Smart and experienced investors know the value of a well-prepared real estate analysis in any investment opportunity before they proceed.
Real estate investing is not for the faint of heart, as it typically involves large amounts of money. While it is possible to get into alternative real estate investment opportunities, the most straightforward way of getting started is by purchasing an investment property. For this reason, you would want to invest in a property that will get you a good return on investment.
Table of Contents
- What Is Real Estate Investment Analysis?
- What Are the 3 Most Important Factors in Real Estate Investment?
- Part 1: Determining a Property’s Market Value
- Part 2: Calculating Costs and Expenses
- Part 3: Finding Market Rents
- Part 4: Calculating the Return on Investment
A real estate investor’s primary goal for getting into real estate investing is to make a good profit and not just break even on the initial investment.
Beginners in the real estate investing business always ask: How do real estate investors recognize if a certain property for sale would make a good deal or is a rip-off? It is probably one of the main concerns you should ask before signing any papers or closing a deal.
As an investor, one of the things you should be concerned about is knowing what a property’s income-generating potential is so you can come up with a thoughtful strategy for it.
The following is our guide on how to do real estate investment analysis on any residential rental property you may consider buying. We will also take a look at Mashvisor and how the software and its tools can help you make a realistic comparative market analysis.
What Is Real Estate Investment Analysis?
A real estate investment analysis is basically the process of analyzing investment opportunities to decide whether or not they’ll give you the profits you’re aiming for as your investment goals. For the real estate investor, it is perhaps the most crucial part of success. There are generally four steps to analyzing rental properties, which are:
- Determining the market value of the rental property
- Calculating the operating costs
- Finding the market rents
- Calculating your return on investment
Seems simple, right? Well, maybe not. Keep reading our guide for beginner investors. We will walk you through the steps of how to do a proper real estate investment analysis with the right tools.
What Are the 3 Most Important Factors in Real Estate Investment?
Before we tackle real estate investment analysis in a more in-depth manner, we need to discuss three very important factors to consider when investing in real estate. These three factors are crucial to making a realistic neighborhood or investment property analysis.
1. Property Location
One of the most common things you will hear from more experienced investors and real estate professionals is, “Location. Location. Location.” The success of an investment property is largely dependent on where it is located.
An investment property’s proximity to amenities, public spaces, transportation, and tourist attractions, as well as a neighborhood’s status, plays a key role in determining its worth. No real estate market or neighborhood analysis is ever complete without factoring in a property’s location and its immediate surroundings.
When looking for a location for a potential real estate investment, you need to take a look at the following things in a market:
- Land size
- Proximity to community and public amenities
- Neighborhood’s appearance
- Local economy
- Future developments
- Public safety and security
- The above are just some of the main considerations when looking for a good investment location.
2. Property Valuation
Before you make any decisions and sign any deals, you must figure out a property’s valuation to know if it’s worth investing in or not. It is one of the things that real estate investors consider before investing. It is also important in the following matters:
- Listing price
- Insurance
- Taxation
- Investment analysis
- Comparative market analysis
As an investor, you need to be familiar with the different methods used to determine the valuation of a property in any real estate market of your choice. The three most common property valuation methods are—
- Sales Comparison Approach – Generally, investors and appraisers use real estate comps to determine a property’s market value. The sales comparison approach is good for both new and older properties.
- Cost Approach – The cost approach pays more attention to how much it will cost a real estate investor to purchase a property minus depreciation. It is ideal for newly-built properties.
- Income Approach – Lastly, the income approach, as already implied, uses expected cash inflows as a basis for determining a property’s valuation. It is especially helpful for rental property analysis.
The above are some of the things that will be reflected in your real estate investment analysis spreadsheet or comparative market analysis spreadsheet. If you don’t know how to do it all by yourself, you can check out online real estate platforms. You can also download software that provides the necessary tools to help you get the job done.
3. Investment Horizon
The third consideration when it comes to investing in real estate is the purpose of your investment and what the future holds for a particular location. While it is true that real estate investing is all about location, you also need to consider the timing and your circumstances.
For example, you might have found the perfect investment property in the right location based on a neighborhood analysis. However, if your financial situation is still not in order to make a property purchase, then you should seriously give it some thought first.
Can you afford to take out a mortgage and make the monthly payments promptly? Or, will you end up in debt trying to make the payments? If this is the case, then it defeats the purpose of investing because your cash flow will most likely be in the negative.
Keep in mind that no investor goes into something that will make him lose money in the end. The goal is to make money and generate a steady income stream to add to your bank account.
For this reason, you must have a very clear and specific purpose for investing. A lack of clarity could lead to unexpected and unfavorable results, especially if you took out a mortgage for it. You must be clear with your investment strategy and long-term goals, so you don’t end up in financial distress.
