How to analyze a rental property to know if it will actually produce income

Estimated read time 9 min read

What is the ultimate reason you want to buy a rental? Guess what it is — income. Right? It has to be. Why else would you buy a rental?

Many people are unaware of what contributes to the income generated by a rental property. You pay the rent and keep the remainder (assuming that you have enough to cover your expenses). But there’s more than meets the eye.

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Need to Perform Analyses If You Want to Profit from a Rental Property

You will never see any income if you invest in rental properties.

  1. Numbers
  2. Risk Factors

Wait, what? What? No. It’s a shocker, because we all grew up thinking that this was true.

What did and not tell us in school about how to make a rental property profitable?

Numbers

Please, everyone, learn math. When I started, I was almost duped into purchasing rental properties that would never have made me any money. I didn’t even know what running numbers were. If you own a rental, you’ll automatically make money, right? No!

Renting properties can provide a variety of income streams, but the majority of it will be generated by monthly cash flow and appreciation (or both). Other benefits are available, such as tax advantages, but they won’t put you in the black. Cash flow and appreciation can, however.

Cash flow

Monthly cash flow is the amount of money you have left over each month once your rent and expenses are covered. What’s left after all that? Cash flow, or income, can be very profitable if done correctly.

If my projections are correct, for example, the money I invested in one of my properties should be returned to me via monthly cash flow within only 5.5 year. I get to keep any money that comes in after the first month. This is not bad at all.

Don’t worry. I will explain how to determine if my projections are accurate. Cash flow can be achieved by having several properties which will generate the monthly income that you desire. You can start to free yourself financially if you have enough of these bad boys. Check out ” Rentable Properties so Easy to Calculate” for more information on how to calculate projected cash flows and cash flow returns.

Appreciation

It can also happen with a property that is cash-flowing, but people will buy properties when they have no cash flow because of the potential for appreciation. Appreciation occurs when the value increases of a home, whether it is because the market value has increased, the property was remodeled to a significant degree, or because inflation. You should know that some markets will appreciate more than others. Also, you need to understand that appreciation is only speculative.

Be aware that investing for appreciation can be riskier than for cash flow. You can be successful when investing for appreciation. Since I do not invest for appreciation I cannot speak to their success. However, if you are interested in numbers, ensure that you understand what they really mean and how much appreciation is needed to turn a profit. The story is different if you purchase a property with cash. What if you purchase a house with a loan? Remember that you would need to cover the interest you paid, plus what you invested in the property, to turn a profit.

Many people do not realize that just because they sold their property for more money than they paid, it doesn’t mean that they made any profit. You should know the stats and trends to be able to predict the possible appreciation of a property as accurately as you can. But you also need to know the math so that you will come out on top if the appreciation happens. You should also know how to calculate cash flow even if you don’t think the property will cash flow. This is because you want to know exactly how much you might be losing in monthly expenses while you await the appreciation.

Risk Factors

Many people are unaware of this fact. If you don’t consider other factors, your projected cash flow and appreciation may not be realized once you own the home.

What do you mean?

You can make your calculations as accurate as you possibly can when you’re looking for a rental property. This is done by considering all expenses, using real numbers instead of estimates, and being conservative in any estimations you use (which are minimal but do exist). Don’t purchase a rental property that only provides $50 in cash flow per month.

Then, in spite of all your efforts, an unknown and unexpected event flies, hits you on the head, and wipes out your entire profit. Ah! You must not have thought of those things! You may have thought about it to some extent. We all know it can be expensive if your tenant damages your property.

What are the other factors that you need to consider with regards to rental property? What I mean is the factors that can throw your entire income estimate into the trash and make you go in the red.

These are all things that, as a landlord, can cost you money. It is important that you lose money, because the point of investing is not to lose money.

Here’s a list of important things to consider when you are looking for a rental home! Let’s call them “potential warning signs.” I will go over each one. But realize that many of them are related to one another.

Seven Property Factors You Should Examine to Check for Red Flags

Property Condition

This is a risky area, as you could underestimate the cost of repairs or renovations. Unexpectedly, a large expense can put you into a hole. You should make sure that a professional property inspector inspects the house. Even then, there may be items overlooked. Always make sure to check the condition of any property that you’re considering!

Numbers

You need to be able calculate the numbers that will ensure you make a profit on your property. But you also have to consider the numbers in relation to risk factors, such as whether the projected rental is realistic and stays realistic. You can’t know these numbers with certainty, but you can do your due diligence and confirm that the numbers are realistic. You can even try out some worst-case scenarios.

Exit Strategy

Exit strategy is the long-term goal for a particular property. It could be things like renting it out or selling it. Will you be able to sell the property at a reasonable price in the future? Will you be able rent out the property forever and ever if that is what you wish to do? Your bottom line could be severely affected if you answer “no” in either case.

Overall Return: A Comparison of Cash on Cash vs. Overall Return

Tenant Quality

I am adamant that bad tenants are the most expensive thing for a landlord. You could face a number of issues with a bad renter, including non-payment, eviction, damage, or even theft appliances and cut lines. I have dealt with bad tenants and they ate me to death.

Always consider the area you’re buying in and the type of tenants that you can expect to find there. Consider the risk factors of the pool that you’re dealing with. Cash flow projections cannot compete with bad tenants.

Vacancies

You may have bad tenants or a saturated rental market, where you can’t find a tenant for some time. Vacancies are less of a problem if your property was purchased in cash. However, if the mortgage is outstanding and you have to pay for other expenses, the cost can quickly add up. Rental property owners must minimize vacancies.

Market Condition/Fundamentals

In a market with a decreasing population, little industrial activity, or a decline in the number of jobs, you may find that the value of the rental property drops dramatically. You may also see a reduction in the quality of tenants, a higher vacancy rate, and a reduced range of exit strategies. All of this is very expensive.

Property Location

The location of the rental property, down to the street or neighborhood, can have a direct impact on the quality of tenants, the vacancy rate, and exit strategy. You already know that all of these factors can have a direct impact on your bottom line.

When looking at rental properties, always consider these factors. It is not necessary to have all the data to determine how each item will turn out. However, having an understanding of what each one means to you at least, can be very important.

To conclude this discussion, if you purchase a property with a lot risk attached to it is not necessarily a deal breaker. Many successful investors specialize in “high risk” properties. These include properties with high-risk tenants, properties in poor condition and in sketchy neighborhoods. If you’re tempted to take this route, you should know that it takes a lot to make these properties successful.

You need to be more educated on how to manage these types of properties. If you’re more risk-averse, and don’t want to wear a football helmet or a revolver when you visit your property, you can minimize the risks listed above. If you want to attract better tenants, buy in areas with nicer properties. They should also be in good shape and a growing market. This will help you to achieve your original profit expectations over the long term.

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