A Step By Step Guide To Rental Property Analysis

20 March 2020

Investing in rental property is a great way to start your pathway to the real estate industry. Rental property investing has a wide range of benefits over other types of investments. These advantages are the steady cash flow, tax benefits, leverage, and appreciation. However, purchasing a rental property does not necessarily mean that your investment strategy will be a success. 

To cut a good real estate deal, you need to conduct a thorough rental property analysis. There are several indicators that define if the investment in the real property for rent will be profitable or not. In this article, we will describe these factors and you will be able to measure the performance of your investment property. 

Location

Location is a vital factor for any type of real property investment, not only for rental apartments but even for commercial property. The well-chosen location affects the rent price, rental income, expenses, return on investment and occupancy rate. Marketing strategy, rental strategy, and target audience also depend on the location of the property. For example, if your flat or house is located in a college town, the target tenants will be college students or faculty members.

Rent Location
Rent Location

Based on the foregoing, it is essential to define the appropriate location at the start of your investment property analysis. The rental property investor can use the online tools to find the best performing location for investments. These tools provide information about the listings in the area, average price, approximate cash-on-cash revenue, occupancy rate, and suitable rental strategy. 

Rental Strategy

The next step is to identify the rental strategy that suits you the most. This decision will influence the revenue from your investment property. There are two common rental strategies: long- rentals and short-term rents. The short-term rental strategy was popularized by the Airbnb platform and was aimed at travelers. 

A long-term strategy is considered to be the traditional approach. According to this method, the properties can be rented out to tenants for a few months of few years. This strategy is the most popular approach among beginners. The long-term rental strategy has the following benefits: good occupancy rate and property management handled by the tenants.

 Rental Strategy
Rental Strategy

The short-term rental strategy is a relatively new approach in the real estate industry. The term of the rent for this strategy varies from one night to a few weeks. Nowadays this strategy is gaining popularity due to the opportunity to generate high income. It is vital to note that the peculiar feature of short-term rentals is their seasonality. It means that your revenue from this type of property will depend mostly on the time of the year. 

Type of Property For Rent

The rental property types include:

  • single-family homes;
  • multi-family houses; 
  • condominiums;
  • luxury homes;
  • townhouses;
  • vacation apartments. 
Type of Property For Rent
Type of Property For Rent

The property type you are investing in is vital for the comparative analysis of the real property market. Comparative market research is the process of analyzing the market price of the investment property by checking the prices of similar apartments in the area. There special online tools with filters like age, size, the number of bedrooms that helps to find the piece of real estate that meets your requirements. The analysis of the rental properties in the market helps you to avoid overpaying when buying a property for investing.

Cash Flow and Income

With the help of rental property analysis, the investor can calculate the potential cash flow and revenue that the acquired property can bring. The term ‘cash flow’ can be applied to certain types of properties, like single-family rentals, apartments, commercial buildings or duplexes. 

To calculate the cash flow from the property you need to subtract rental expenses from the sum of the rental income. The expenses will depend on the type of real estate that you choose for investing. These costs may include taxes, vacancy rate, insurance, property management, maintenance (repair and upgrades), utilities, advertising, and others. 

Cash flow
Cash flow

If you receive the negative cash flow as the result then you are losing money every month. The positive cash flow displays profitability. The level of cash flow affects the final revenue and return. 

If you want to find the most reliable way to analyze the profitability of the property, you may use the 1% rule. This formula shows whether the property will gain a positive cash flow.

Vacancy Rate 

The following step of the analysis is to calculate the occupancy rate and vacancy rate. When the property has a high vacancy rate, it means that there were no tenants for the most part of the year. If the property has a high occupancy rate, it means that the property was occupied during a large amount of time in the year.

The best property for investment is a piece of real estate that has a high occupancy rate. Due to this fact, the property will generate income throughout the year. The best occupancy rate for the piece of real estate is 100%. The vacancy is perceived as an expense when defining the return on investment and cash flow because of monthly payments, as long as you do not receive the monthly income. 

Cash-on-Cash Return

The most common metrics in rental estates analysis are capitalization rate and CoC return. These criteria are used to estimate the income from the investment property. The main discrepancy between these two factors is that cash-on-cash income is based on the financing method, while the capitalization rate is not. 

Cash-on-Cash Return
Cash-on-Cash Return

Conclusion

Every real property investor should conduct the rental property analysis in order to find the most suitable and profitable apartment. When the analysis is made before putting money into an investment property, it prevents the investor from the risks of losing finance. While analyzing the rental property, you need to take into account such important factors as the location, rental strategy, the type of investment property, the potential amount of the cash flow, the occupancy and vacancy rates, CoC return and capitalization.

Rental property analysis is aimed at finding the best transaction with the dealer of the investment property. If you are new to the real estate industry, it is better to consult with the skilled realtor or real estate agent before the purchase.

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