Part 1: Determining a Property’s Market Value
Now, let’s talk more about real estate investment analysis and how to make one with the right tools and software.
Sellers of investment properties will always try to sell for maximum profits. Meanwhile, a real estate investor hopes to buy the property at a fair market price. It can be hard to calculate what a real estate property should sell for. It is because values can vary significantly between two similar properties.
So, the first step in real estate investment analysis is to find the real value of the property to avoid overpaying.
To find the value of residential real estate properties, you need to find comparable properties (comps). Comps are simply other properties in the area with similar characteristics that were sold recently.
By looking at what rental properties have sold for, real estate investors can get a hint about the value of another property. It is known as comparative market analysis.
For example, a single family home in your neighborhood will increase in value if similar single family homes are rising in value, and vice-versa. It allows you to determine how well or how bad your choice of investment property is compared to the overall performance of other investment properties in the area.
A comparative market analysis also allows you to gauge the property’s overall performance in a specific housing market.
Before moving on to the next part of a real estate investment analysis, it’s important to mention that larger investment properties (like multifamily homes) are valued differently. You can’t just compare an apartment building to others to see how much it is worth.
Instead, the value of the real estate rental properties is related to their income-generating potential (how much rental income they generate).
How to Determine the Value of a Property Using Mashvisor
A comparative market analysis can be done quite efficiently and effectively with a real estate platform like Mashvisor.
Mashvisor is a real estate company that specializes in helping investors find the best possible deals on investment properties in any location of their choice. It is one of the best real estate investment analysis tools available today. Thousands of investors found their dream properties using Mashvisor’s software and investment analysis tools, including an Airbnb calculator.
To determine the fair market value of a property, simply log onto Mashvisor. Enter the location in the search bar and hit the Start Analyzing button. It will then take you to a vicinity map of the location that shows all actively listed properties in the area.
You will notice three tabs beside the map labeled Investment, Short-Term, and Long-Term. You can click on each tab to see which available properties are listed under each category. It will give you an idea of what the prices are for specific property types in the area.
In addition, you can simply just click on any property on the map or tab. A window will pop up to show you more information about the property. Click on the See Comps link under the Property Valuation Analytics section. The site will then take you to a page that will show you all rental comps in the area. Click on each property to get an idea of how much each one cost.
Get started on your 7-day free trial with Mashvisor today on your way to a thriving real estate investing career.
Part 2: Calculating Costs and Expenses
Every real estate investment property comes with different costs and expenses, which impact the returns and profits that you can expect to gain. So, the next step of the real estate investment analysis is to gather enough information about the property. It is necessary before making the purchase in order to calculate your operating expenses. They include, but are not limited to:
- Property taxes
- Insurance
- Utilities
- Turnover costs
- Maintenance expenses
- Property management fees
- Marketing/rental fees
- Principal/interest payments
The seller will provide you with pro forma data (estimated data about the property’s value). However, remember that a seller wants you to buy the rental property, so they will likely give you high estimates of the rental income. It is likely they will not mention operating expenses that you’ll face down the line. Therefore, you can’t always guarantee accurate pro-forma data.
So, the real estate investor should ask the seller/previous owner for actual data on the rental income and operating expenses. For example, ask to see previous years of tax returns, property tax bills, maintenance records, and other similar records.
After obtaining the pro forma data and the actual data, you’ll be in a better position to decide whether the property makes for a good investment. This step of real estate investment analysis is part of your due diligence before buying an investment property. It assures you won’t run into surprises after closing the deal.
How to Calculate Potential Costs and Expenses on a Property Using Mashvisor
Calculating potential costs and expenses on an investment property can also be done easily on Mashvisor. As a rental property analysis tool, it will give you the information that you need using actual rental comps in the area.
Mashvisor’s database contains not just information and data about a property’s profitability but also gives you access to costs and expenses associated with rental property management. It will give you a better idea of what the market can offer as you work on your rental property analysis.
To do it, simply just follow the same process in determining a property’s value that we stated in the previous point. When you click on a particular property on the map or any of the tabs, it will take you to a page containing more information about the property.
On the Property Valuation Analytics section, simply click on Customize under Expenses. It will take you to a table that lists the associated expenses that go with the property. The table already includes actual market information on that property’s expenses and costs.
You can further customize your rental analysis by putting in data according to your own research. Customizing the data will give you more accurate and realistic results on your investment property analysis. It is why due diligence should never be neglected.
Part 3: Finding Market Rents
Another important thing that should reflect on your real estate investment analysis is its income potential. If you’re in the market for rental properties, the rental income should be seen in your rental analysis.
