Conducting residential rental market analysis for rental property is essential in real estate.
Rental market analysis, or RMA for short, is the process of analyzing rental markets to determine the overall profitability and the profitability of a specific property. The process involves researching real estate markets, making educated market predictions, conducting a neighborhood analysis, finding rental comps, and estimating rental costs, among other factors.
Since conducting real estate rental market analysis can be quite hectic and complex, we broke down the process into five steps. But before talking about the steps of doing RMA, it’s important to first talk about rental analysis and why it’s important to understand what goes into analyzing rental properties in general.
What Is Rental Analysis in Real Estate?
In order to conduct a rental market analysis, you first need to understand what goes into analyzing rental properties in the first place.
Rental properties are unique in that they generate a passive income that can sometimes cover the costs of running a rental property. The complexity of a rental analysis lies in the fact that this passive income can change over time depending on a number of factors.
The unpredictable nature of rental properties means that a rental analysis needs to take into account possible changes in the future and how they might affect the short-term and long-term performance and financial planning of your investment.
When learning how to do rental property analysis or rental market analysis, there are many metrics and aspects that you will come across. So, let’s take a look at the most important factors that are unique to rental analysis in real estate:
The first factor that needs to be taken into consideration in any rental analysis or rental market analysis is the occupancy rate. It is one of the most important metrics to track when analyzing rental real estate.
A rental property’s occupancy rate is the percentage of time throughout a year during which the property is occupied by a tenant and therefore generating income.
Some people prefer using the vacancy rate, which is the opposite of the occupancy rate. The vacancy rate represents the time during which the property is vacant. The occupancy rate is used when calculating the annual rental income of properties.
Price to Rent Ratio
Another important metric to take into consideration when doing a rental analysis is the price to rent ratio in the location you want to invest in. The price to rent ratio tells you whether it is more affordable to buy or rent a house in a specific area.
A price to rent ratio of 15 or less will generally mean it’s more affordable to buy, while a value of 21 or above is considered better to rent. Of course, it can mean different things to each investor, as the price to rent ratio can indicate the level of demand for rentals and is often linked to high or low occupancy rates.
However, locations where the price to rent ratio is high can also contain expensive properties. It makes it harder for investors to profit from the market if they don’t already own a property there.
Another key factor to look at in a rental analysis is the cash flow of the property. The cash flow of a rental property is the amount of money that it is generating for you or costing you at the end of each month.
Rental properties can either generate a negative or positive cash flow. A negative cash flow means that the property is costing you more money than it is generating, and therefore is not profitable.
However, there is more to doing a rental property cash flow analysis because it can mean different things. For example, you can do a cash flow rental market analysis for several properties to identify ones with a positive cash flow.
But when you include your mortgage payments, the cash flow of some properties might become negative, with the addition of a major expense that they need to cover through their rental income. Also, if the occupancy rate of the property drops below its predicted value, it might result in an overall negative cash flow for the property.
Some investors are willing to take these risks if they depend on a financial backup to make up for the negative cash flow. Generally, however, beginner investors are advised to avoid negative cash flow properties when doing a rental property analysis.
Last but not least is perhaps the main reason why most people choose to invest in rental properties, which is that rental income can cover the mortgage payments.
The appeal of buying a rental property using borrowed money, and letting that property pay back your debt while also making you some profit is the main reason why many people get into real estate investing. However, many fail in making it a reality due to their lack of planning or neglecting the rental analysis step.
When doing a rental analysis, the main thing you’re trying to understand is whether the property will allow you to achieve your goal. So, when doing your rental property cash flow analysis, make sure to use proper tools to calculate your mortgage payments and include them in your analysis.
You can use a rental property analysis spreadsheet, for example, to see if a property will generate enough money annually to cover its mortgage payments and other expenses.
How to Do a Residential Rental Market Analysis
For proper guidance on conducting a residential rental market analysis, follow the steps below:
1) Evaluate the Neighborhood
If you haven’t heard the saying “location, location, location…” are you really investing in real estate?
Location is the first thing you should be looking into when doing residential rental market analysis. Once you decide on a city to invest in, your next step is to evaluate different neighborhoods in the area to find a good rental market.
