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Let me ask you a question: How long do you spend picking out clothes each morning? Probably longer than most investors spend doing the math for real estate investment analysis. Unfortunately, people choose deals based on intuition, not analytics.

Digging into deal analysis details might feel like a trip to jargon town. Cap rate? NOI? Cash-on-cash return? Total return?

Feel bewildered? You’re not alone. We get a lot of posts on the BiggerPockets Forums asking about analysis. In this post, we’ll deeply dive into investment analysis, how to perform it, and how it can help you develop your real estate investment portfolio. 

What is an Investment Property Analysis?

An investment property analysis is a process that helps real estate investor to determine their investments’ current performance and identify areas for improvement. In its basic form, investing analysis involves calculating investment returns.

Choosing a Property Type

Before diving into real estate investing, make sure you understand how to compare markets and properties. Whether you’re trying to decide between investing in Boise or Sacramento or comparing two similar homes, read our beginner’s guide to investment analysis for more information.

Real estate investment analysis can be applied to single-family homes or multi-unit properties. However, be aware that the market value of single-family homes is determined differently from that of multi-unit homes.

making future projections (say, 1 year or 5 years ahead).

The projections, or investment analyses, give detailed assessments of how future returns will be impacted by current costs and expenses, taxes, loan values/equity, and other factors that can impact your ROIs. Investment analysis is a better, more precise tool for an investor than simply calculating cash-on-cash return, for example, because it takes into account the many variables that impact real estate investment yields.

Here are the main steps to performing an accurate and useful real estate investment analysis.

Single-family homes

Market “comps” determine the value of single-family homes, investment or not. These comps—or “comparables”—are nearby properties with similar characteristics. They share variables like the floor plan, number of bedrooms and bathrooms, garage size, and amenities. A single-family investment home generally rises in value if a similar home also rises—and vice versa.

Multi-unit properties

Larger investment properties—those with at least two units, and especially those with more than four—are priced and valued differently. The value equates directly to how much income or profit the property produces. It’s possible that an apartment building in a neighborhood where house prices are dropping could, in fact, increase in value.

You can’t just compare your apartment building to others down the street to see how much it’s worth. That’s why real estate investment analysis is so important.

There are several primary factors to consider, but cash flow and appreciation are the two most important variables. Cash flow is simply the money left after all the bills have been paid, and appreciation is the equity gained as the property value increases.

There are not many great ways to estimate future appreciation without a crystal ball, so I generally focus on the cash flow.

Vital Elements of a Real Estate Investment Analysis

So, now you know what property type you’ll be analyzing, you can move on to the analysis part of the process. These are the main steps to evaluating a property’s investment potential. It combines several real estate evaluation methods to give the most accurate ROI prediction possible. Note the word ‘’prediction’’ here: it’ll never be 100% accurate. An analysis is just that: it gives you an estimate or a prognosis. It gives you potential return numbers, which are not guaranteed.

Let’s take a sample property—1950 Maybury Avenue. Here are the stats you’ll need to know:

Units	Eight, with seven, rented and one vacant, and needing $10,000 in repairs
Price	$400,000
Cap rate	9%
Gross income	$54,000
Other income	$2,400 from laundry
Vacancy rate	12%
Taxes	$4,000
Insurance	$600
Maintenance	$3,000
Advertising	$300
Utilities	$2,000
Net operating income	$37,169

Good financial analysis involves inputting key information metrics into a financial model and using its calculations to determine whether the investment is good or bad—and right for you. You’ll need to know the following variables for the most thorough financial analysis of residential rental property:

• Property Details: Number of units, square footage, utility metering design, etc.
• Purchase information: Total purchase expenses—or purchase price plus rehab or improvement costs and closing costs
• Financing details: Mortgage or loan information, such as the total loan amount, down payment, interest rate, and closing costs
• Income: Rent payments and any other income the property produces

Expenses: Maintenance costs, including property taxes, insurance, and repair costs

Where to find data

Not sure where to track down the necessary information? Start here.

