# Rental Property Investment Analysis

Prior to purchasing a rental property, potential landlords should consider the income, tax benefits, and depreciation deductions the property will generate. These three considerations can be used to determine whether the investment is beneficial.

## Analyzing Rental Property

There is one main calculation to conduct when considering purchasing a rental property: an income cash flow calculation. This calculation, however, includes two other calculations: tax deduction calculation and depreciation deduction.

### Tax Deduction Calculation

This calculation determines the amount of mortgage interest you can deduct on your taxes. To calculate this amount:

1. Determine the interest rate of your loan and how much, if any, that rate will increase in the future.
2. Most interest rates are yearly, so divide that interest rate by 12, to obtain the monthly interest rate.
3. Determine how much interest and principle you will pay on a monthly basis by multiplying the monthly interest by your loan amount to determine how much interest you are paying each month.
4. Subtract that amount from the monthly mortgage payment to determine how much principle you are paying each month.
5. Subtract the amount of principle you are paying from the total loan amount to determine your loan balance.
6. Repeat steps 3-5 to identify how much interest you pay each month for one year. If you have an adjustable rate mortgage, you will need to repeat steps 3-6 for each year the interest rate increases.
7. Add together all monthly interest payments to determine the total amount of interest you pay in a year.

The result in step 7 is the amount of interest you can deduct on your taxes for the next year. Remember, because the balance on the loan decreases each month and year, you will need to calculate this amount for every year individually.

### Depreciation Deduction

This calculation identifies how much "annual allowable depreciation deduction" you can subtract on your yearly tax return. This calculation mainly applies to commercial properties. The formula is:

Purchase price - land value = building value/annual allowable depreciation deduction = depreciation deduction

Check your homeowner's insurance paperwork to determine land value; most homeowner insurance policies contain this information in their coverage limits explanation.

The annual allowable depreciation deduction is available via the Internal Revenue Service (IRS) website. Land is not depreciable, but the building is. Depreciating property requires use of the Modified Accelerated Cost Recovery System (MACRS). The specific depreciable amount depends on the type, age, and use of property; consult the MACRS document to determine the amount you can depreciate from the property each year.

### Income Cash Flow Calculation

This calculation identifies how much income you will see from the property. It requires deducting potential rental income from the cost of the mortgage, any tax savings the property will provide, and any other deductions you can claim from the expenses incurred from running the property. The term "cash flow" refers to the amount of money that will land in your pocket after paying the home's operating expenses. Specifically:

• Mortgage costs + taxes + insurance + homeowner association dues + any other expenses to running the property (e.g., landscaping) = Total cost to operate the home
• Total cost to operate the home - tax deduction calculation - depreciation deduction calculation = Adjusted operating expenses
• Adjusted operating expenses - monthly rent = Income cash flow

Alternatively, you can calculate this cost by:

Rental income + tax savings + depreciation deduction - operating expenses - mortgage payments = Income cash flow

## Investment Analysis Tools

Several software programs are designed to assist potential landlords in conducting a rental property investment analysis. Reviews are available for some of these products. Offered products include:

• Landlord's Cash Flow Analyzer: This product is designed for real estate investors. It determines cash flow and investment return, and allows users to create graphs showing predicted income and investment return. The program costs \$99.95. Customer reviews of this product identify it as giving a thorough analysis and as being easy to use.
• ProAPOD: This program allows users to conduct property cash flow predictions, rate of return analyses, and profitability analysis. Its calculations include tax considerations. The program is available at several different levels of complexity, and range in cost from approximately \$149 to \$279. However, the company also offers an online calculator costing about \$50.00. Customer reviews of this product identify it as being easy to use, professional, and easy to understand.
• iAnalyzeREI: This program is offered online and is designed for individuals considering purchasing a rental property. The program includes a profitability financial forecast that assists users in predicting future income potential. A full subscription costs about \$35 per month or \$299 per year.
• Property Metrics: This program is designed for commercial real estate investments. It is available online and creates a detailed cash flow analysis and discounted cash flow valuation. A free trial is available, but subsequently a one-month subscription costs \$29, one-quarter subscription \$78, and one-year subscription \$295.

### Free Online Analysis

There are also several rental property investment analysis tools available online for free, including:

• The American Association of Retired Persons (AARP) offers an investment calculator on its website. According to the site, this calculator is designed to predict potential returns on investment properties. The calculator considers the amount of cash invested, land value, depreciation rates, interest rate, gross operating income, and more.
• The School and Housing website also offers an online rental property investment tool. This calculator considers the purchase price, down payment amount, closing costs, mortgage rate and loan term, and rental income and costs.

Another online investment calculator is available through the Rental Property Reporter. This tool includes purchase assumptions, such as home value and initial investment, income assumptions, such as monthly rent, operating costs, and taxes and inflation.

## Choosing an Analysis Tool

Not all real estate investment analysis programs are the same. When choosing a software program to use to conduct your analysis, consider the program's usability and customer support. An easy-to-use product with customer support can help you avoid or overcome questions.

Also consider the information the program provides. A more comprehensive program will provide rates of return, measures, ratios, and mortgage amortization. Even more advanced programs may analyze market reports and calculate tax shelter potential.

## Using Calculation Results

You've performed the complicated analysis using the calculations provided above or software programs. Now, it's time to use these analyses as a decision-making tool. When reviewing these calculations, consider:

• The income you will obtain both in the short- and long-term: is the income worth it? Will you bring in as much money as you expected or wanted?
• The tax benefits: even though the property may not generate as much income as you would like, consider whether the tax and depreciation benefits from owning a property will offset your other income. You may find that these two benefits increase the income you earn from other sources.

## Investing in Rental Property

Investing in a rental property requires conducting an extensive analysis into the true profitability of the property. Whether performing the calculations by yourself or using an online tool, make sure that any property you are considering purchasing will provide you with the income you anticipate.