Real Estate Deal Analysis & Advice

How Do I Know If a Property Is a Good Investment? (With a Buy & Hold Example!)

Expertise:
3 Articles Written
choosing-investment

For those of us that are buy and hold investors, the numbers have to work in order to be able to make a property cash flow.

Want more articles like this?

Create an account today to get BiggerPocket's best blog articles delivered to your inbox

Sign up for free

What does cash flow really mean, though? This is the money left over from the rental income after you take out all of the expenses associated with keeping that rental unit up and running. We are going to take a hard look at all of the things you might want to account for when calculating those expenses.

Most of us are familiar with the costs of a mortgage, insurance, and taxes, but we don’t always consider some of the other costs associated with holding a property as a rental.

In this article, we will cover all of the factors that you could consider when analyzing a property as a buy and hold investment. I’ll also give an example of one that wouldn’t work as a rental, but could still make you a profit as a fix and flip, putting money in your pocket that you can invest down the road.

Before we begin, I would like to say that I am fairly risk averse. My numbers may seem high to you, but I try to do my best to protect my hard-earned money. With that said, let’s dive right in.

Breakdown

Mortgage and Insurance

These are two of the most obvious costs to owning a rental property. This is going to be the monthly amount that you have to pay to a lender for the principal and interest on the loan amount you borrow. You can elect to have your insurance payments wrapped into the loan for you, making it easier to make your payments.

Property Taxes

Here is another example of one that most of us will be familiar with. This will all depend on the county that the house is located, and can vary drastically state by state.

For example, a state with little or no state income tax is more likely to have higher property taxes than a state that has a much higher state income tax. Most of the time, you can get a good estimate on the property taxes by going to the county assessor’s website where the property is located.

Again, you can elect to wrap this into your loan payment.

Income Tax

This is one that a lot of us might neglect when we evaluate a property. As with property taxes, this one will vary depending on what your tax bracket is. If you have a portfolio of 1,000 investment properties, you are going to pay a much higher tax rate than someone who only has two.

Personally, I don’t take income tax into consideration when I am evaluating a property. I just stick to setting aside about 30 percent of whatever I bring in into a savings account for taxes at the end of the year. Here is a detailed article about taxes on rental income.

Property Management

As a general rule, I calculate 10 percent as a management fee to be paid each month. This number can vary depending on your management company, and does not include a fee, which is usually half the first month’s rent.

Well, what if I am going to manage the property myself?

It is always a good idea to factor in property management into your calculations. Remember, we are investing in properties, not buying a job. If you want to manage your properties to begin with, great, just pay yourself the fee. But if down the line you decide you don’t want to manage it anymore, it would be a huge bummer to all of a sudden be cutting 10 percent out of your income and have your homes no longer be cash flow positive.

Related: Professional Property Management vs. Self-Management: A Look at the Pros & Cons

Maintenance

property-management-maintenance

Everyone looks at this differently. I like to take 10 percent of rent and set it aside each month for any repairs that may pop up over the course of a year. Some people out there won’t save for this at all. If that works for them, great!

At the end of the year, if I haven’t needed to make any repairs to the home, I will take this extra and move it into my investing money.

Capital Expenditures

Capital expenditures are large items that need to be changed over the course of time. Examples would be the roof or HVAC. This is an area that is absolutely necessary to factor into your calculations when evaluating a rental property.

As with maintenance, I stick with 10 percent. The only difference is that I will not re-allocate capital expenditure money out of a savings account for each property. It is not if you are going to need to change these items, it is when. Don’t leave yourself on the hook for a huge expenditure because you didn’t account for it.

Vacancy

It is inevitable that at some point your house is going to be vacant. Personally I like to have three months of necessary costs set aside for this occasion. These would be the mortgage and insurance. I will take about 5 percent out each month to account for vacancy.

Closing Costs

These are costs associated with buying the home, and then with taking a loan out if we are going to do a BRRRR (buy, rehab, rent, refinance, repeat) on it. These costs won’t be used to calculate your cash flow on the property, but should be considered as part of your total investment when calculating cash-on-cash return.

Related: 10 Key Components of BRRRR Strategy Success

Example Scenario

Let’s look at a recent property I just purchased that I was hoping to BRRRR when I first walked it, but will end up being a flip instead due to the numbers. I always do what the numbers tell me to do.

