Real Estate Deal Analysis & Advice

How to Analyze Real Estate Deals in 3 Easy Steps

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Would you be happy with $200 in cash flow on a deal? Why or why not? This shouldn’t be an easy question to answer without conducting some type of analysis.

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Everything in real estate requires analysis, and it comes in all forms—from incredibly simple to extremely complex. Analysis is about running thousands of potential properties through a funnel and getting to the one(s) that meet your criteria.

There are three stages to analysis, and a successful deal makes it through all of them:

  1. Immediate analysis
  2. Pre-offer analysis
  3. Post-offer analysis

Before we dive in and explain the types of analyses, it’s absolutely vital you identify your investment goals and criteria. You don’t want to throw everything into a funnel you borrowed from someone and see what happens to come out on the other end; instead you must carefully select the filters you’re going to install in your funnel to make sure only the most important pieces make it through.

These filters are based upon the goals you’ve set for yourself and the strategy you’ve identified in order to get there. Are you investing in buy and hold or flips? Are you buying for cash flow or appreciation? Are you seeking a 6 percent return, or do you need at least 10 percent-plus?

Are you trying to fund a vacation? Looking to supplement your income with a little extra cash? Or do you want to generate enough cash flow to quit your job?

Why Are You Investing in Real Estate?

If you don’t know the answer to that question, pause here and figure it out. It doesn’t need to be perfect, and answering it now doesn’t mean you can’t change  your plan as you learn more.

To be transparent, as we go through these analyses, my strategy is to buy and hold multifamily properties with value-add potential for cash flow, seeking a return of 12 percent on my cash left in the deal.

Related: How Finding Your “Why” Will Jumpstart Your Real Estate Career

With a goal in mind, you’re almost ready! But first, there are a few things you should know.

researching-ADU

Common Factors in Your Analysis

When you start analyzing properties, you’re going to find a few common numbers and considerations you’re going to have to take into account on each potential deal. While these numbers will vary slightly, having a starting point going in will help you out immensely.

Consider the following data points that I use, as well as where I find that information:

Mortgage: 5% interest rate, 25% down on multifamily (20% on single family)

  • How do I know? Work with a lender to get pre-approved for a mortgage.

Insurance: $75/mo (usually about $20-30 less, but a good conservative estimate)

  • How do I know? Talk to a couple insurance agents and get quotes on a couple of properties. After you get a few, you should start to see trends based on the type and condition of property.

Property management: 15% of rent (10% monthly + 50% first month’s rent annualized = 14.2%)

  • How do I know? Talk to local property management companies. Some may only charge 8 percent, but I find that being conservative is always better.

Reserves: 20% of rent (10% CapEx, 5% vacancy, 5% repairs)

  • How do I know? This is going to be up to a number of things—your risk tolerance, vacancy in the area (which you can find out from fellow investors or a property manager), age/condition of capital items, etc. Ultimately, you need to settle on a number you're comfortable with. But understand that you can adjust it as you get more data or as you find different properties.

Target return: 12% COCROI (total return on the cash I leave in the deal, see equation below)

  • How do I know? This is a target I set for myself based on my goals and what I want my money to do for me. Nobody can tell you what the right number is. You need to know what you want.

Finally, if you aren’t already, you’re going to want to be familiar with these two equations:

Time to start the analyses. Let’s go!

Immediate Analysis

Your first analysis is extremely simple and often occurs without thinking. This is a very hasty analysis that should be completed no more than two minutes after getting the first view of the property. It answers one extremely basic question: Does this property warrant a second look and more of my time?

This question can be answered by running the property through two tests:

  1. The “sniff test”
  2. The “math test”

The sniff test is extremely simple. Are you only looking at multifamily under $300K? Those meet the sniff test.

Did you skip past properties requiring a full gut? Those fail the sniff test.

Did you click on the listing but then close it as soon as you saw the roof leaked? It turns out that rose didn’t smell so good, did it?

You’ve determined that these properties do not warrant a second look, because they don’t meet your most basic criteria.