The rent you’ll charge tenants after acquiring the property is an important consideration. You want your rental income to cover your operating expenses, make reasonable profits, and be competitive within the local market at the same time. To estimate the rent you can receive from investment properties, you need to determine the overall market rent.
You can determine the market rents by simply asking other real estate investors/landlords in the area where you’re investing. Local real estate agents and property managers can also give you an idea of what rents are. In addition, finding and analyzing rental comps will also allow you to see what similar residential rental properties are renting for.
To make this step of the real estate investment analysis easier, use Mashvisor’s heatmap tool. With the heatmap tool, you can see the average monthly rental income (traditional and Airbnb) you’ll receive from investing in that location.
What’s more, the heatmap uses color codes to help real estate investors determine how well the housing market is performing compared to surrounding areas.
Start searching for and analyzing investment properties in the best-performing markets in the US!
Use Mashvisor’s heatmap tool to find the most profitable area in your selected city.
How to Find the Rental Rate in Your Market Using Mashvisor
On top of using rental comps on Mashvisor to figure out rental rates in a specific location, you may also use the site’s real estate heatmap. The heatmap feature allows you to get a better understanding of what the market offers. You can look at the monthly rental income and cash on cash return, among other factors.
To do it, simply type in a location or address of your choice in the site’s search bar. Once you get to the map, you can turn on the heatmap by clicking on the dropdown menu in the map’s upper right corner.
Depending on the information you’re looking for, select a filter. In this case, you can choose between a long term and short term monthly rental income. Once you pick a filter, the map will show you a visual representation of areas that are performing excellently or poorly. You can also find areas in the middle.
The green areas indicate neighborhoods with high rental income, while the red ones show the opposite. Simply click on each property to get an idea of the rental rates in the neighborhood. You can use the heatmap feature along with the rental comps for a more accurate analysis.
Part 4: Calculating the Return on Investment
This is the part where all the data you’ve gathered will come together to give a final estimation of whether or not buying the rental property makes financial sense. There are different types of ROI you can calculate for real estate investment analysis. The most important ones are:
- Cash Flow: This is the amount of money left after all rental expenses, principal payments, and interest have been paid. As a real estate investor, it’s important to estimate your future cash flow in any transaction. You want to ensure you’re buying positive cash flow rental property to make money in real estate.
- Cap Rate: This is the ratio of the net operating income (NOI) over the property’s value. It is great for comparing multiple properties in a given area, determining market trends, and identifying the level of risks associated with the investment property.
- Cash on Cash Return: This is the cash you get back compared to the cash you invested in the property. It takes into account your down payment, closing costs, repair costs, etc. So, knowing the cash on cash return is extremely important because it lets you know whether you’ll have the money to pay your bills.
As you can see, each metric for calculating the return on investment tells you something about your choice of rental property. So, it’s important to account for all of them in your real estate investment analysis and not make a decision depending on just one.
How to Calculate Your Potential ROI Using Mashvisor
To calculate the return on your investment, you can use Mashvisor’s investment property calculator for better and more accurate results.
Just follow the instructions previously stated. When you click on a property on the map or tabs, you are already given an overview of the potential ROI on a subject property. The page will even show you a comparison between long term and short term strategies. It allows you to see which one will give you the best returns in the location you’re considering.
When computing your ROI, you should be on the lookout for the monthly rental income, average cap rate, average cash on cash return, and occupancy rates. If you’re taking out a mortgage, we suggest using cash on cash return to compute your ROI. The cash on cash return metric factors in financing options in its formula.
The formula is quite simple and straightforward for cash on cash return:
Cash on Cash Return = Annual Net Operating Income (Pre-tax) / Amount of Cash Invested
For example, a short term rental property earns an annual rental income of $85,000. The annual mortgage payment is $65,000. So, your annual pre-tax cash flow is $85,000 less $65,000, which is equal to $20,000.
The total cash invested includes the down payment for the property ($200,000), and other expenses like closing costs, repair costs, and initial property management fees (total of $20,000). For our example here, our total cash invested is $220,000.
Using the cash on cash return formula above, the cash on cash return for our example is computed as follows:
Cash on Cash Return = ($20,000 / $220,000) x 100 = 9.09%
The Bottom Line
It’s obvious that with real estate analysis, you’ll get all the information you need to make the right decisions with confidence. Without it, a real estate investor may face severe losses.
Investors should never take for granted the value of an investment property analysis to any investment opportunity. A well-done investment analysis will give you a better understanding of what you’re going up against and how beneficial it will be in the long run.
If you’re overwhelmed by all the calculations, use Mashvisor’s investment property calculator. It will let you get your hands on readily calculated data and analytics for investment properties in any city/neighborhood in the US housing market.
Learn more about how Mashvisor can help you find the best deals in the most profitable markets by scheduling a demo now.