I got the home under contract for $25,000 and estimated that the ARV (after repair value) would be $110,000 after it was all fixed up. With closing costs, it cost $27,500 to purchase this home.

With a $110,000 appraisal, I can take out a maximum of $82,500. This number is based on the fact that most banks will loan up to 75 percent of the appraised value. I was fairly confident that it was going to take about $60,000 to bring this house up to that ARV, so all in I would be sitting at $87,500.

The Rent

rental-appraisal

Next, I took a look at what I thought it would rent for given the area and type of home. After careful consideration, and a call to my local property management team, we concluded it would most likely rent at $850.

Once I get the house all fixed up and ready to rent—as well as knowing what the rent will be—I can start to figure out what my fixed costs are going to be. We are going to do our best to figure everything out at this point except for the mortgage. We will get to that shortly.

Insurance

You can easily get a solid idea of what insurance is going to cost by giving your insurance company a call and telling them about the property. Sometimes it will take them a day or so to get you a quote, but a lot of the time they can do this over the phone. For my example property, I found that insurance was going to cost me $70/month.

Taxes

Now let’s look at taxes. For this I like to go to the county assessor’s website and see what taxes have been costing. However, much of the time you can find this on the properties page on Zillow. I usually will add about 30 percent to what was charged previously just to be cautious. This property’s taxes will run about $100 per month.

Management/Maintenance

The next costs are fairly easy. Property management, repair costs in the future, and capital expenditures will each be 10 percent of rent per month, so $85 each. Multiplying that be three we get $255 per month.

Vacancy

The last thing to account for in monthly cash flow is our vacancy cost. At 5 percent per month, this costs $45 (rounded up) per month.

Calculations

Monthly Cashflow

Here comes the fun part: calculations. We will take the rent and subtract out all of the expenses to see what our monthly cash flow would be before a mortgage.

$850 – $70 – $100 – $255 – $45 = $380

Annual Cashflow

The next part of evaluating a property is to figure out what our cash-on-cash return would be. Cash flow is nice and all, but if it costs us too much money to obtain that cash flow it would not be a desirable situation.

In order to calculate cash-on-cash return we will take our monthly cash flow and multiply by 12 months to turn this into annual cash flow for the property.

$380 x 12 months = $4,560

Cash-on-Cash Return

We the take this annual cash flow and divide by what we put into the property.

We will assume that my estimations for repairs of $60,000 are correct. We know that it cost us $27,500 to purchase this property. This brings our total investment into this house at $87,500.

$4,560 / $87,500 = 0.052

To turn this into a percentage we must multiply that decimal by 100, which give us 5.2 percent.

Analyze the Numbers

analyze-numbers-investment

Now you might be asking yourself if that is a good number. Well, the short answer is no. Not only is that not a great return on our investment, but it leaves a whole bunch of cash left in the deal. This is not something that I am interested in doing.

The BRRRR method is meant to allow us to accelerate our cash by getting most if not all of it back out of the deal when we do the third R, refinance.

Time to Tinker a Little

Let's take a look at what would happen if we got a maximum loan out on this property, which we said earlier would be $82,500. For a loan of this amount, it would cost $443 per month for a mortgage. It won't take long to figure out that this won't work. It would cost us more per month than our cash flow of $380. From this we know that we can't take a max mortgage out.

For this exercise we will just try one more way, but you could run the numbers with as many different mortgage scenarios as you like.

Let’s try a mortgage of $50,000. This mortgage would cost us $268 per month, leaving us with $112 left over in cash flow. We calculate our annual cash flow to be $1,344. This would be a 3.58 percent cash-on-cash return when calculated. This is worse than having no mortgage at all. And we didn’t even add in closing costs for financing the house yet, which would have to be added to our total cash invested.

Conclusion

As you can see from this example, the numbers just don’t add up for being a very positive rental, at least in the short term. My plan is to get this house nice and fixed up and then sell it for a profit.

In the meantime, I will continue looking for a different house where the numbers make sense to do a BRRRR on.

There are many ways that you can do these calculations. You can use a pencil, paper, and a calculator. You could use an Excel sheet that breaks everything into small sections, which is the way I am going about it. I like this because I can see how everything changes as soon as I change one of the numbers in the sheet.

You can also use the calculator that BiggerPockets has created that has all of the equations already done for you. All you have to do is put in the numbers that you want and, bam, out comes all of your data. Whatever method you choose is up to you.