The math test should be a very simple back-of-the-envelope calculation, as well. So if you just had a terrifying flashback to Mrs. Johnson chastising you in algebra class, I apologize—but don’t fear! Follow these very simple steps that can be done quickly using a cell phone:

  1. 60 seconds: Identify a very conservative rent estimate for the property (using Rentometer or Zillow)
  2. 15 seconds: Subtract the percentage of reserves and management from above (rent x 65%)
  3. 30 seconds: Subtract the estimated monthly mortgage payment based on full asking price to find a rough estimate of monthly cash flow
  4. 15 seconds: Multiply the cash flow by 12
  5. 30 seconds: Divide the total cash flow by your down payment + a very rough estimate for rehab costs

Two-and-a-half minutes later you have a rough estimate for your COCROI! This is obviously incredibly inaccurate, but it serves as a bellwether.

As I stated previously, I look for 12 percent COCROI. Did it come out to 8 or 9 percent? With more accurate estimates, it could work. So let’s dig a little deeper!

Did it come out to 2 percent? That’s probably not going to work.

Beautiful african american woman with afro hair wearing casual pink sweater looking unhappy and angry showing rejection and negative with thumbs down gesture. Bad expression.

Is it scientific?

Absolutely not. I’m not a scientist, but this has helped me analyze a ton of deals.

If this is too complex to start with, just consider the the 1% rule, which isn’t actually a rule but may simply serve as a filter. (We can debate the validity of the rule in the comments.) The 1% rule states that if a property can rent for 1 percent of the after repair value (ARV), it will likely be able to cash flow.

I’m not a fan of this rule due to how easily misinterpreted it is. I think it provides a false security blanket for new investors who don’t understand it, which is why I use the method above. (OK, I didn’t wait for the comments to share my opinion. Yell at me down there!)

Related: The 2% Rule Should Die a Horrible Death

If you’ve completed both steps and the property doesn’t meet your initial criteria, congratulations! You’ve narrowed the field and don’t need to waste any more time. If it does meet your criteria, kick it into gear and start the pre-offer analysis!

Pre-Offer Analysis

The goal of the pre-offer analysis is simple and once again needs to answer a single question: Is this property worth submitting an offer?

In order to figure this out, you take those numbers you threw into that initial analysis and dig a little deeper. But as you dig in, you have to make a promise to me. Two of them actually:

  1. Always err on the side of caution and be conservative in your estimates. It’s better to have the unit rent for $100 more than you planned for, than less. Don’t hesitate to walk away if it doesn’t work.
  2. Dig a little deeper on rehab costs, look a little more into comparable rent values, and double check your insurance. But don’t wear rose-colored glasses, and don’t try to force something through because “you’ve come so far already.” Your bank account isn’t going to care how optimistic your spreadsheet was when you wanted to make this deal work; it’s going to care that you’re bleeding money.

OK, warning done. Now back to the fun!

Let’s take a look at how you can get a little more clarity on these different estimates.

Repair Costs

This doesn't need to be terribly complicated; your estimates should just be in the same ballpark. Start with the easy stuff first! If there are pictures, see what improvements you'd make and ask a contractor or fellow investor to help you roughly price them out.

Ask your agent to see if the listing agent provided any details in the agent remarks or in the seller attachments on the MLS. If it says the HVAC needs to be replaced, take that into consideration. But if they say "No Representation," don't take that to mean no problem!

You can also go see the property in person, although it’s certainly not required and not necessarily recommended if it puts you in jeopardy of losing a deal in a hot market.

If it suits you though, go check it out! This could be as simple as driving by the house to get a feel for the exterior or setting up a showing with your Realtor.

Note: Be respectful of your Realtor’s time! If you’re taking hours of his/her time driving to a dozen $60K houses all over the place that he/she is only standing to earn a meager 2 percent commission on, they’ll surely be put off by you in fast order. Respect their time, and you will develop an invaluable relationship with them. Waste their time, and you’ll find yourself looking for a new agent.

The final thing you can do is quite simple: ask! Have your real estate agent reach out to the listing agent to ask about deferred maintenance, capital equipment updates in recent years, or any other insight they can provide. They may not offer much additional info, but you'll never know unless you ask!

Once you have these numbers, you should have a rough estimate of your repair costs. Don’t forget: You made two promises to me!

Businessman talking on mobile phone and making notes. Man sitting at his office desk working on graphs and charts and discussing on phone.

Rent

It’s hard to identify a good deal if you don’t know how much revenue you’re bringing in, so let’s figure it out! There are a lot of different ways to do so, and I recommend you use multiple sources to come to a consensus, rather than take a single source as fact.

Rentometer is a fantastic resource that I use constantly. For a low price, you can get a pro account, which allows you to see all of the different rentals they use to determine the value. This is extremely helpful, as you can search the addresses to see how the condition compares.

