. This means you pay a larger portion of the interest up front, as opposed to over the course of the loan. What this means for you is that in the beginning, your monthly payments will not add huge amounts of equity to your property unless you pay extra towards the principle.
There are several different mortgage calculators, but I generally use this one from bigger pockets on the computer. On my phone, I use the Zillow mortgages App.
The largest factors in mortgage payment amounts are the interest rate and the term (length) of the loan. These are things to discuss with your lender during the pre-approval purchase to ensure your actual mortgage rate is close to, or better than, what you planned for.
Insurance is a must for your investment property! Not only is it required by most (if not all) lenders, but it will save your skin in the case of a natural disaster or tenant injury. Insurance can be somewhat expensive, but the cost greatly outweighs the risk of not having insurance on the property.
Talk to your insurance agent as soon as possible in the analysis process to get an accurate quote for your expenses. Make sure that you factor in floodplains, fire hazards, tornados, and other potential disasters. Also, after purchase let your agent know about updates because items like a new roof can help lower your insurance payment!
Taxes are easy to find for real estate analysis. A simple search of your county tax assessors website will reveal everything you need to know. All you need is the address of the property in order to search most county assessor websites.
These websites can show you the last few years property tax paid, and often tell you other details like permitted improvements to the property. This is great because it isn’t speculation, it shows you exactly what was paid in property tax, and is an easy way to confirm the sellers advertised numbers.
side note; I have also used the assessors’ website to discover other properties the homeowner might be looking to sell. This is easy because searching the owners’ name will reveal all of the property they own!
Utilities (Tenant or Landlord)
By far, the most important question I ask here is whether the tenant or landlord pays utilities for the property. You need to verify this!
I once had a seller omit utilities from their expense report, and tell me tenants paid utilities. During the inspection I had my property manager confirm, and the tenants informed us that the landlord paid for utilities. Had I taken the sellers word I would have been out an additional $150-250 a month in expenses.
Most utility websites have an option to view the last year or two worth of utility reports for a property that you’re looking at purchasing. I then take all of the payments for the last 24 months and find the average. That is the number I use for my calculations!
Maintenance includes new lightbulbs, air-filters, cleaning the gutters, and other preventative measures. These can be factored utilizing the expense report, or by simply talking with your property manager about what items they replace, and how much that costs. Basic maintenance is generally not too expensive to budget for.
This is the section that covers those dreaded leaky toilets, blown fuses, and every other item that breaks during the tenancy. It is critical to look through the expense report and notice trends. Take the average of all expenses, and see what percentage of gross monthly rent is being spent on repairs.
I have found that it is usually 5-6% for my investment areas but I plan for 7% to be on the safe side. Something to consider is the age of the building. Older buildings will cost more in repairs than newer buildings. If the building has been renovated properly it will be better than other old buildings.
For example, the 10-plex I recently bought has seven units that were renovated in the last two years. Those expenses killed a significant amount of the cash-flow from those years, but I know that I won’t have to pay much in repairs for those seven units in the near future!
Capital Expenditures (Capex) are the large ticket items that need to be replaced occasionally, but not every year. These are things like a new roof, appliances, driveway repairs, plumbing etc. These items need to be budgeted for the long term because a roof will only need to be replaced every 15-20 years or so, but if you don’t budget for it that can be painful to replace. I usually factor 7-10% for Capex depending on the age and condition of the building.
MAKE SURE YOU SAVE THAT 7-10 PERCENT! Too many people make the mistake of counting every penny left after monthly expenses as income, and fail to save for Capex. That is a huge mistake and one that you won’t realize until it is time to buy a new roof and you have no money saved for it. Plan for Capex during your real estate analysis, and then stick to that plan!
Closing costs will vary based on the area where your real estate analysis is taking place and the title company that you use. Ask your Real Estate Agent and title company for an estimate.
The best thing about closing costs is that you don’t have to pay them! I have never paid closing costs because of how I negotiate my real estate investing deals. I have several negotiating strategies but one common trend is to use the philosophy of “my price, your terms…your price, my terms.” I will generally offer to pay half of the closing costs and offer a little less than I’m willing to pay for a property. When the seller counters (which they often do) I will increase the purchase price, but no longer offer to pay any piece of the closing costs.
At this point, they will either go with your lower first offer, or you will have ZERO closing costs to pay!
Commission (upon sale)
It is safe to factor in 6% commission for the buyer and seller Real Estate Agents upon the sale of your property. This isn’t something you need to worry about for monthly calculations, just know that it will come out of your profits when you sell the investment property.
Running the Numbers
Now that you understand how to find the income and expense information for real estate investment analysis, let’s do it!
These are the numbers for my first Duplex.
|TOTAL MONTHLY INCOME||1010|
|UTILITIES (IF APPLICABLE)||0|
|REPAIR (7% GROSS MONTHLY RENT)|
|CAPITAL EXPENDITURES (7% GROSS MONTHLY RENT)|
|VACANCY (7% GROSS MONTHLY RENT)||50.5|
|TOTAL MONTHLY INCOME||1010|
|TOTAL MONTHLY EXPENSES||868.17|
As you can see from the above analysis is actually somewhat simple. All we have to do is subtract all of the possible monthly expenses from the gross monthly income, and boom! Cash-flow!
Investment property calculator
For a more detailed, and long-term real estate analysis I recommend utilizing an investment property calculator. There are a lot of ways to analyze these numbers, but my favorite is the Bigger Pockets rental property calculator. This calculator is easy to use and easy to understand. The best part of this tool is the awesome PDF that can be saved, shared, or printed to showcase the property.
This allows you to share the information with your lender or partner. You could even use this as a negotiation tool with the seller if you wanted to explain why you offered less than the asking price!
Example of my First Analysis
Here is the PDF printout for my first duplex, courtesy of the Bigger Pockets rental property investment calculator!
Avoid the Dreaded “Analysis Paralysis”
All of your Real Estate analysis means nothing if you can’t get past your fears. Analysis Paralysis is real, and I understand that buying your first rental can be scary to pull the trigger on. However, the perfect property does not exist, and if it did somebody that isn’t afraid to TAKE ACTION would buy it first!
The hardest part of becoming a Real Estate investor is purchasing the first property. If you run these numbers conservatively and still come out with positive cash-flow I recommend you go for it! Even if you broke completely even in cash-flow it would still be beneficial from a tax, depreciation, and equity pay-down standpoint.
However, if you follow all of these steps, and triple-check that your numbers are cash-flow positive I am certain that buying your first investment property will open the door to massive success!
Real Estate Analysis takes gets easier with practice, but it is a critical step in the real estate investing process! This is one of my favorite parts of the process because I love running the numbers!
Check out The first step of the Real Estate Investment process: How to find Deals!