How to Analyze Rental Properties - Concepts & Rules of Thumb

Find out what you should be considering when evaluating if a rental property will be a good deal for you or not. Example analysis included at the end!

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Time Stamps:
2:02 - Important questions to ask yourself at the beginning
2:45 - Cash Flow vs. Appreciation ("organic" and "forced")
5:33 - Ease of Management vs. Price
6:17 - 2% and 1% Rules
9:33 - Dollar Per Unit Rule
10:42 - 50% Rule
12:08 - Detailed Analysis of Income and Expenses
14:51 - List of possible landlord-paid expenses
17:08 - Vacancy Expense
18:48 - Repairs and Maintenance Expense
19:53 - Capital Expenditures (CapEx)
22:29 - Property Management Expense
24:24 - Analysis of an Actual Property Listing

Cash flow is the income that a rental property generates on an ongoing basis after subtracting ALL expenses. This can be tracked on a monthly or an annual basis.

Appreciation is the increase in a property’s value over time. There are two types of appreciation: organic and forced. Organic appreciation occurs naturally over time. Forced appreciation occurs through specific efforts undertaken by the investor to improve the property and raise its value.

Cash flow and appreciation often appear to have an inverse relationship. The more cash flow potential the property has, the less likely it will be to appreciate over time. This usually goes hand in hand with quality, location, and ease of management of the property.

The 2% “Rule” is a guideline that can help you decide whether a property might be a good cash-flow property. The 2% “Rule” says that you should only buy a property whose monthly gross rental income equals at least 2% of the purchase price. The 1% “Rule” is a variation of the 2% Rule. The 1% “Rule” says that you should only buy a property whose monthly gross rental income equals at least 1% of the purchase price. Both rules should be used to give you a quick assessment of whether or not you should look at a property more closely.

Dollars per unit rule is a rule that adheres to a specific dollar per unit number for deciding whether a building is worth considering. For example, an investor may not want to spend more than $50,000 per unit. The dollar per unit rule is based on what is typical for the area in which the property is located and the investor's own experience.

The "50% rule" says that a property’s expenses, not counting the mortgage expense, will on average equal 50% of the property’s gross rent. So, when looking at a potential property listing, if after you deduct 50% from the property's gross income, the remaining income is insufficient to cover the mortgage costs or is just barely enough, this may be a reason to pass on the property. Again, this is a general rule for deciding whether to look into a property further and should not replace a full analysis of its income and expenses.

Capital expenditures are expenditures for replacement of mechanicals and building components (i.e. roofs, furnaces, hot water tanks, appliances, flooring, doors, windows, etc.) when those components have reached the ends of their useful lives. Most investors think that because they accounted for repairs, that they covered themselves for these expenses. Most of the time, they have grossly underestimated the cost of replacing these items.

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