Websites and apps like Zillow and Trulia also are excellent resources for finding rent values. Filter out units that are similar in size and number of beds/baths, and then look at the condition compared to what you’re looking to purchase. See how this compares to the calculated value on Rentometer!

Additionally, you can check private listings on marketplaces like Facebook and Craigslist. I’ve found that these can often be cheaper—but a great option nonetheless!

Finally, this is where a good property manager is like gold! If you have someone who is familiar with the area you’re looking, they can likely provide you with a good rental comp based on their portfolio. If you don’t know anyone, now is a good time to start developing that relationship.

Related: 10 Questions to Thoroughly Vet Potential Property Management Companies

Now that you have an estimated rent value, it’s time to look at expenses. But don’t forget to be conservative. You promised!

Monthly Expenses

Your monthly expenses shouldn’t be difficult to calculate. Remember that simple little equation from before? Just use that here and dig a little bit further into each one. You have your rent value, so then subtract the other pieces:

Reserves: Probably the most CRITICAL and often overlooked factor by new investors. Unexpected issues will pop up! Units will go vacant! You need a reserve fund to handle it. Repair and capital expenditure (CapEx) allocations will vary, but I like to typically account for at least 15 percent between the two. Just remember: a roof on a $100K house is not 3X cheaper than on a $300K house. So be sure to err on the side of caution with CapEx.

Property management: If you don’t have one already, start networking to find a good property manager. Most charge 8 to 10 percent monthly, plus a tenant placement fee of 50 to 100 percent of first month’s rent. I like to plan for annual turnover, meaning that 10 percent monthly with a 50 percent placement fee comes out to an annualized 14.2 percent.

Mortgage payment: This consists of your principal, interest, taxes, and insurance (often described as PITI). A simple mortgage calculator can tell you the principal and interest based on rates from your lender; an insurance agent can provide a quote for insurance; and you can find the annual property tax bill on the county’s website.

man standing in front of desk drinking coffee and going over paperwork

Finally, take other little expenses into account. Does the owner pay utilities? Are there lawn services that tenants don’t take care of? Is cable or internet provided? All of these expenses must be accounted for.

Subtract all of these from your rent, and you have your monthly cash flow!

Determine the Value

Once you know what your cash flow looks like, the final step is to determine the value of the property and see what you should pay for it. This could warrant an entire post of its own, but take a look at a great concise article by Nathaniel Hovsepian on “How to Determine a Property’s After Repair Value (ARV).”

One additional point I'll add is that it's critical you understand how properties are valued and how an appraiser makes that determination.

Related: Home Appraisal: 9 Tips to Get a Higher Valuation (& Appeal a Too-Low Assessment)

Ultimately they use a combination of three different approaches:

Sales comparison approach: This may come as a surprise to hear. This approach… wait for it… compares recent sales. This is the most common method relied upon for single-family homes and is a huge factor in small multifamily properties (two to four units), as well. With the sales comparison approach, the appraiser looks at nearby (sold) properties of similar size with a similar number of bedrooms and bathrooms.

Replacement cost approach: I’m not going to insult your intelligence by telling you that the replacement cost approach uses an estimated replacement cost… OK, maybe it does. Either way, this approach is another factor to look at along with the sales comparison approach. This is typically not weighted as heavily unless you’re looking at new construction or something else where there is currently nothing comparable.

Income approach: While sales comparison approach is the most prevalent, if the property is being used as a rental with strong income, the appraiser can take that into account. This is found by multiplying the monthly rent by the gross rent multiplier for your area. When evaluating a small multifamily property, this approach will likely have an impact. But it will not be near as much as the other approaches.

My good friend Jake is an appraiser. He likes to say that if you ask three different appraisers to tell you the value, you’ll get three different answers. There is certainly a method to their madness; however, as you can see, there are also a number of variables that can make it difficult. That’s why appraisers exist. But if you can understand what they look for, you can have a better idea of how to analyze the ARV of a property!

How Much Should You Offer?

I’d be remiss if I didn’t lead this part by telling you to read Never Split the Difference by Chris Voss. It will help you think about how to negotiate with a seller and how to approach them. Even if you are going through a Realtor, this is invaluable knowledge!

