How to Analyze a Rental Property So You Actually Make Money

by | Nov 24, 2015 | 7 comments

Do you dream of money coming in while you sleep from your real estate investments?

Have you wanted to begin investing in real estate, but you are not sure where to start?

Or maybe you are a current landlord, but your rental investments are just not making you the kind of money that they should be.

I’ll admit it, the sound of being a “real estate investor” is much sexier than being a “landlord”.

In fact, being a real estate investor is definitely different than being a landlord.

And trust me, it is much better to be a real estate investor.

A landlord rents out apartments, but has to manage every aspect (tenant screening, tenant calls, toilet repairs at 2 am… you get my drift).

A real estate investor understands how to analyze and put together deals that allow them money to come in without them needing to ever pick up a hammer.

So how do you make sure you are a real estate investor and not a landlord?

Well, read on and I will show you.

How to Avoid Becoming a Landlord

Do you know the #1 fear that people have when they begin thinking about investing in apartments?

Do you?

It’s the infamous fear of getting “calls to fix the toilet” at 2 am.

Well, it is a legitimate fear. We know, as when we started buying apartments, we did get those 2 am calls (well, more like 1:12, 3:42, Christmas Eve… you get the idea).

And that wasn’t all. We felt like all we were doing was advertising apartments, showing apartments to prospective tenants (who often didn’t show up), screening tenants, answering their calls, fixing issues, trying to collect rent and cleaning when tenants moved out.

Then the process starts over again. And at that point, we only had 4 apartments.  We saw our future as we looked to purchase more apartments, and we didn’t like it.

I’m going to be honest. We almost sold those apartments and gave up our dream of financial freedom.

But we didn’t, and I’m so glad that we didn’t. Today, we own 20+ apartments, which add a nice revenue stream each month, as well as really help build our net worth.

So how do you avoid this landlord trap so that you can enjoy the same benefits as us? You make sure you are buying good investments and have systems set up to handle each of these scenarios.

That is, you become an investor, not a landlord.

And Not Just Any Investor, But a Real Estate Investor

How does this differ from a landlord?

Well first, real estate investors start things off right by making sure they purchase good investments.

This avoids many issues down the road by ensuring that the investment will bring in the desired amount of cashflow.

Second, because they analyzed and purchased the property right, they then hire people to take care of the things that they don’t want to deal with.

The Surefire Way

There is a common saying among successful investors

In real estate, money is made when you buy, not when you sell. Click To Tweet

And they are right.

But one of the reasons that real estate investing (specifically buy-and-hold investing) is so great is that we actually can make money in six different ways:

  1. Instant Equity (Purchasing Under Value)
  2. Monthly Cashflow
  3. Mortgage Paydown (By Your Tenants)
  4. Tax Deductions
  5. Appreciation (Natural)
  6. Appreciation (Forced)

In order to make all of this work, there is one essential element that these investors all have in common.

Do you know what it is?

These investors all know their numbers, which allow them to only purchase good deals and avoid the duds.

Keep it Simple

If you begin searching for how to determine what a good real estate investment deal looks like, you will be overwhelmed with search results, formulas, and information.

We know, because before we sold our properties, we wanted to see if we could figure out what we were missing.

And after being overwhelmed with information, we almost quit again.

But we determined, and we dove deep into understand how to analyze and determine what made a good deal.

What we learned was that there are many good formulas out there, but we couldn’t find anything that easily told us if we should purchase a property or not. So we decided to create something that did just that.

We created a real estate investment (buy and hold) sheet to help us quickly evaluate deals and determine which deals were great and which ones to pass on. For this, we narrowed in and focused on the outcomes of 3 main calculations.

Our favorite part about this sheet is just by entering a few numbers, the sheet will tell us whether or not we should purchase the property.

Real Estate Evaluation Purchase Direction

If the numbers are not adding up, it will tell you that as well.

If you want to get a free copy of this sheet and follow along, get your copy here.

Criteria #1: Monthly Rent vs. Total Investment (Purchase + Renovations)

If I tell you that I’m renting out an apartment for $1,000/month, is that a good or bad investment?

Hopefully you will tell me that depends. In addition to how much rent is coming in, we need to understand the the total investment in the property.

For this, we like to use the “2% rule”. That is, our monthly rents should be 2% or more of the total property investment.

Example:

  • Monthly Rent: $1,600
  • Total Investment: $78,000
  • Target Rent for 2%: $1,560/month ($78,000 * 2%)
  • Purchase?: Yes. Monthly rent is $1,600, more than 2% ($1,560).

Real Estate 2% Rule

Criteria #2: Cashflow Exceeding $100/Month

This one gets many people into trouble. Simply put, cashflow is the difference between the money that comes in and the money that goes out.

Far too often people forget about various expenses, such as large one-time expenses (ex. a new roof).

To make sure we cover all of these expenses, we use the “50% rule”. That is, we assume 50% of our income will go towards expenses of one sort or another (not including a mortgage or any related financing costs).

Example:

  • Monthly Rent: $1,600
  • 50% Expenses: $800
  • 50% Remaining: $800
  • Mortgage Amount: $56,000
  • Mortgage Length: 15 years
  • Mortgage APR (Interest): 5.5%
  • Mortgage Payment (Monthly): $457.57
  • Estimated Cashflow: $342.43 ($800 – $457.57)
  • Estimated Cashflow per Unit: $171.22
  • Purchase?: Yes. Monthly cashflow per unit is $171, more than $100.

Rental Minimum Cashflow

Criteria #3: Debt Coverage Ratio Above 1.20%

The third criteria is one that banks often use. So if you are getting a mortgage, the property will likely have to pass this test. Even if you are not getting a mortgage, it is a good test to be sure that you can cover your debts.

Essentially, this formula says that you need to have at least 20% more income coming in than your debt (ex. a mortgage).

Example:

  • Monthly Income Remaining (After 50% Rule): $800
  • Monthly Mortgage Payment: $457.57
  • Debt Coverage Ratio: 1.75%
  • Purchase?: Yes. The Debt Coverage Ratio is well above 1.20%

Rental Debt Coverage Ratio

So now that you have seen the three criteria, you should have what you need to start running analysis on real estate deals that you are evaluating.  And instead of trying to do the calculations by hand, why not grab our free calculation sheet that will automatically run these calculations for you?  Simply click here to down it now.

And if you already have some property and need a complete set of the essential forms to market, screen tenants and get a lease signed that protects your investment, check out our Essential Landlord Forms.

Real Estate Calculation Sheet Download