How to Analyze a Rental Property
Buying rental properties can be a difficult process, even for those with years of experience in property investment. There are several different steps involved in making a purchase, and each step requires research and careful thought before a decision is made. One of the most important steps in the purchasing process is analyzing your rental property.
This type of analysis is the best way to try and predict whether a property is a good investment, and if it will perform well for years to come. The best way to analyze a rental property is to take the following steps:
- Determine the market value
- Calculate operating expenses
- Estimate repair/renovation costs
- Calculate net operating income
Determine the Market Value
The first step in analyzing your possible investment property is to determine its market value. It can be difficult to determine how much a property is worth — to someone who values location over size, a two bedroom home close to the city may be more valuable than a three bedroom home in the suburbs. A good way to assess your investment’s market value is by using comparative market analysis.
Comparative Market Analysis
Comparative market analysis is comparing your investment property to other homes in your area. Knowing what similar homes in a similar location charge for rent can help give you an idea of the profits your property could potentially earn. Of course, your home is unique and will probably not rent for exactly the same amount that your neighbor’s did. But, knowing the market value of properties that are similar to yours can at least give you a solid starting point in the process of setting rent prices.
Calculate Operating Expenses
Calculating total operating expenses for a property can be tricky. Oftentimes, there are expenses that are easily forgettable, like the cost of advertising your real estate. It’s important to list out every expense you can think of, from once-a-year costs to regular maintenance. Usually, expenses break down into the following categories:
- General maintenance (not including renovations)
Of course, each of these factors can vary depending on the location, age, and other characteristics of the property. However, it’s essential to come up with the most accurate estimate of monthly or yearly operating expenses as you can — this number can make or break your profit margins. If the operating expenses of a property are much higher than the amount of profit you could possibly earn, it won’t be a lucrative investment.
Estimate Cost of Repair/Renovation
If you have an older property or simply want to drive up your market value, repairs and renovations will be necessary. This aspect of rental property investment can be difficult to estimate because there are so many variables that can change the overall cost of your projects. Your repairs could go on without a hitch, or you could encounter an expensive surprise along the way — you never know until you start.
However, the general rule of thumb is that renovations shouldn’t exceed more than 5 to 15 percent of your property’s rent. While flipping homes is a big real estate trend, it’s easy to forget how costly renovations can be. If you’re not careful and don’t estimate the cost of your repairs ahead of time, you can quickly eat away your profit margin.
Calculate Net Operating Income
One of the most important aspects of analyzing your rental property is calculating your net operating income, or NOI. This number determines the total income your property will generate after all your expenses, including renovations. This number doesn’t include any loan costs, however.
Simply stated, calculating your NOI is done by subtracting your total expenses from your total income. Make sure your expenses and income data are both in the same unit (months or years) — otherwise, you may get a drastically different number than the actual NOI. Your net operating income will generally tell you whether the property you’re looking at is a good investment or not, and will set your expectations for how much income you’ll be generating if you do invest.
Let Memphis CashFlow Help You Find the Right Investment Property
Looking to invest in real estate? Our team at Memphis CashFlow works hard to provide investors with ideal rental properties and locations. If you are interested in property investment in the Memphis area, contact us today for more information!