Now for the offer… You need to go in with the end in mind, knowing what your maximum allowable offer (MAO) is before you start negotiation. You can do this in a number of different ways, depending on your resources, goals, and limitations:

  1. Fixed price: Your MAO is fixed, based either on the cash you have available (for down payment, closing costs, and rehab) or the pre-approval you received from your lender.
  2. 70% rule: People will often cite the 70% rule for flipping homes (which also applies to rentals/rehabs), which says that your all-in costs cannot exceed 70% of the ARV. This indicates that if your ARV is $300K and your rehab cost is $30K, your MAO is $180K (all in for $210K minus $30K rehab).
  3. Buy and hold goals: This is a method I haven’t seen elsewhere, but one that I will use when looking at a true buy and hold, where I will use my cash flow and target COCROI to determine the maximum amount of cash I can put into a deal (and therefore determine the MAO). Let’s look at the following example, assuming $500/mo cash flow, 12 percent COCROI, $10K rehab, and $5K closing costs:
    1. Determine the maximum cash available: Annual Cash Flow ($500/mo x 12) / COCROI (12%) = $50,000
    2. Subtract rehab and closing costs from the cash available to determine your maximum down payment: Cash Available ($50,000) – Rehab ($10,000) – Closing Costs ($5,000) = $35,000 Maximum Down Payment
    3. Use your max down payment and LTV to determine the max purchase price: Down Payment ($35,000) / Down Payment % (20%) = $175,000

As a result, I know that the most I can pay for this property is $175,000! I can put in an offer and be confident when I go into negotiations with the seller, knowing that if they refuse to sell it for $175,000 or less, I’ll say no. This takes the emotion out of the offer and negotiation and makes the whole process much simpler.

Black casual shoes standing at the crossroad making decision good or bad.

Post-Offer Analysis

Congratulations! Your offer was accepted, and you’re under contract! Now begins the due diligence period. For the purposes of completing your analysis, it’s important to take advantage of the time you have.

This is where you lock down your estimates. What does the inspector say? If you have contractors come out, what do they say is required, and what’s the estimate? When you walk the property, did you identify other issues that would need to be resolved or amenities that would need to be provided in order to yield the rent you estimated?

Once you have all of these quotes and more concrete numbers, go back to your pre-offer analysis to plug them in! If you have repairs to make, does your cash flow still produce enough of a return with the added upfront expenditures? If you can avoid making the repairs but see decreased rent instead, does the change in cash flow still meet your target return?

Related: 5 Lessons I Learned When I Walked Away From a $10 Million Deal

At the beginning, I made you promise that you'd walk away if the deal didn't work. This is where the rubber meets the road! Now is the time to be very familiar with the idea of "sunk costs." Don't chase a bad deal because you don't want to "lose" the money you spent on the deposit, inspection, and/or appraisal.

It’s hard to do, but it’s worth it. A previous deal I had under contract needed repairs I was unaware of that were at least $10K more than I had planned for. As a result, my ROI was going to plummet.

Unfortunately, backing out of the deal meant losing money… I had already spent more than $1,500 on my due diligence deposit, appraisal, and inspection.

But those expenses had already been paid, and I wasn’t going to get them back. Pursuing that deal would have drastically decreased my ROI below what I was comfortable with, so I backed out. And I’m happy I did!

Conclusion

If you don’t know the numbers, you don’t know your deal. So make sure you perform the proper analysis before you dive in! Use each part of the funnel to filter out a bad deal:

  1. Hasty analysis: Quick 5-minute evaluation. Is this deal worth spending any of your time on?
  2. Pre-offer analysis: Thorough deal analysis. How good is this deal, is it worth pursuing, and how much should you offer?
  3. Post-offer analysis: Final confirmation of the numbers. Is your deal as good as you thought? Are you going to close?

Understanding these steps and the tools that can help with your analyses is extremely important in determining whether or not to pursue a deal—and how much to pay. Master all of this to ensure that you only close on properties that are going to be profitable and in line with your goals!

Questions? Comments? Suggestions? 

Join the discussion below.