• Property details should be available from the seller. Check with your local records office for more comprehensive, detailed information.
• Purchase information includes any upfront maintenance or improvement work that must be completed before the property can meet its income potential. Have the property inspected to ensure that there are no hidden issues or problems.
• Financing details can be provided by your lender or mortgage broker.
• Income details come directly from the seller—but don’t rely on pro-forma data. You can also talk to the property management company currently handling the property, if one exists, for this information
• Expenses should also come directly from the seller or property management company. A building inspector can warn you about any major repair costs that may come due, such as a new roof or HVAC system.

Pro-forma vs. actual data

Getting good data from your model requires reliable, accurate information. Remember: It’s in the seller’s best interest to provide appealing—not accurate—numbers. For example, they may provide high rental income estimates or neglect to mention certain maintenance expenses. Part of the investor’s job is to ensure you have the best available information.

“Pro-forma”—or estimated—data from the seller merely kick off the discussion. Before closing,  determine the actual numbers. Ask to see previous years’ tax returns, property tax bills, and maintenance records. Hopefully, the actual data is similar to the Pro-forma data—but don’t be surprised if it’s different.

Check for potential surprises, too. For example, when was the last time the property was assessed for taxes? If it was a while ago, and values have increased significantly, it’s possible that the property will soon be reassessed and taxes will increase. Even small changes to the income and expense numbers can mean big changes in your bottom line.

Comp analysis

Comp analysis is short for comparative market analysis. Quite simply, it’s a way to predict the value of a real estate asset by comparing it to the values of similar assets recently sold. Real estate professionals use various metrics to perform a comp analysis: typically, the size, age, and location of a property, as these can be compared on a like-for-like basis.

Rental comps are calculated the same way sales comps are, but instead of determining the potential sales price of a home, you will be determining how much rental income the property can generate.  

Comp analysis can be performed for any building type, from a single-family home to a 100,000-square-foot office building. Plenty of digital tools and services can give you the right data, including sales history if you need to perform comps on commercial real estate.

Income analysis

Income analysis, or the income approach, is one of the most popular real estate valuation methods. It has a simple formula: net operating income divided by the capitalization rate (projected rate of return). We consider both elements of this equation in more detail below. First, let’s find out how to work out our net operating income. 

Assessing property income

Gross income is the total income generated from the property, including tenant rent and other income from things like laundry facilities and parking fees. 1950 Maybury, for example, has eight units renting for between $525 and $650 per month, for a total of $4,500 per month. In addition, we have $2,400 per year in additional laundry facility income. That means the total monthly income is $4,700, and the annual income is $54,000.

Most of a property’s income generally derives from tenant rent—making it extra important to account for unit vacancy. Most areas have an average vacancy rate, although your property’s specific vacancy rate may be higher or lower. If so, you’ll want to factor that into your analysis.

Here are questions to ask if the vacancy rate doesn’t correlate with the average local vacancy:

• Is the data pro-forma or actual? If it’s actually, what is the current management doing to keep the building filled?
• Is the rent lower than the market rent?
• When do current leases expire?

You’ll need to determine what you think is a reasonable vacancy rate going forward—I recommend erring on the conservative side.

When determining how much income you can expect, start by subtracting the income that you likely won’t see due to vacancy. In our example property, only one out of eight units are vacant, equating to about 12 percent vacancy. We’ll use that number for our analysis.

So, our total monthly income would be $4,160, with a total annual income of $49,920.

Calculating net operating income

One of the cornerstone metrics of your financial analysis is “net operating income” (NOI). This determines the property’s total income after all expenses, not including debt service costs—or your loan costs.

In mathematical terms, NOI equals the total income of the property minus the total expenses of the property:

NOI = Income – expenses

Typically, NOI is calculated monthly using income and expense data, which can be easily converted to annual data simply by multiplying by 12. 

