In order to be able to find profitable real estate deals, you have to learn how to conduct investment property analysis. If you’re thinking of investing in income properties in specific, then you need to master the art of doing rental property analysis. This is the only way to ensure positive cash flow and a high return on investment.
The Importance of Location
Location location location… The three most important factors for the success of a real estate investment.
Clichés aside, as a beginner real estate investor, you should never underestimate the importance of location. The place of your income property will determine the sale price, the expenses such as property tax rate and rental income tax rate, the vacancy and occupancy rate, the rental rate, the positive or negative cash flow, and ultimately the return on investment. Moreover, location also helps you decide on the optimal rental strategy (traditional vs. Airbnb), the most profitable property type (single family home, multi family home, townhouse, condo, apartment, or other), and the most appropriate number of bedrooms and bathrooms.
Thus, the first step of conducting rental property analysis is looking at the place where you’re considering buying an investment property. There are two things which you need to do in this regard:
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Comparative Market Analysis
Performing real estate market analysis, also known as comparative market analysis, or CMA for short, is a must. This type of real estate analysis will give you a general idea of the current state of the local housing market and what type and size of property you can buy with your budget. Finding a few real estate comps, or recently sold properties similar to the ones you are planning to buy, is the best and most accurate way to do rental property valuation. Buying an investment property at fair market value – rather than overpaying – is a prerequisite for making money in real estate.
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Neighborhood Analysis
Once you’ve selected the best place to invest in real estate based on your budget and preferred rental strategy, you should search for the top neighborhoods there. Location in rental property analysis is not limited to the city only but includes the neighborhood as well. Mashvisor’s analysis shows that income properties in even adjacent areas within the same city can yield a drastically different return on investment. To ensure positive cash flow properties, you should identify the best neighborhoods for buying rental properties in the market of your choice.
One quick, efficient, and accurate way to do that is to use Mashvisor’s heatmap real estate investing tool. This analysis tool will color-code the neighborhood in any US housing market to show you the areas with highest, medium, and lowest:
- Property listing price
- Traditional and Airbnb rental income
- Traditional and Airbnb cash on cash return
- Airbnb occupancy rate
Once you’ve narrowed down your neighborhood search to a few top-performing areas with the highest rate of return on rental properties within your budget, you can use Mashvisor’s investment property calculator. This must-have real estate investment tool will provide you with the neighborhood-level:
- Median property price
- Average price per square foot
- Average traditional and Airbnb cash on cash return
- Average traditional and Airbnb rental income
- Number of real estate listings for sale, traditional rentals, and Airbnb rental properties
- Average Airbnb occupancy rate
- Optimal rental strategy
- Walk Score
- Real estate comps as well as traditional and Airbnb rental comps
- Optimal property type
- Optimal number of bedrooms
All this will be available within a few clicks of the mouse.
The Cost of Buying and Owning Rental Property
The next obligatory step in the process of conducting rental property analysis is estimating the costs associated with buying the property and managing it. You should consider both:
One-Time Startup Costs
The largest and thus most important expense for buying a rental property is the purchase price which could be at or below the listing price. This depends on the dynamics in the real estate market, your negotiation skills, and whether you hire a real estate agent or not. You can decide to buy the income property in all cash if you have enough funds or to go for a mortgage for rental property. The method of financing should go into the expenditure side of your rental property analysis, whether the entire sale price (in case of all-cash purchase) or the down payment plus closing fees (in case of a mortgage loan).
Other costs that you’ll need to pay just once include a home inspection, a real estate appraisal, any necessary fixes and repairs, and furniture (if you decide to invest in an Airbnb property or a furnished apartment).
Recurring Monthly Expenses
Investing in rental properties entails some ongoing costs as well such as property tax, property insurance, rental income tax, property management, maintenance, utilities, HOA fees (if investing in a condo), and cleaning fees (in case of vacation rental homes). The amount of these expenses varies by location, property type and size, and rental strategy.
How much you need to spend on your income property is an integral part of the rental property analysis as the rental expenses are one of the determinants of cash flow and rate of return. The lower the rental expenses compared to the rental income, the more profitable the investment property.
A rental property calculator like Mashvisor’s provides accurate estimates of all these cost items for any real estate property in the US housing market, whether available on the platform or added by the user. The cost analysis is based on data on actual investment properties in the neighborhood as well as publicly available data.
