Buying rental properties is a great way to invest your money. You cannot buy any property and hope it turns out to be a great rental. You have to analyze the numbers to make sure you will make money with the rental property and the returns will meet your goals. To get great returns you need to buy below market value with great cash flow. New investors struggle with deal analysis, because they are missing many key factors that you have to know. At a minimum you have to know the repaired value, the rental rates, the cost of repairs and financing terms. To get the full picture of a rental property investment you will need to know much more.
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Why do so many investors struggle with deal analysis?
I am on many real estate forums and I get many comments from readers on Invest Four More. Many new investors want to know if a deal they found is worth buying. They want someone else to confirm that it is a good deal or in some cases do the analysis for them. I understand the need to get confirmation you are getting a good deal, real estate is very expensive. However the majority of people seeking advice have not done their homework to figure out the basic costs you have to know.
The more knowledge you have and the more experience you have the easier it is to analyze a deal. I can decide if I want to buy a property in about ten minutes after seeing the house. You don’t have to make a decision that quickly, but if you know the numbers you should be able to decide if you are getting a good deal without relying on strangers online.
What value is the most important number to know when analyzing rentals
No matter what type of investment you buy, you have to know the value. What is the home worth when you are buying it and what the home will be worth after you fix it up.
I see many investors asking if a home is a good deal when they have no idea what it is worth. What’s even worse is when investors use Zillow as the only way to value a home. Zillow can be off by 20 percent or more as I discussed here. If you are 20 percent off on your values, you are going to have a horrible time trying to buy anything or you will lose a lot of money.
The most important number to know when buying rental properties is how much the property will be worth after it is fixed up. The reason you need to know the value on rentals is you have to know if you are getting a good deal. Getting a good deal allows you to refinance, get more cash flow and if you have to, sell the home. I prefer not to sell my rentals, but you never know what will happen in life and you have to be ready. If you are looking to buy a lot of rental properties like me, the banks love it when you have a lot of equity in your houses and they can see you get great deals.
You have to know how much the rehab will cost on rental properties
Some people prefer to buy properties that need no repairs, but I like houses that need work. In a perfect world I would love to buy homes that were perfect, but to get a great deal many times I have to buy houses in bad condition. Most investors tend to buy homes that need some work, because they want a good deal as well. If you buy a short sale, REO or estate sale it will probably need work.
You have to know how much the rehab will cost, because it affects the cash on cash returns, the total cash needed and if you are really getting a great deal. If you buy a home for $100,000 that is worth $150,000 after it is repaired, that looks like a great deal on the surface. If the home needs $50,000 in work it is a horrible deal, because of the time and risk it takes completing a $50,000 rehab. But if the home only needs $20,000 in work, it may be a great deal if the other numbers work.
Another mistake I see beginning investors make is not taking the time to estimate repairs. They guess what they think repairs will cost without experience or talking to a contractor. They also don’t take the time to create a scope of work that lists every repair needed. They may estimate $5,000 in repairs because the home needs paint and carpet. They don’t see that the furnace is 30 years old, the roof is shot and it has galvanized plumbing. Those repairs could easily add another $20,000 to the rehab cost. In the worst case scenario investors don’t know what repairs are needed or have any idea what they will cost and they assume they can figure that out later.
You have to know what the rental rates are when analyzing a deal
It may seem fairly obvious that you have to know what a home will rent for, but many new investors don’t take the time to dial in the rental rates. It takes time and work to find rental rates and many investors are looking for quick answers. You can’t just look up rental rates in a certain neighborhood for three bedroom houses. You have to check houses that are listed for rent, make sure they rent for that amount, call property managers, talk to other investors and talk to real estate agents. I discuss the entire process of determining rental rates here.
You cannot hop on Zillow or another rental website and hope the figure they give you is correct. You have to do the work to make sure a home will rent for what you think it will rent for. Being off by $100 or $200 a month on rents can mean the difference between losing money and making money.
You have to know what type of financing you will get on your rental property
One of the first things a new investor should do is talk to lender. Even if you don’t plan on getting a bank loan, you need to talk to a lender. They can tell you what your credit is, if you qualify for a loan and what programs they offer. I think using leverage or loans is a great way to increase returns. The sooner you talk to a lender the sooner you will know if you need to repair your credit, save more money or have a longer job history.
If you want to buy a REO or short sale you will have to have a pre qualification letter. If you have not talked to a lender and want to make an offer you may miss out on a deal.
When analyzing deals you need to know the costs the lender will charge you and how those costs will affect your cash flow. You also need to known how much cash you will need, because many lenders require you to have reserves in the bank in addition to the down payment.
Can analyze a deal with these basic numbers?
If you know the value of a home, the repairs needed, the rental rates and the type of financing you are going to use, you can get a basic idea of the deal. If you are buying below market value that helps any deal whether it is a rental or a flip. If you figure the repair costs into the equation with the value you get an idea if you are creating equity with the purchase. When you figure the financing costs, rental rates and expenses you can see what the cash flow will be on a monthly basis.
Cash flow may be the most important number besides the value of the home. To figure cash flow you subtract the expenses from the rents. Knowing the financing terms and rental rates is part of cash flow, but there is much more. You need to know the other expenses like insurance, property taxes, maintenance and vacancies. Many investors forget to account for these and their expenses end up being higher than they planned for. This article describes how to figure cash flow and account for all expenses.
After determining how much cash flow you will make and how much equity you will have you have to decide if the numbers make sense for your strategy. I like to see $500 a month in cash flow and a 20% cash on cash return on the money I invest. You may not need returns that high or you may want even higher returns.
It takes a lot of work to analyze a rental property deal when you are a beginning investor. You have to do the work to find the right numbers to analyze if you will make money and how much. No one can help you determine what a good deal is if you don’t know the value, the repair costs, the expenses or financing terms. If you want a little extra help figuring these numbers and learning how to determine them, check out this article on how to jump-start your real estate investing.