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Investment property analysis basics
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I'm trying to learn how to properly analyze potential investment properties, but I'm getting overwhelmed by all the numbers and metrics. Cap rate, cash on cash return, IRR - it's a lot to take in.
Can someone explain investment property analysis basics in simple terms? What are the key numbers I should be calculating for every property I look at? How do I estimate repair costs and rental income accurately?
What tools or spreadsheets do you use for your analysis? Also, how do you account for things like vacancy rates and maintenance costs in your calculations?
Let me break down investment property analysis basics in simple terms:
1. Purchase price: what you pay for the property
2. Repair costs: what it costs to make it rentable
3. After Repair Value (ARV): what it's worth after repairs
4. Monthly rent: what you can charge tenants
5. Monthly expenses: mortgage, taxes, insurance, maintenance, vacancy (8-10%), property management (8-10% if you use one)
6. Cash flow: rent minus expenses
Key metrics:
- Cap rate: NOI (net operating income) divided by purchase price. 6-10% is typical.
- Cash on cash return: annual cash flow divided by your cash invested. 8-12%+ is good.
- Debt service coverage ratio: NOI divided by mortgage payment. Should be 1.2+.
For estimating repair costs: get contractor bids or use cost per square foot estimates. For rental income: look at comparable rentals in the area.
Use a spreadsheet or BiggerPockets calculator. Don't guess - actually run the numbers for every property you consider.
The most common mistake beginners make in investment property analysis: being too optimistic. They underestimate expenses, overestimate rental income, and assume everything will go perfectly.
Here's how to be more realistic:
Expenses: use actual numbers from comparable properties or industry averages. Property taxes: check the county assessor's website. Insurance: get a quote. Maintenance: budget 1% of property value annually. Vacancy: 8-10% for most markets. Property management: 8-10% even if you manage yourself initially (to account for your time).
Rental income: don't use the highest comparable. Use the median. And consider seasonality - some markets have lower rents in winter.
Repair costs: get actual bids, not estimates. And add 20% contingency for surprises.
Holding costs: if you're doing renovations, account for mortgage payments, utilities, insurance during the renovation period.
Exit strategy: what's your plan if things don't work out? How long would it take to sell? At what price?
I use a simple spreadsheet for investment property analysis. Columns for: purchase price, closing costs, repair costs, total investment, monthly rent, monthly expenses (broken down), monthly cash flow, annual cash flow, cash on cash return.
For expenses, I include: mortgage (P&I), property taxes, insurance, HOA (if applicable), maintenance (1%), vacancy (8%), property management (8%), capital expenditures (5% - for big items like roof, HVAC).
The 1% rule is a quick filter: monthly rent should be at least 1% of total investment (purchase + repairs). So a $200,000 property should rent for at least $2,000/month.
The 50% rule: expenses (excluding mortgage) will be about 50% of rent. So if rent is $2,000, expenses are $1,000, mortgage is $800, cash flow is $200.
These are rules of thumb, not exact calculations, but they're good for quick analysis.
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