As I stated earlier, I am very conservative with my investing. It has served me well so far. There are those out there who only look at rent minus PITI (principal, interest, taxes, and insurance). There are some who don’t care about cash-on-cash return, as well as those who are even more risk averse than I am.

You are free to pick and choose how you want to evaluate rental properties. Play with the numbers and do what you are comfortable with. The best advice I can give is to have a plan and stick to it. Do not change your numbers on a whim just to try and buy a property because you feel you need to. This may work out OK at the beginning, but it will sneak up and bite you at some point.

Buy and hold investors, what factors would you add to this list when analyzing a deal?

Share with a comment below!

Nathaniel is an active real estate investor and entrepreneur. He served in the Marines from 2003 to 2007 and got his bachelor's in Mechanical Engineering from Cal State Long Beach in 2016. It was shortly after graduating that he began his journey in real estate in 2016. In September 2019, he became fully invested when he started The Expert Home Buyers. Nathaniel wants to share his experience investing in real estate with anyone who has the desire to learn, grow, and become financially free. He does his best to stay active, exercising outside as much as possible with his wife and dog.

    Brandon Moore from Central Arkanas
    Replied 25 days ago
    Great article, I found it interesting that you looked at the property in two different scenarios to see if it was a deal.
    Nathaniel Hovsepian Rental Property Investor from North Augusta, SC
    Replied 23 days ago
    Yeah, and I kind of only scratched the surface here. There are many different scenarios that you could run that might make the situation different.
    Jason Johnson Flipper/Rehabber from Lehi, UT
    Replied 25 days ago
    Very solid article. Many investors bank on appreciation of the property. You should never rely on this. Your profit is made when you buy. Great job on the numbers. Great way to reduce your risk and not rely on the "hope" the housing market will increase.
    Nathaniel Hovsepian Rental Property Investor from North Augusta, SC
    Replied 23 days ago
    Thanks Jason. I totally agree. I try to mitigate risk as much as I can. It may mean that I do less deals than some, but it takes some headaches off the table for me
    Christopher Wyatt
    Replied 24 days ago
    I don’t understand how you came up with the management fee of 250? Can you please explain it to me?
    Cj Huntsman
    Replied 24 days ago
    Management costs (10% = $85) Repair costs (10% = $85) Capital Expenditures (10% = $85) $85 + $85 + $85 = $255 He just grouped it all into one number for easier math later.
    Nathaniel Hovsepian Rental Property Investor from North Augusta, SC
    Replied 23 days ago
    That's correct. I'm sorry that was a little confusing, I just tried to streamline it a little
    R.J. Petrillo
    Replied 24 days ago
    >Property taxes ~$100 a month *cries in NY Tri-State Area*
    Nathaniel Hovsepian Rental Property Investor from North Augusta, SC
    Replied 23 days ago
    RJ, you probably charge like 5 times more for rent though. Lol
    CJ M. Rental Property Investor from Canton, OH
    Replied 24 days ago
    Nice explanation. I really like how you showed the numbers with and without leverage. In the example where you had $112 CF ($50K loan), would you have done that scenario "if" it allowed you to recover 100% of your initial investment? In other words, would you take the $112 CF if you had $0 out of pocket?
    Nathaniel Hovsepian Rental Property Investor from North Augusta, SC
    Replied 23 days ago
    I would be very interested in doing any deal that I could recover all my cash from. That would make your cash on cash return infinite, even if it was only $20 per month.
    CJ M. Rental Property Investor from Canton, OH
    Replied 24 days ago
    P.S. thank you for your service
    Nathaniel Hovsepian Rental Property Investor from North Augusta, SC
    Replied 23 days ago
    Thank you CJ!
    Jessamyn Smith
    Replied 22 days ago
    Thanks for the article, it was the perfect amount of detail. I like the excel spreadsheet idea to play with numbers!
    Nathaniel Hovsepian Rental Property Investor from North Augusta, SC
    Replied 18 days ago
    And it's kind of fun!
    SALIAH S. New to Real Estate
    Replied 9 days ago
    Awesome article for a newbie like me! I also loved how you provided an alternative solution instead of simply saying, this deal won't cash flow! Thank you
    Nathaniel Hovsepian Rental Property Investor from North Augusta, SC
    Replied 9 days ago
    Saliah, you are very welcome. I am doing my best to pass on what I have learned in my adventures so far. Stay tuned for more! What are your goals with real estate?