One of the most basic skills you need to know as a real estate investor is how to evaluate a rental property. Let’s face it; if you cannot quickly evaluate a rental property for sale and determine if it is a good income property, you can’t be assured of success in your business. Instinct is always helpful. However, there are some tried and true real estate ratios and metrics anyone can apply to determine if an investment property you are considering buying is a good rental property.
This story will focus primarily on simple math. But, we will also provide some tips on which property features to look for and which to avoid. Here is Mashvisor’s guide on how to evaluate a rental property quickly.
Quickly Evaluating Rental Property – Use a Rental Property Calculator
Conducting a rental property analysis means crunching some basic numbers. Don’t be put off by the math. We will explain it to you and also direct you to added resources. First, you need to understand the basic definitions to understand the rate of return on a rental property. Next, you can let the rental property calculator do the work. And can you guess who has the easiest-to-use rental property calculator? If you guessed Mashvisor, you are way ahead!
The sections below will define some useful terms for you.
Net Operating Income (NOI)
Net operating income (NOI) is the (rental property income – operating expenses). Think of this as a top-line profitability guide. You simply add up the rental income and then subtract your expenses like property taxes, maintenance, condo fees, utilities, and any other costs associated with the rental property. If the net operating income isn’t a very positive ratio, run!
Capitalization Rate (Cap Rate)
The cap rate is a helpful metric when one pays cash for a real estate investment property. Cap rate is helpful for a few things, but it is a great way to compare specific investment opportunities against one another. Cap rate is simply NOI/Purchase Price x 100. The “x 100” just switches the value from a fraction to a whole number.
Cash on Cash Return (CoC)
Cash on cash return is helpful in determining which of a few different rental properties will bring you the best cash flow. Here’s how CoC works. You simply divide the annual cash flow by the total cash you invest. The formula looks like this: Cash on Cash Return = (Annual Cash Flow/Total Cash Invested) × 100%. When you calculate your annual cash flow, be sure that you incorporate the mortgage payments. Use the whole payment, not just the interest costs. Remember, we are looking to determine the cash flow and the principal payments on your mortgage are not free cash.
How to Evaluate a Rental Property Using a Tool to Do the Math
Can you see how each step of the way we added a bit more to the formulas using the above terms? The math used to evaluate a rental property is not difficult as long as you start at the top and work your way down. You can use a scratchpad to do your calculations if you like, but there are tools that help to prevent mistakes and omissions.
A real estate investment calculator will ask you to input various values that you know and then it will spit out the answers for you. Try Mashvisor’s calculator. Mashvisor is a great place to find real estate for sale. And you’ll get a lot more with this tool like a list of real estate comps (similar properties). Helping you determine the profitability of a rental property- that is our specialty.
Vacation Property and Airbnb Calculators
Not all rental properties are let on traditional 12-month leases. Some are short-term rentals. The two most popular types of which are vacation properties and Airbnbs. You can conduct an Airbnb investment analysis or vacation property calculation the same way. Both have all of the same types of values. In fairness to yourself, you should consider all of the possible rentals available to you as an investor. To evaluate a vacation rental property, you can use Mashvisor’s calculator as well!
How to Understand the Results of a Rental Property Analysis
Now that we have shown you the way these calculations and tools work for evaluating rental properties, what’s next? Of course, you need to understand what the answers mean to you. If you are comparing the list of rental properties available to you, the property with the best result is the winner. However, you may also want to do a bit of background research and determine what minimum values will work for you as a real estate investor.
Non-Mathematical Rental Property Analysis
Not every analysis is a math quiz. Here are a few tips on what you should look closely at when evaluating rental properties available in your area:
- Avoid septic systems when possible. Always opt for town sewer given the option. A failed septic system can cost tens of thousands of dollars in repairs or replacement. That can turn a rental property from profitable to a loss in a flash.
- Beware of older homes. Homes and apartments built before the 1980s have unique risks. If you consider buying an investment property older than one built in 1996, be certain your inspector checks for lead paint, asbestos, proper wiring, polybutylene water pipes, and Urea-formaldehyde foam insulation (UFFI). If any of these are flagged, do your homework.
- Beware of buying one unit inside of a duplex or triplex. You do not want to be in business with your investment property’s other owners. Buy the whole duplex or triplex, or walk away.
- Know the tenant situation. Are the existing tenants holding leases or month to month? Be sure you understand the legal ramifications of both. You may not be able to ask tenants to leave until the lease is up.
- Beware of rent-controlled areas. If you must invest in a rent-controlled zone, be sure you know what you are getting into. Rent control can limit your profitability and your resale options.
- Ensure that any investment property you buy has been properly constructed and that the dwelling spaces were built to code. In many areas, there is no guarantee that the space you purchase is legal to rent if it has not been built to code. For example, an addition may be “illegal.” A basement bedroom may not have a legal means of egress (emergency escape and rescuer access in case of fire).