It doesn’t matter if you failed pre-calc or graduated with a Ph.D in theoretical physics. All real estate investors have to learn to love the numbers. Love them like they are part of you. For good or for bad, ‘til death do you part, never leave the numbers—because they’re the core building blocks of rental property analysis.
There are several things I do and look at with any new potential property, but the most important is the numbers. If they aren’t good, I walk. Save yourself some time by running the numbers before you do anything else. If they work, awesome—you didn’t waste energy, money, and time.
What numbers do I run? Well, what should anybody care most about when real estate investing? Cash flow, or your monthly earnings. It doesn’t matter whether you’re investing in single-family homes, a duplex, or large multifamily apartment buildings. You need to know these numbers either way.
What determines cash flow? Income and expenses. Simple.
People make metrics out to be so complicated. It’s no wonder more people aren’t involved in real estate. In reality, the numbers can be one of the easiest parts of shopping for a property—even if you did fail pre-calc.
Ready? All you need are the numbers and a napkin to do a basic cash flow analysis.
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 you’re just comparing two similar homes—this guide will walk you through all the numbers you need to know. From calculating cash-on-cash return to running a comparative market analysis, the experts at BiggerPockets demonstrate the steps you need to follow and the statistics you must know with The Beginner’s Guide to Real Estate Market Analysis.
Running a Rental Property Analysis… on a Napkin
While you can calculate potential rental income in a spreadsheet (and, okay, let’s be honest: you’ll probably want to do that too), why not start with paper? Pen and paper (or, in this case, pen and napkin) get you up close and personal with the number, so you can be sure your investment property sings.
Pro tip: After running the initial numbers, plug your details into the BiggerPockets Rental Calculator for a full report. We’ll help you determine the profitability of a potential rental property, estimate potential monthly and annual cash flow, calculate return on investment, and plan for unforeseen expenses. You can even create a PDF to show your partners.
1. Figure out the monthly income (gross income)
This will either be rent the current tenants are paying, the asking rent, or, if you have neither of those, you can talk to a local property manager or real estate agent who can give you a market rent value for the property. If the property already has tenants paying a certain rent, or you have an ideal asking rent in mind, make sure it’s realistic for the neighborhood before moving forward. Are the existing tenants paying above market rent? They might be inclined to leave. And if they’re paying below market rent, there may be room for a future increase.
2. Calculate the monthly operating expenses
These may include property taxes, insurance, property management fees, mortgage or financing costs, and homeowner’s association (HOA) fees.
Most importantly, don’t forget vacancy and repairs! They are a real part of any property investment, and they can dramatically affect the cash flow. Still, many people don’t think to include them in the expenses.
Here’s how to estimate your total expenses.
- Property taxes: Look on Zillow or another online source for the most recent annual tax amount and divide by 12.
- Insurance: Get a quote from an insurance provider.
- Property management company fee: Usually around 10% of the monthly rent.
- Utilities: Ask the previous owner for bill estimates to get a rough idea of your expected monthly spend. Of course, if tenants will pay utilities, you don’t need to include this in your equation.
- Financing: Use an online mortgage calculator, like the one here on BiggerPockets, to calculate the monthly mortgage payment for your debt service. Confirm with your lender what your down payment and interest on the loan will be to ensure you are using accurate numbers for your calculations.
- HOA: Sometimes, HOA fees can be tough to determine. The seller or agent may know the number already—but if not, you will have to call the neighborhood’s HOA. If you only know the annual fee, divide by 12. Don’t skip out on finding out what the actual HOA fee is! It can absolutely kill a property’s cash flow.
- Vacancy: I conservatively estimate 10% of the monthly rent toward vacancy expenses. In situations where you have a rockstar property manager or your tenants are under a lease option, the actual percentage should be much less. I still use 10% no matter what as a conservative margin.
- Repairs: Again, this is an estimate, but it should not be left out. Just like with vacancy, I err on the conservative side. If a house is a turnkey property or recently rehabbed and gets a good report from the inspector, I use 5% of the monthly rent. If the property is not in top shape, conservative could mean closer to 25%. Use your judgment to decide what percentage to use—but don’t overestimate the quality of your property and estimate too low.
3. Subtract the monthly expenses from the monthly rent
This is your net income—your monthly cash flow. Yay! Hopefully it’s positive. If it’s not positive, run.
4. Calculate the returns
Two numbers I want to see on any property I evaluate are the cap rate and the cash-on-cash (COC) return.
Capitalization rate (cap rate)
This gives you an idea if the property is a good deal. It basically compares the return on investment (ROI) to the purchase price. Here’s the cap rate equation:
Net operating income (NOI) ÷ purchase price (or market value, if you already own the property) = cap rate
NOTE: I don’t include the mortgage payment in this calculation.
The lowest cap rate I would ever want to see for any property, whether residential or commercial, is 6%. The lowest I would want to see on a residential rental property in this market is 8%—and even then, there better be a good reason it’s that low, like the property is in a “sexy” market or highly desirable area. Anything over 8% means you’re doing well, in my opinion.
This number indicates how much return you are getting on the money you invest. If you pay all cash for a property, this number will be the same as the cap rate. If you are financing, this number is the most accurate way to see the actual return you are getting on your cash-in and the leverage. Here is the equation—and remember to include the mortgage payment, since this one is focused on financing:
Net annual income ÷ total cash invested = cash-on-cash return
Understand the difference? One measures how good of a deal you are getting on the purchase price, and the other tells you the exact return on your money you are getting. They are the same for an all-cash buy but can be very different for a leveraged purchase.
Pro tip: If you compare the cash-on-cash returns of an all-cash buy versus a financed buy, you may quickly see the benefit of leveraging! Way more bang for your buck. Try it out on a napkin sometime.
Practice problem—on an actual napkin
Apply these steps to an actual property? On a real napkin? You got it. Even more fun: I’m going to use a property that I bought for myself in Atlanta.
What do you think? Good deal? Absolutely!
- Cash flow: $358 per month—and actual number when there are no vacancies and repairs is $558
- Cap rate: 9.7%
- Cash-on-cash return: 17.97%
Not only are the returns great, but the tenants are under a three-year lease, and the property is in a great area. Score!
Running a rental property analysis takes no time at all. Jot down the list of expenses on a scrap sheet of paper, fill in the numbers, and calculate your cash flow. Done. In fact, I’ve done this on multiple napkins. Write everything out and look for positive cash flow. If it’s not there, ditch the property and move on to the next.
What to know before running the numbers
The only trick? The calculation doesn’t include expenses for rehabs or work that may have to be put into a property once you purchase it. I usually only deal with turnkeys, which are fully rehabbed when I buy them, so this formula works because there is no work required on the houses.
At the end of the day, numbers are just that—numbers. The reality of a property after purchase may create far different numbers than your initial calculations. For instance: Detroit. Oh, Detroit. On the surface, the numbers are out of this world. In reality, because of several key market factors, those initial numbers often turn out to be so far from reality (in a bad way). If you are a Detroit investor, rock on, and I wish you well. It’s just not my thing.
The point is, don’t ever just go off the numbers on a property. But the numbers are an important first step in evaluating a deal. If you don’t have a solid reason to believe you will be getting positive cash flow consistently out of a property, don’t bother with it.
Any horror stories? If you initially calculated that a property would have great returns and then the reality was something totally different, what caused it?
Weigh in with a comment!