Patrick Menefee is a six-year Army veteran turned management consultant, now working full-time for one of the "Big Four" in the payments industry. He began investing in real estate part-time in the...
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    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied 3 months ago
    Great article!
    Patrick Menefee Rental Property Investor from Charlotte, NC
    Replied 2 months ago
    Thanks Andrew!
    Tola Kehinde Rental Property Investor from Vaughan, ON
    Replied 3 months ago
    Great Article
    Patrick Menefee Rental Property Investor from Charlotte, NC
    Replied 2 months ago
    Thanks Tola!
    Manuel Segarra III from Denver, CO
    Replied 2 months ago
    Nicely done Patrick ! Thanks for sharing your knowledge ... I'm on Chapter 3 of Chris Voss book !
    Patrick Menefee Rental Property Investor from Charlotte, NC
    Replied 2 months ago
    Happy to share! It's a fantastic book...the podcast on BP where they interviewed him is also fantastic and I highly recommend checking it out
    Javier Cabero Chavez
    Replied 2 months ago
    Thank you. Great article
    Patrick Menefee Rental Property Investor from Charlotte, NC
    Replied 2 months ago
    Thanks Javier!
    Todd Crawford from Rockford, Illinois
    Replied 2 months ago
    Great article Patrick thank you for breaking it down for this newbie.
    Patrick Menefee Rental Property Investor from Charlotte, NC
    Replied 2 months ago
    Thanks Todd, glad it helped. Let me know what else I can write about to help a newbie!
    Ben Johnson
    Replied 2 months ago
    Good stuff. Thanks Patrick!
    Patrick Menefee Rental Property Investor from Charlotte, NC
    Replied 2 months ago
    Thanks Ben!
    Phillip Davis Rental Property Investor from Edgerton, WI
    Replied 2 months ago
    Very well laid out article and thoughtful steps on each level of the process. Remember the more practice you put in the more routine this becomes! Never split the difference is pure gold for offers as well!
    Patrick Menefee Rental Property Investor from Charlotte, NC
    Replied 2 months ago
    Thanks Phillip, and couldn't agree more. After a while it becomes second nature...but it can definitely be daunting at first. Just need to try to cut through the noise to figure out what's important!
    Juan Luna New to Real Estate from Wadsworth, IL
    Replied 2 months ago
    This is a great article and it definitely opened up my eyes of things I should know and/or do. Thank you for your insights. Its helpful.. Juan
    Patrick Menefee Rental Property Investor from Charlotte, NC
    Replied 2 months ago
    Glad to hear it Juan, I hope it helps you analyze some deals! Let me know if there's anything you'd like to hear more about in the future!
    Fitzroy Harvey New to Real Estate from Poughkeepsie, New York.
    Replied 2 months ago
    I love this article. Well laid out and full of great tips for us new beginners. I took a lot of notes that I will apply going forward. Thank you!
    Patrick Menefee Rental Property Investor from Charlotte, NC
    Replied 2 months ago
    Great to hear Fitzroy! Let me know once you apply those tips towards your first deal!
    Darius White New to Real Estate from Detroit, MI
    Replied about 2 months ago
    Great Read
    Patrick Menefee Rental Property Investor from Charlotte, NC
    Replied about 1 month ago
    Thanks Darius!
    Larry Russell Rental Property Investor from Whitsett, NC
    Replied about 1 month ago
    This a very insightful and informative article that packed with golden nuggets related to analyzing rental properties. I'm noticing not too many investors go into great detail about the numbers they use when analyzing rental properties. Thank you for posting your Reserves criteria (20% of rent (10% CapEx, 5% vacancy, 5% repairs)). I typically use 18% in my calculations (5% CapEx, 5% repairs, & 8% vacancy) since all of my properties are generally complete rehabs. I especially like your point of view when it comes to realizing you may have under estimated the amount of work involved in fixing up a property. "Pursuing that deal would have drastically decreased my ROI below what I was comfortable with, so I backed out. And I’m happy I did!" Backing out of a deal can be tough, however sometimes necessary.
    Patrick Menefee Rental Property Investor from Charlotte, NC
    Replied about 1 month ago
    Thanks Larry! I love the reserve criteria you shared too...I find most people don't post it because they often don't have any criteria and don't take it into account like they should. Did you take your 8% vacancy based off of 1 month per year? I started to use that on mine but given the fact that all of my properties are multifamily I felt comfortable bumping down a little bit
    Thomas J. Clifford from Gainesville, FL
    Replied about 1 month ago
    I've read a number of books on estimating cash flow and crunching the numbers, but organizing the analysis into, "First glance, pre-offer, and post-offer," was an approach that felt a little more straightforward. This helps lesson the fear of, "not knowing what I don't know," with what steps are needed and which order - Thanks so very much. Saving this to my favorites!
    Patrick Menefee Rental Property Investor from Charlotte, NC
    Replied about 1 month ago
    Glad to hear it helped! Knowing the difference between each step certainly helps ease that fear a bit and helps you pull the trigger on deals faster