Your goal here is to find the most profitable neighborhoods and then compare the different neighborhoods within the city. When conducting residential rental market analysis, it’s important to focus on neighborhoods, rather than whole cities. Doing this will give you a more accurate prediction for potential profit generation.
Now, there are a few factors that help you determine what a good neighborhood is in real estate. For residential real estate, look out for neighborhoods that are in good school districts, are safe and secure, and which are close to amenities (supermarkets, parks, shops and restaurants, healthcare facilities, gyms and leisure spots, etc.). These are things residential tenants look for when finding a place to live.
2) Identify the Real Estate Comps
Comps, or real estate comparables, refer to properties located in the same area or neighborhood. Real estate comps are also similar in size, condition, number of rooms and bathrooms, and lot size, among other characteristics.
Comps help real estate investors in two ways. For one, they allow investors to calculate the average rent for the area. And two, comps help investors compare different investment properties to decide which of them is the ideal real estate investment. Real estate experts advise you to look for at least three comps when conducting residential rental market analysis.
Now that you know what comps are, how do you find them?
There are several ways to find real estate rental comps when conducting residential rental market analysis. Traditionally speaking, you would need to consult with a real estate agent or a realtor in the area, search local ads, or look into public records.
While any of the said methods are effective, they can be rather time-consuming. The alternative way is to use online residential rental market analysis tools. Mashvisor’s investment property calculator is one tool that grants you access to comp reports for your area of choice.
3) Calculate the Rent per Square Foot
Next up, you need to calculate the rent per square foot. We use square footage in real estate because it gives us a measure of “livable space” in the rental property. The value can be calculated per month or per year. Rent per square foot varies across different cities and areas in the US.
To calculate the rent per square foot, you need to research rental rates and the space (square footage) of the comps you’ve selected. As you can see from the image above, you’ll get the info with Mashvisor’s comps report. You can then average that out. Simple, right?
Calculating the rent per square foot is important, but make sure to keep in mind the factors that affect this value. The key here is to select similar comps to find the most accurate value.
4) Adjust the Rental Price
This step is also important to ensure accuracy when learning how to do a rental market analysis. When adjusting the rental price, you need to look into two things:
- Amenities. Amenities affect the rental price a landlord can charge. Rental properties with a pool, that are pet-friendly, with high security, an extra bedroom, etc., can command a higher rental price. So, make sure to adjust the rental price per square foot, considering the available amenities.
- Occupancy rates. The occupancy rate is a value that indicates the percentage an investment property is occupied during the year. If your rental property is occupied nine months a year, your occupancy rate is 75%. The same value can be calculated for Airbnb investment properties and on a monthly or annual basis. When conducting residential rental market analysis, you should take occupancy (and vacancy) rates into account. It will help you in determining which areas to invest in and which areas to avoid. Ideally, you’d want to invest in areas where occupancy rates are closer to 100% for traditional rental properties. A vacancy rate of over 11% is considered high in real estate. If you happen to invest in a rental property with a lower occupancy rate, you may want to decrease rent to attract tenants.
5) Estimate the Costs of Rental Properties
Finally, and after completing the above steps, you need to calculate the expenses of rental properties. They refer to any costs real estate investors incur when owning a rental property. They can include carrying costs – costs like utilities, mortgage, insurance, and taxes. Costs can be influenced by factors such as location and housing inventory.
You want to make sure that investment properties are priced low enough so you’ll be able to generate positive cash flow. To figure it out, you should measure the costs of rental property against the rental price per square foot. The above calculations will thus help you decide which of your select investments is most profitable in the area.
Running a residential rental market analysis is vital in real estate, but it can be a time-consuming and difficult process. To make the process of rental analysis less challenging, you can use Mashvisor.
Mashvisor is a residential rental market analysis tool that offers the necessary data needed to conduct an RMA. Our investment property calculator can display comp analytics as well as key data such as cash on cash return, cap rate, occupancy rate, and neighborhood analytics. This will allow you to select the best neighborhoods to invest in and find the ideal investment property.
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