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How to Evaluate Rental Property: An Investment Guide

System - Tuesday, December 28, 2021
Property Management Blog

In the third quarter of 2021, national vacancy rates for rental housing reached 5.8%. Finding tenants for a rental unit is essential to make a return on investment.

Some of the vacancy problems can be attributed to rental property evaluations. If you fail to evaluate a property before buying it as a real estate investor, you risk major issues down the line.

You need to learn how to evaluate rental property the right way. Keep reading to find out how.

Rental Property Cash Flow Analysis

The first step on how to evaluate rental property is to figure out if it can make you money. You can do this by analyzing the property's cash flow potential.

These are the specific expenses to account for when creating a cash flow analysis:

  • The mortgage payment
  • Utilities you pay
  • Rental property management
  • HOA fees
  • Vacancy
  • Maintenance

Other expenses you might pay on an ongoing basis include pest control, lawn maintenance, etc.

During the cash flow calculation, your property should produce a positive cash flow from the first day and thereafter. The analysis will calculate immediate cash flow but it should increase over time.

The most important number to know for an investment property is the net operating income (NOI). This is the number you will get after all expenses except for financing costs.

Compare Properties

Property hunting takes time and you'll find that you have more than one option you are interested in. Part of the evaluation process calls for comparing properties to one another.

This step is made easier with the capitalization rate (cap rate). This number is found by dividing the NOI by the property value. This is also the return if you purchase the property outright instead of financing.

Using this simple equation will help you figure out which property is a better investment.

Put Down a Large Down Payment

Once you learn more about real estate asset management, you'll find that putting down a large down payment can increase positive cash flow. Most lenders require you to pay a 20% to 30% down payment.

Your financing costs should be less than the NOI to have a positive cash flow. You can leverage the property but it comes at a cost because you might lose more than the original investment.

Talk to Other Investors

If you are a first-time rental property investor, you'll find that talking to others who have done what you are trying to do is beneficial. Other investors can give your advice on how to evaluate rental property the right way.

You can also do your own online research to figure out some of the common approaches to property evaluation and buying. 

You might also come across a real estate agent referral program that can help you find a pro who knows more about property evaluation.

How to Evaluate Rental Property the Right Way

Learning how to evaluate rental property sounds like an easy concept, but it takes time. One of the most important things to do is to complete a rental property cash flow analysis for every building you are interested in.

Once you have the numbers, compare rental properties to find the right investment. If you don't have the equations down, hire a rental property management company that can do the evaluation for you.

Contact us today to learn how we help real estate investors like you.