We are going to walk through analyzing an investment property. I found a sample buy and rent home on Zillow that we will use. This is a property that looks reasonably ready to rent after cleaning, meaning the purchase price will be pretty close to the base price for our return calculations. This aligns well with what I’m looking for in my first investment property. The numbers in this post are real, but you should use your own sample property to get a feel for it.
You should also first check out my primer on real estate investment analysis if you haven’t seen it already.
The Sample Property
I’m going to use a sample investment property in Indiana. Why Indiana? Well, it’s at or near the top of the list for most landlord friendly states, and you would be hard pressed to find such a list without Indiana on it. Cash returns also seem to be somewhat decent there at the moment.
Our particular property of interest I estimate will sell around $230,000. There was no science to me picking this one, the price range just looked good and the property looks like it won’t need too much love to get ready. For the purposes of this post, I’m not going to look too deep into expected rent and comps, as that is a subject for another time. I’m just going to use Zillow’s rent estimate tool and take it at its word that we could get around $1,800 a month in rent.
Estimating Income
We have an estimate for rent, but we can’t assume it will be rented out 100% of the time. In this case, I’m going to assume a pretty good rental market. Half a month vacancy per year seems reasonable, so we’ll reduce our rent by 0.5/12 to come up with $1,725
Estimating Other Start Up Costs
This is a category that I like to include in the denominator for cap rate and cash on cash return calculations. The things we will put here I consider to be part of the cost of the house. Closing costs are a great example, since the IRS also considers many closing costs to be a part of your investment basis. Stessa actually has a nice quick primer on this topic if you’re interested. In general, for my calculations I don’t care how the IRS treats these items. I think about all one-time at the outset expenses as part of my start up investment costs.
I will include:
- Inspection – estimated $400
- Appraisal – estimated $500
- Repair – estimated at $1,000
- Furniture/Appliances – maybe we need a new fridge? Estimated at $1,000
- Closing Cost – $3,500
A quick note on some of the items above, you probably won’t need an appraisal if you don’t get a loan. The other items are quick plugins. I like to be conservative and still include a couple of thousand for miscellaneous items even if everything looks good and add a bit more if the property looks like it might need some TLC. You can tweak these line items after you go see the property.
As for closing costs, there are many items that will be included at closing that should not appear here. For example your lender may have you prepay taxes or insurance in an escrow account. Property taxes and insurance I consider to be monthly ongoing expenses that we will offset against income even if you have to pay them all up front.
Estimating Mortgage Rates
It is pretty easy these days to get a quick quote. Head over to Bankrate.com to get a quick estimate using the purchase price above. I left the credit rating untouched (which will assume you have good credit) and in order to compare apples to apples, I only looked at loans with no points or other fees. Make sure you adjust the type of property to investment property! Mortgage rates will be higher for an investment property than your primary or vacation (secondary) house.
For a $230,000 investment on a 30 year loan I came up with the following rates:
25% down: 3.5% – monthly payment is $775
20% down: 4.375% – monthly payment is $919
We’re going to use the 25% down number for our analysis, which is a $57,500 down payment and a monthly payment of $775 (annual is $9,300).
Estimating Your Investment’s Property Taxes
There are several “monthly” expenses we need to estimate, but property tax tends to be a big one. It isn’t actually paid monthly, but I like to think about it as monthly and set money aside for when it is due. Estimating it can also be pretty tricky!
There is a quick way to estimate property taxes, but it’s definitely not highly accurate. The quick way is that Zillow has a property tax history listed. You can simply take the most recent year’s property taxes and divide it by the tax value assessment. Maybe run it for the prior year too just to make sure there are no major discrepancies. I came up with about 0.7% on our sample property.
Beware the Quick Property Tax Estimate!
Beware using the above quick estimate for your property taxes! Many states will provide a tax break if you are living in the home (called a homestead exemption or deduction) or if you are over a certain age. This is less of a concern if you know the property is currently rented (since the owner wouldn’t be getting a homestead exemption). It’s not always entirely clear, but the best way I have found to check is to google the particular city name and then “tax assessor.” You will typically find a county tax assessor where you can look up the property’s most recent tax history with any listed exemptions.
Sometimes, once you’ve found the property, you may have to do some math or searching for tax rates. In this case, they did the math for us so we can work backwards to find the tax rate without exemptions or see the actual tax rate (not modified by exemptions). The tax rate is actually 1.7% for this property. That’s a huge difference from our Zillow estimate!
A tax rate of 1.7% on our estimated purchase price works out to $326 a month.
Estimating Other Monthly Expenses
Here I will list a few other expenses and how I came up with them.
- Insurance – $1,000/yr – Zillow has a section for property listings called Monthly Cost. It seems reasonable, though you can/should ask your agent if they think it’s reasonable. Consider adding $50 – $100 to the Zillow estimate if you’re getting landlord insurance.
- Utilities – $0 – typically the tenant will pay in a single family home, but worth thinking about
- Property Management – $180/month – I don’t live in Indiana and so would fully outsource management. 10% of monthly rent is common and generally would include tenant acquisition.
- HOA dues – $15/month – Zillow has an estimate for this
- Maintenance – $192/month – this one is tougher. You won’t actually be paying it monthly, but it’s a very rough estimate of the little things and the big things. Someday you will need a new A/C or roof, and in between there will be plenty of calls to the plumber. I estimated 1% of the purchase price per year and converted to monthly.
Calculating Our Metrics
Here we will put our estimates from above into practice to calculate a Cap Rate and CoC Return.
Purchase Price: $230,000
Start Up Costs: $6,400
Total Investment Costs: Purchase Price plus Start Up Costs = $236,400
Monthly Income: $1,725
Monthly Expenses: $796
Monthly Net Income: Income minus expenses = $929
Annual Net Income: $11,148
Cap Rate: $11,148 / $236,400 = 4.7%
Annual Net Income: $11,148
Annual Mortgage Expense: $9,300
Cash Down: $57,500
Cash Start Up Costs: $6,400
Cash on Cash: ($11,148 – $9,300) / ($57,500 + $6,400) = 2.9%
Analyzing the Results
Well, the results aren’t all that spectacular for this particular property. I think these results, given that it is a market that I don’t know well and didn’t spend too much time determining the potential rent (a very large ingredient in these metrics!) are more useful as we compare other similar properties.
If we invested, would the actual Cap Rate and CoC Return look exactly the way we calculated them? Probably not. We would continue to adjust our estimates and more would become clear as we got to know the neighborhood, the market, and proceeded down the path of making an investment. For example, we probably won’t get an insurance quote until we were under contract.
These results are meant to give you an idea of how good an investment this property might be from a cash flow standpoint. We did not consider potential appreciation here given our goal for cash flow. This process can be very helpful once you have identified where you want to invest as you can compare similar properties to each other. It can also help you determine what to offer for a home and your price limits as you begin the process of negotiation.
There are many ways to analyze an investment property, but you will certainly be making estimates. I hope this walk through helps you analyze your own investment properties!
