If you are interested in starting a business in real estate, rental property can be an ideal investment. They allow you to generate regular income and accumulate wealth over time. The decision to invest in rentals is a hefty one, in terms of finances. You must learn to evaluate and select the right properties to ensure a profit. Here’s where a rental property analysis comes in handy.
What is a Rental Analysis?
Rental analysis is a special process that involves thoroughly analyzing a property that will be used for investment purposes to determine its overall viability and its potential – in terms of profitability. This is a means for an investor to determine or assess the rental potential of a specific property.
It will give an investor a complete visual of how an investment property and the portfolio will fit into the local market for rentals. By obtaining a property evaluation, investors will be able to avoid overpricing or underpricing single-family rentals and/or multi-family rentals.
Why is a Rental Analysis Important?
Generally speaking, a rental analysis holds a high level of importance because it will provide you with a snapshot of how well your investment will do and will help in making money. In the rental property business, you will make money in two basic ways.
First, through generating the cash flow from the property. Second, from building equity. It is always considered to be ideal to place a focus on the cash flow of the rental property.
The main reason to focus on cash flow is that the appreciation of equity is often considered to be challenging to predict.
The longer that you have the rental property, the more equity appreciation you will have. This much is true.
In the long-term, the appreciation from the equity on your rental property will likely become more than the cash flow generation. It must be understood, though, that fluctuations in property value will likely occur throughout the time that you own the rental property.
The values of properties are likely to increase and decrease at about the same overall rate. When repaying mortgages, the amount you pay will be consistent. Now, equity is important in rental analysis, but the cash flow is what really should draw your attention.
When it comes down to it, the amount that you generate in cash flow will determine how well one property investment stands against another investment. In nearly all instances, if you are able to generate a large flow of cash with a particular rental, that is the investment property that you will want to focus on.
How Do I Do My Own Rental Analysis?
In short, conducting your own rental analysis means analyzing the amount of cash flow that a property will generate. “Cash flow” is defined as the income that a property generates after subtracting the associated expenses. This includes all expenses for general ownership, management of the property, all the associated maintenance, and any other expenses associated with the rental. The calculation required to determine cash flow is actually quite simple; however, the process of calculation may prove to be quite challenging.
In order to conduct an appropriate and realistic calculation for your rental analysis, you must include the following:
- Mortgage Payment – In nearly all instances, lenders will require you to pay a mortgage that covers the expense of the home, the property taxes, as well as the insurance to cover the investment. When conducting your own rental analysis, you must include all three of these components when deducting the amount that you pay for your mortgage.
- Property Management – If you go into the rental business, you absolutely must employ a professional property management team to assist you. When doing a rental analysis, always make certain to include the fees that they charge and deduct the rental fee, too!
- Utilities – While it is true that tenants are typically responsible for covering their own utility costs, landlords often cover trash collection, sewer, and other items. Remember to deduct any and all utility expenses to get an accurate figure when doing your rental analysis.
- Homeowner’s Association Fees – If your rental property will be part of a homeowner’s association, you must include the fee that you pay to the organization.
- Various Other Expenses – As a landlord, you may find that you have to pay for various other services and activities. Examples include lawn maintenance, pest control services, window cleaning, pressure washing, and those that are similar in nature. Always include these expenses in your calculations.
- Maintenance – Eventually, you will come to a point where your rental requires maintenance such as repairs and replacements. You must account at least 10% to 15% for these expenses out of the cash that is generated from your rental property. If you work with a property management company, they may include these fees in with the services that they provide. If so, you only subtract it once when conducting your rental analysis.
- Vacancy – In most instances, you will eventually find that your property becomes vacant. If you use a property management company – which is highly recommended – it is likely that you will not experience this complication; however, it is always best to err on the side of caution. Therefore, when you are doing your rental analyst calculations, always take out a percentage of your cash flow to cover the property and necessary expenses – should it become vacant.
Rental Analysis Requires Comparative Analysis
When conducting a rental analysis, it is imperative that you perform an analysis of the comparative market. This means you have to compare your rental property to other properties that are in the general vicinity.
A comparative analysis will allow you to determine if the other properties are performing below the market average, at the market average, or above the market average.
By comparing all of the various values and associated metrics, you can determine which properties have the absolute highest potential for success. If you have not purchased a rental property, the comparative analysis will actually allow you to determine if the one you are interested in is actually worth the investment.
The Cap Rate
It is worth mentioning that you should consider the cap rate on a rental property that you are interested in purchasing. This is a special metric that provides a calculation to the overall return associated with the investment, based on how much it is currently valued. The equation is the following:
(Net Income)/Current Value) x 100 = The Overall Cap Rate
Generally speaking, this particular metric is utilized by investors to determine the overall profitability associated with the property in which they are interested. It outlines how much you can expect to make within a year compared to the price of the investment at this particular or specific time. This does not take out any type of financing.
It is basically an evaluation that assumes that the property in question will be purchased solely with money or cash. Remember to take this fact into account when you are conducting the official rental property analysis.
When doing a rental analysis, it is important that you understand that the overall success you will experience as a landlord is based on the tenants that rent that property. Tenants are considered to be the foundation of rental property success. Remember, tenants, are the ones who will be providing you with the compensation to fund your business.
You must determine what types of tenants rent properties in certain areas. Then, you must match your marketing efforts to attracting the best. Again, we strongly advise seeking the assistance of a property management company. Not only will they help in maintaining your property, they will also assist in tenant screening, credit checks, background checks, employment checks, and more! Very few tenant complications will arise when working with these types of companies.
Professional Rental Analysis
While it is possible to conduct a rental property analysis on your own, it is best to leave it to the professionals. Like any other business, you want to make certain that everything is considered in the analysis so that you make the absolute best investment decision. We here at Pioneer Property Management are currently offering a free rental analysis so that you are capable of seeing how much a particular property is worth. In addition to this, we offer numerous services that will help you succeed in your real estate endeavors.
These include a rental analysis, property evaluation, virtual tours of your property, professional photography sessions of the rental, supervised showings, tenant screening, lease preparation, rent money collection, 24/7 emergency services, and more! We are capable of bundling our services so that you get exactly what you need, when you need it. If you would like to learn more about our free rental analysis or the service packages that we offer landlords, contact us today.