Analyzing real estate expenses

Now let’s calculate our total expenses for this property. In general, expenses break down into the following items:

• Property taxes
• Insurance
• Maintenance—estimated based on the age and condition of the property. Maintenance expenses will include repairs. When estimating potential repair costs, budget for looking at the property itself. Generally, you can assume between 5-15% of the rent, depending on the condition and age of the property. And keep in mind that you may go six months without a single repair and then get hit with a $1,500 water leak. You just never know.
• Capital expenditures: Also known as “CapEx,” this means those expensive big-ticket items that need to be replaced every so often, such as roofs, appliances, and HVAC systems. For each major system, estimate the cost to repair, divided by the remaining lifespan, and set aside that amount every month.
• Management, if you employ a professional property manager. Property management companies typically charge a percentage of the rent and a fee to rent out a unit. These numbers can change based on your local area, but in my area, property managers charge 10% of the rent and 50% of the first month’s rent when a unit is turned over.
• Advertising
• Landscaping, if you hire a professional landscaping company
• Utilities, assuming any portion of the utilities are paid by the owner

Convert any monthly expenses to their annual costs to find the property’s annual operating cost.

Now that we know our total annual income and expenses, we can calculate NOI:

$49,920 – $12,751 = $37,169 NOI per year

NOI doesn’t give you the whole picture or enough information to make any decisions, though. Instead, it is the basis for calculating most of the important metrics in our analysis.

Common Real Estate Performance Measurements in a Real Estate Investment Analysis

In the last section, we learned that NOI was the property’s total income. But you might have been wondering, “Why doesn’t NOI include the expensive cost of the loan since that will ultimately affect your bottom line?”

Now, it’s time to get serious about cash flow.

Cash flow

Cash flow is the money left over after all the bills have been paid. However, this simple definition gets a lot of people in trouble. You see, technically, cash flow is:

Income – expenses = cash flow

But income may include more than just the rent, and expenses will include more than just the mortgage. You might say, “The mortgage is $800 per month, and the property will rent for $1,000 per month—so my cash flow is $200 per month.”

False.

Other expenses include:

• Taxes
• Insurance
• Flood insurance (if needed)
• Vacancy
• Repairs
• Capital expenditures
• Water
• Sewer
• Garbage
• Gas
• Electricity
• HOA fees (if needed)
• Snow removal
• Lawn care
• Property management

Some of these items are easy to calculate. You can call your insurance agent and ask for a quote or ask the HOA president about typical fees. Don’t get overwhelmed—the more properties you look at, the more you will understand what’s “normal.”

Unlike NOI, cash flow also includes your debt service under “expense.” We don’t include debt service in the NOI calculation because NOI dictates how much income the property produces—independent of the owner’s financing.

The monthly or annual debt service amount is specific to your financing plan. If we included debt service in the NOI, then NOI would only be meaningful for that specific loan. Different buyers have different financing, so having a property-specific income metric is important.

In real estate, we typically calculate an annual cash flow instead of a monthly cash flow because the margin for error is greater when analyzing cash flow month-by-month. Even fluctuating energy costs alone can skew your metrics, so stick to calculating your real estate cash flows on an annual basis.

As might now be obvious, your annual cash flow is your total annual profit. The higher your loan payments, the smaller your cash flow. If you pay cash for a property, your cash flow is the NOI exactly because that’s the property’s maximum cash flow.

Our monthly debt service on Maybury is $2,129, making our annual debt service $25,548. For this property, our cash flow would be:

$37,169 – $25,548 = $11,621

Paying cash minimizes debt service and thus maximizes cash flow. So, if you have the means to pay all cash for the property, why wouldn’t you? There are good reasons.

Rate of return

Cash flow isn’t the only important factor. You must consider the rate of return—also known as return on investment or ROI—too.

ROI is your cash flow relative to the cost of your investment or your “basis.” Mathematically, that would be:

ROI = Cash flow/investment basis

What is a reasonable ROI? Let’s compare other investing vehicles.

