Rental Property Investment Analysis

A rental property investment analysis can help you identify the right property to purchase in order to maximize your investment return. Be sure you understand all the calculations; if you don't, your investment could quickly become a financial loss.

Rental property can be a good investment.

Purchasing property as rental property can be a smart investment strategy if you do your homework. You need to be able to earn enough from the property to offset the expenses of owning the property. There are also potential tax advantages to being a landlord.

Rental property can also potentially become a bad investment. The inability to keep tenants, rising repair and maintenance costs as well as falling land values can also turn a good investment idea into a bad investment reality.

Running the numbers before you purchase the property is the key to having an excellent investment return on your rental property. You need to know more than the difference between the rental income and the property expenses. You also need to be able to evaluate the impact of future expenses you know you'll have (like carpet replacement) as well as those that will come as a surprise (such as a heater breaking down).

Ideally you should complete a rental property investment analysis before you purchase the property. The completed analysis will help you determine whether you should purchase the property, and if so, the maximum purchase price that you should consider paying. The analysis will also tell you what you what you can afford to pay in financing costs and what you'll need to charge for rent in order to cover all your expenses.

Remember that rental property is an investment. This means that for a rental property to be a good investment, your total return has to be more than you would earn if you didn't purchase the property and instead invested the money in another investment such as stocks, bonds or mutual funds.

Your analysis should include:

• An income forecast – What can you realistically expect to receive in rental income on the property? Don't assume that you will have paying tenants every month. Factor in timeframes between tenants when the property is not rented as well as the potential that a tenant may pay late or only a portion of the rent.
• An expense forecast – There are monthly expenses that you can expect such as a mortgage payment, escrow payments for taxes and insurance or maintenance. Be sure that your forecast also includes expenses for:
  • Tenant acquisition such as newspaper advertising
  • Maintenance expenses such as carpet replacement, plumbing repairs, heating and air-conditioning servicing
  • Outside maintenance such as painting and tree trimming
• Rate of investment return - After deducting the expenses from the income, the resulting profit should be compared against the rate of return that you would receive on other investment options such as stocks and bonds.

A spreadsheet software program such as Excel can be used for your analysis. Just be sure to build your spreadsheets to fit your specific situation. The more your various spreadsheets connect together, the less data input you need since an entry on one spreadsheet automatically gets entered into the appropriate place on another spreadsheet.

There are software programs available that have already developed the key spreadsheets that are necessary for a rental property investment analysis. Look for a program that will calculate a wide range of rental property factors such as:

• Potential gross income
• Vacancy loss
• Operating expenses
• Capital improvement
• Pre-tax and post-tax cash flow
• Rental advertising
• Pre-tax and post-tax profit
• Pre-tax and post-tax rate of return
• Break even occupancy rate and rental rates
• Annual depreciation

There are many factors to analyze and the full screens of numbers can become confusing. The more you can turn the spreadsheets into graphics, the easier it may be for you to understand the analysis.

Sources for rental property analysis software include:

• Real Val – A free software program with basic analysis
• Landlord's Cash Flow Analyzer – A low cost, and easy-to-use program
• RealEstateCritic – A free software available after registration

Whether you choose to run the numbers on your homemade spreadsheets or on a software program, the important thing is to analyze all aspects of the rental property. A good rule of thumb is to under-forecast your rental income and over-forecast your rental expenses. This will give you the chance to review the numbers in a "worst case" scenario. If the resulting analysis shows that you can make more on your rental property investment that you can make in other investment tools, then you should consider purchasing the rental property.

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