The best tool in my side hustle belt!
Rental property analysis is a must-have skill for a new investor. Back-of-the-napkin math will work, but probably not until you’ve looked at dozens or hundreds of deals. If you don’t know how to do it, you can easily make mistakes.
Annual Property Operating Analysis Sheet
Before I get into the numbers, a quick warning. Numbers and analysis are great and any property can look exceptional on paper. The first property I ever analyzed was a sure thing! The rent was good, the price was right and the expenses and management would be perfect for my first rental. It wasn’t until I investigated further that I found out this two-bedroom ranch was a literal stone through from the river that swallowed it up twice in the previous five years. Once I factored in the flood insurance cost, the deal was…well…sunk.
I was looking around for a bit when I decided to call one of the local listing real estate agents. I gave him my spiel, the short of which was that I wanted to be a real estate investor and I was interested in this one particular house. He said, “Ok son. Why don’t you come on into the office and we can sit down and talk about what you want to do.” I went.
The realtor asked me a few questions and probably judging by my age and the way I poorly answered a few questions, he then began to explain to me that there were a few things I should consider when buying rental houses. He asked if I was going to flip the house. This meant I would make an offer, close, improve it, and then try to sell it for a profit. I said that sounded great but that wasn’t what I was after.
I knew that real estate could generate longer-term wealth if I were to buy the property, improve it, rent it, then refinance it using a bank. This is commonly referred to as the “BRRRR” process which stands for Buy, Renovate, Rent, Refinance, Repeat…If this sounds enticing, it should. It’s an excellent wealth-building tool and works in concert with so many of the other methods used to invest in real estate.
Back to the realtor, and what this post is about. He pulled up a tool on a Google Sheet that day. He called it “APOD,” Annual Property Operating Data. It’s just an excel or Google sheet with some algebra. I had been working with excel as an analytics manager for years so it was straightforward. In fact, it was way too simple — so what I’ll share with you today are the calculations I built into my own tool after a few years of investing.
I always tell people who want to be real estate investors that they should begin analyzing deals on paper. Punch in the details on a calculator to find out if the deal makes sense. Learn how to “buy it right.”
My experience has been that even if the worst-case scenarios occur with rental situations, buying them right goes the farthest to ensure the success of the asset. To that end, I built a tool to help me see what the ‘right’ number would be.
There are some basic components you’ll need in order to leverage this analysis tool to its greatest advantage. Purchase Price, Rent, and Expenses are the main throughputs and while they’ll get you most of the way there, you’ll eventually want to understand all of the metrics.
Vacancy Rate — The percentage of time your property will be vacant. This number is usually immediately subtracted from your rental income. I am conservative and use one-twelfth, or 8.33% which amounts to one month vacant per year. Living in what’s characterized as a very legally-tenant-friendly state, I also keep this number high in order to mitigate the risk of nonpayment, or evictions.
Generally, though, I see 4%-6% used most often. Depending on the number of units in the building you’re analyzing, you may want to want to go higher for a single-family and lower for a multifamily, as the number of units, can be a large variable in the overall vacancy of an asset.
Operating Expenses — These are expenses such as taxes, insurance, management, repairs & maintenance, utilities, and landscaping/snow removal. Other expenses can include professional services, advertising, supplies, and marketing. These are costs you will pay in order to run the property.
Net Operating Income (NOI) — Gross Income minus Expenses. Not counting debt service, this is how much money you should expect to make per year. Income — Vacancy — Expenses = NOI
Debt Service — This is the cost of any money you are borrowing. If you have a $100k loan at 5% over 30 years, you will pay $537 dollars per month to the bank. At the beginning of your loan, about 80% of that payment, $417 is going toward interest.
→ A note on debt service — In my analyses, I do not split out principal and interest when considering debt service amounts, though you could do that if you wanted to. If so, you would count the interest payment only, like debt service, and because the principal is actually paying down the amount of money you owe, you could also decrement that from the loan amount calculation. I find little value in doing this at the beginning of an investment but I like to look at it toward the end of one. It gives me a better perspective of what I have in the deal, totally, as an investments sunsets.
Cash Flow — This is NOI — Debt Service, or the amount of money you will make after you pay your debts but before you pay taxes. Cash in hand on a monthly and annual basis.
Cash on Cash Return (COCR) — This is Cash Flow / Purchase Cash. It’s the amount of cash you receive before taxes, divided by the amount of cash you laid out on the purchase, representing how much of your investment you’re receiving back per year. I look for a COCR of over 10%.
Capitalization Rate — This is NOI / Purchase Price and is a representation of the larger investment viability. I think of this as my initial rate of return and use it for purchase analysis. Anything higher than 8% is pretty good these days, but as always, whether the Cap Rate works for you will depend on the market and the work you need to do to raise your NOI.
After Repair Value (ARV) — The ARV is the expected value of the house after the repairs are complete. When buying rental houses, many investors are (or should be IMHOP) looking for deep discounts. When purchasing houses at deep discounts, investors need to rehab property which can incur significant costs. For example, if an investor purchases a house for $25,000 in a neighborhood where similar houses sell for $125,000, they may be able to spend $50k in rehab costs for a total investment of $75,000. This amounts to instant equity. ARV is used to determine the resale value of a property or the amount of money that can be taken out of the equity later when refinancing.
Equity — (Property Value — Debt) / Property Value. This is the amount of ownership you actually have in the investment, the amount you actually own. The main factors here are the value of the property and the amount of debt you have in the deal. Zero debt = 100% equity. Equity is the amount you can borrow against when refinancing.
The 2% Rule — The calculation for this one is Rent / (Purchase Price + Rehab cost). If the number is greater than 2%, it is considered a good deal. The value and interpretation of this metric can vary wildly among investors. While some investors are ok with 1%, others look for 3%. I am more conservative and try to get good deals on the purchase, so I lean toward 2%–3%.
Now that you have all the numbers, what will you do? Get out there and start analyzing deals!
Final Thoughts
Know your numbers but don’t get lost in them. At first, you won’t be able to feel if the deal is right. This will come much later. Experienced investors barely need to use a calculator like this but using it often and using it correctly when you are new, will serve you in the long run. As always, I learned through other people helping me and my goal is to pass along that knowledge to others. Hope this helps!
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