Analyzing your cash flow on your rental property is super important! It’s even more important that you analyze the cash flow on a rental property long before you even purchase the property! If you end up doing the analysis after the purchase, it’s kinda too late and there’s no refund policy in most real estate purchases! It’s yours!
So, before you even get into the deal or even consider buying a rental, here’s an ideal method on how you can quickly analyze the cash flow to see if it’s a good rental or a bad one. Keep in mind, this method may vary or slightly change depending on the size of the property, age, location and more. There are also a variation of this method for multi-family properties. I’m going to give you an explanation of both.
First, you start with the gross rent. You can figure out what the ideal rent is for the area by visiting rentometer.com. This website will give you the ideal rent range for the given area with a given bedroom count. The more accurate method is to getting a rental comp from your local real estate agent. They’ll be able to give you all the properties that were recently rented that are just like your subject property.
Next, here’s the formula for calculating your expenses. First, subtract 10% of your gross rent for maintenance reserve. This will also depend on how old the property is and what kind of maintenance is required. If the property is older and bigger, you may want to factor in 13-14% for your maintenance reserve. If the property is newer than the average property, then you may only need to factor 8-9% maintenance and gradually increase the reserves as the property ages.
Then, subtract another 10% of your gross rent for management expense. Whether you’re managing the property yourself or having a management company manage, you will need to set aside 10% for management expense. You’re always going to pay one way or another using money or time. My suggestion is to save the time by paying someone else to manage the property and skip the stress.
Next, subtract at least 8% on vacancy expenses. This is to set aside money incase your property goes vacant for a month. You need to be able to handle a whole month of expenses in case of a vacancy.
From there, you must subtract your local real estate taxes and insurance payment. This should be expressed in a monthly format. So, if your property taxes are $3000 a year, the monthly property taxes are $250/mo. Most single family insurance cost fall under $60-$100 a month. It depends on how big, how old, and how the property is valued.
The final figure you will get is the net operating income or the NOI. This is the figure after the expenses. Depending on where you are in your market, you will be at 50-70% expenses out of the gross rent. If you’re using financing, you will also need to factor in your debt service (loan payment). If the loan payment at 20 year amortization doesn’t fit inside the NOI, then you have a deal that may not work. I recommend amortizing your financing at most 20 years. You want to be able to build enough equity quickly so that you can insulate yourself in case of a market crash. You do not want to be caught in a crash with little to no equity because your property can foreclosed on if the bank decides to call the note due.
For multi-family properties, the figures may vary. For example, you may have to factor in less vacancy reserves since you have lot more units that are rented to handle the expenses. Your property taxes and insurance are going to be lot higher than a single family property. There are other expenses related to multi-famiy properties such as public area utilities, snow removal, lawncare, parking lot maintenance, laundry room maintenance, etc.
Having a sound and accurate analysis will help you in case of a disaster hits. Many new investors buy a rental property without setting aside appropriate expenses and when a disaster hits, they will be in a big trouble. Some investors take out a new loan just to make repairs or keep the maintenance. This is a recipe for disaster! So make sure you do your figures correctly!