The Rental Income Expected from the Investment Property
The next step in doing rental property analysis is answering the question: “How much can I rent my house for?” From the perspective of a real estate investor, this means estimating the expected rental income. The traditional way of performing this part of the investment property analysis is finding rental comps, or similar rental properties in the area, and figuring out how much rental income they generate.
The better way to do that is with the help of a rental income calculator, which is a type of rental property calculator. Mashvisor’s will show experienced and beginner real estate investors the comparable rental income for any US property, whether rented out traditionally or on Airbnb or another similar homesharing platform. The estimates are based on a detailed neighborhood analysis of comparable income properties, which makes them very accurate and reliable.
In most markets, operating the same house as a long term rental or a short term rental will bring drastically different incomes. That’s why it’s important to consider both options in your analysis if you are still searching for the optimal rental strategy.
The Vacancy and Occupancy Rate of a Rental Property
Rental demand is one of the determinants of the rate of return on an investment property. The way to measure demand in real estate investing is through vacancy and occupancy rates. For what part of the time your property is occupied factors directly into the rental income, the cash flow, and the return on investment calculations. Actually, the vacancy rate is a cost in the eyes of real estate investors as they have to continue paying most of the costs without receiving any rent.
Estimating the traditional and Airbnb occupancy rate in rental property analysis is hard as it depends on the current rental market conditions, the specific characteristics of your income property, and your marketing skills as a landlord or an Airbnb host. The best you can do is to look at the average occupancy rate for both rental strategies in your neighborhood, taking into consideration the property type and the number of bedrooms.
Mashvisor’s real estate calculator does exactly that. It looks at the performance of actual comparable rental properties in the area to calculate the expected occupancy rate of your investment property.
The Cash Flow of the Income Property
Once you have the rental income and rental expenses estimates, it’s easy to complete the next step in the rental property analysis: calculating the cash flow. However, is there a way to know how much cash flow an investment property for sale will generate on a monthly basis without all previous tedious calculations?
Yes, there is – with Mashvisor’s cash flow calculator. For each income property that you want to analyze, you’ll get a readily available estimate of the cash flow it will bring under each rental strategy. All you have to do as a real estate investor is to remember to always go for positive cash flow properties. Buying a negative cash flow investment property with the hope that your luck will turn soon is wrong. Making money in real estate is only possible with positively geared properties.
The Profitability of an Investment Property
The ultimate goal of conducting rental property analysis is to know how much profit you will make from your property investment. The two most popular metrics of rate of return on a rental property are:
1) Cap Rate = Net Operating Income (NOI)/Current Market Value x 100%
2) Cash on Cash Return = Net Operating Income (NOI)/Total Cash Investment x 100%
While the cap rate formula and the cash on cash return formula are somewhat similar, there is one crucially important difference between the two. While the CoC return considers the method of financing of a rental property, the capitalization rate does not. The reality is that the majority of investors use rental property loans, whether a conventional mortgage, a hard money loan or a private money loan. The type of loan, its duration, and interest rate have a major impact on the rate of return on an income property, and that’s why it is necessary to calculate both measures in rental property analysis.
Do you need to do the cash on cash return and cap rate calculations manually or is there a rental property software tool that can do them for you? You might have guessed right that the latter is true. Mashvisor’s platform has both a cap rate calculator and a cash on cash return calculator to make rental property analysis easy and quick. With our real estate investment tools, you will be able to access readily available estimates of the two metrics of profitability for any income property in the US.
The Optimal Rental Strategy for Investing
Last but not least, a rental property analysis has to identify the best way of renting out a property. As mentioned above, the two main rental strategies result in different costs, income, cash flow, and return on investment. This depends mostly on the location but also on the property type and the number of bedrooms. To maximize their profitability, it is important for investors to choose the right rental strategy when buying an income property.
Note: Before you buy an Airbnb investment property, you have to make sure that short term rentals are legal for non-owner occupied properties in the area of your choice. Many major US cities have been imposing various Airbnb regulations and restrictions including prohibiting non-primary residences to be rented out on vacation rental platforms altogether. To stay legal and avoid problems with the local authorities, you have to choose a location where Airbnb is legal.
Rental property analysis is the basis of successful investment in an income property. This is the only way to know exactly how much money you will make in real estate. To put yourself ahead of the competition in the real estate industry, sign up for Mashvisor now to start conducting investment property analysis quickly and accurately.