• High-interest savings accounts often have an ROI, or interest rate, of between 2-5%.
• A certificate of deposit (CD) sports an ROI of about 5%.
• The stock market has an average ROI of about 8-10%.

So, what’s our ROI on Maybury? You should consider a few numbers in your real estate investment analysis.

Capitalization rate (or cap rate)

Just like NOI is completely independent of financing costs, the cap rate is a neutral figure independent of the buyer or their financing. It’s calculated as follows:

Cap rate = NOI / property price

Cap rate may be the single most important number in your real estate investment analysis. The cap rate, or capitalization rate, is independent of the buyer and financing, making this calculation the purest indicator of a property’s potential return.

Here is the cap rate for Maybury:

$37,169 / $418,000 = 8.89%

Here’s another way to think about the cap rate: It’s the ROI you would receive if you paid all cash. Cap rate assumes the maximum investment amount—the full price of the property.

A “good” cap rate depends on where you’re buying. Most areas, however, see maximum cap rates between 8-12%.

Just like single-family houses, where prices are determined by comparable houses nearby, larger investment properties are valued based on the cap rate of comparable investment properties. If the average cap rate in your area is 10%, look for a 10% cap rate investment, at minimum. (Barring other more complex situations and considerations.)

Cash-on-cash return (COC)

Just like there are multiple income measures—NOI and cash flow—there are also multiple measures of return. The cap rate is the rate of return independent of financing, and the cash-on-cash (COC) return is dependent on financing. It’s directly related to the amount of cash you put down.

If you put $100 into a savings account, you might receive $4 per year, or 4% ROI. The COC measures your return if you put that $100 into the property instead. COC is calculated as follows:

COC = Cash flow/investment basis

For Maybury, the annual cash flow is $11,621. In total, the down payment, improvements, and closing costs equal $98,000, creating a COC of 11.86%.

Here, we see clearly that Maybury beats both savings accounts and diversified stock portfolios… albeit with a lot more time and energy spent.

Everyone’s ideal rate of return varies. However, if you’re getting less than a 10% return on a property, it’s probably not worth your investment—consider investing that cash in the stock market instead.

Total return on investment (ROI)

In addition to cash flow, there are several other key financial considerations in your real estate investment analysis:

• Tax consequences: You may gain or lose money to taxes.
• Property appreciation: Because the real estate market is volatile, you may not be able to predict this.
• Equity accrued: This is the difference between the value of the investment and the amount remaining on the mortgage. And don’t forget, your tenants’ rent covers the mortgage payments..

COC only considers cash flow’s financial impact; total ROI considers all the factors affecting your bottom line. It’s calculated as follows, where “total return” contains all of the considerations above.

Total ROI = Total return/investment basis

Let’s assume we can expect a 2% yearly appreciation for Maybury—or $8,360. The equity accrued in the first year of the mortgage is $3,251. And for the sake of this example, no tax breaks are available—or taxes due.

The total return for Maybury would be $23,232, making the total ROI 23.71%.

Not too shabby, huh?

Keep in mind that our real estate investing analysis only covers the first year of property ownership. In subsequent years, accrued annual equity increases, expenses rise with inflation, rental rates increase or decrease, and tax situations change.

Analyzing Real Estate Investing Metrics—In Conclusion

Real estate investment analysis involves a series of number-crunching exercises that can help you predict your ROIs with a high degree of accuracy. Rather than relying on a single metric (e.g., cash flow or COCs), an investment analysis takes advantage of all the metrics available to an investor to predict the returns. 

As we mentioned at the start of this article, no investment analysis can be 100% accurate. However, perseverance over time will pay off when building your real estate investment business. No, you can’t predict the future—but you should extend your analysis out a couple of years using trends or demographic data indicating the direction of the market and inflation. The more data you collect and the more consistent you are about it, the better your projections will be. The better analyses you are able to make, the better you will become at choosing properties that deliver returns worthy of your money and effort. 

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.