If you have ever thought of buying real estate as an investment, then you’ve probably been curious about how to analyze the financial details of an investment property. Beginners in the real estate investing business always ask: How do real estate investors recognize if a certain property for sale would make a good deal or is a rip-off? The following is our guide on how to do real estate investment analysis on any residential rental property you might consider buying.

What Is Real Estate Investment Analysis?

A real estate investment analysis is basically the process of analyzing investment opportunities to decide whether or not they’ll give you the profits you’re aiming for to achieve your investment goals. For the real estate investor, this is perhaps the most crucial part to success. There are generally 4 steps to analyzing rental properties, which are:

Determining the market value of the rental propertyCalculating the operating costsFinding the market rentsCalculating your return on investment

Seems simple right? Well, maybe not. Keep reading our guide for beginner investors where we walk you through each step.

Part 1: Property Valuation  

Sellers of investment properties will always try to sell for maximum profits. Meanwhile, a real estate investor hopes to buy the property at a fair market price. It can be hard to calculate what a real estate property should sell for because values can vary significantly between two similar properties. So, the first step in real estate investment analysis is to find the real value of the property to avoid overpaying.

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To find the value of residential real estate properties, you need to find comparable properties (comps). Comparable properties are simply other properties in the area that have similar characteristics and were sold recently. By looking at what rental properties have sold for, real estate investors can get a hint to the value of another property. This is known as comparative market analysis.

For example, a single-family home in your neighborhood will rise in value if similar single-family homes are rising in value, and vice-versa. This allows you to determine how well or how bad your choice of investment property is in comparison to the overall performance of other investment properties in the area and the overall performance of the housing market.

Looking for rental comps in your area to begin your real estate investment analysis? Find them in a matter of minutes using Mashvisor’s Investment Property Calculator.

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Before moving on to the next part, it’s important to mention that larger investment properties (like multi-family homes) are valued differently. You can’t just compare an apartment building to others to see how much it is worth. Instead, the value of these real estate rental properties is related to their income potential (how much rental income they generate).

Related: Multi-Family Real Estate Investment Analysis: The ONLY Guide You Will Need

Part 2: Calculating Costs and Expenses

Every real estate investment property comes with different costs and expenses which impact the returns and profits that you can expect to gain. So, the next step of the real estate investment analysis is to gather enough information about the property before making the purchase to calculate your operating expenses. These include, but are not limited to:

Property taxesInsuranceUtilitiesTurnover costsMaintenance expensesProperty management feesMarketing/rental feesPrincipal/interest payments

The seller will provide you with pro-forma data (estimated data about the property’s value). However, remember that a seller wants you to buy the rental property, so he/she will likely give you high estimates of the rental income or neglect to mention operating expenses that you’ll face down the line. Therefore, you can’t always guarantee accurate pro-forma data.

So, the real estate investor should ask the seller/previous owner for actual data on the rental income and operating expenses. For example, ask to see previous years of tax returns, property tax bills, maintenance records, etc. Once you have the pro-forma data and the actual data, you’ll be in a better position to decide whether this property makes for a good investment. This step of real estate investment analysis is part of your due diligence before buying an investment property because it assures you won’t run into surprises after closing the deal.

Related: 14 Things to Consider Before Buying Investment Properties in 2019

Part 3: Finding Market Rents

The rent that you’ll charge tenants after acquiring the property is an important consideration. You want your rental income to cover your operating expenses, make reasonable profits, and be competitive within the local market at the same time. To estimate the rent you can receive from investment properties, you need to determine the overall market rent.

You can determine the market rents by simply asking other real estate investors/landlords in the area where you’re investing. Local real estate agents and property managers can also give you an idea of what rents are. In addition, finding and analyzing rental comps will also allow you to see what similar residential rental properties are renting for.

To make this step of the real estate investment analysis easier, use Mashvisor’s Heatmap. With this tool, you can see the average monthly rental income (traditional and Airbnb) that you’ll receive from investing in that location. What’s more, the Heatmap uses color codes to help real estate investors determine how well the housing market is performing compared to surrounding areas.

Click here to start searching for and analyzing investment properties in the best-performing markets in the US!

Part 4: Calculating the Return on Investment

This is the part where all the data you’ve gathered will come together to give a final estimation of whether or not buying the rental property makes financial sense. There are different types of ROI you can calculate for real estate investment analysis. The most important ones are:

Cash Flow: This is the amount of money left after all rental expenses, principal payments, and interest have been paid. As a real estate investor, it’s important to estimate your future cash flow as you want to ensure you’re buying positive cash flowing rental property to make money in real estate.Cap Rate: This is the ratio of the net operating income (NOI) over the property’s value. Knowing the cap rate is great for quickly comparing multiple properties in a given area, determining market trends, and identifying the level of risks associated with the investment property.Cash on Cash Return: This is the cash you get back compared to the cash you invested in the property. It takes into account your down payment, closing costs, repair costs, etc. So, knowing the cash on cash return is extremely important because it lets you know whether you’ll have the money to pay your bills.

As you can see, each metric for calculating the return on investment tells you something about your choice of rental property. So, it’s important to account for all of them in your real estate investment analysis and not make a decision depending on just one.

Related: Real Estate Questions: What Is a Good Return on Investment?

The Bottom Line

It’s obvious that with real estate investment analysis, you’ll have all the information you need to make the right decisions with confidence. Without it, on the other hand, a real estate investor may face severe losses.

If you’re overwhelmed by all these calculations, use Mashvisor’s Investment Property Calculator to get your hands on readily calculated data and analytics for investment properties in any city/neighborhood in the US housing market. To start your 14-day free trial with Mashvisor and subscribe to our services with a 20% discount after, click here.

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