How to Analyze a Real Estate Investment
Adding real estate to your investment portfolio gives you the opportunity to earn consistent returns regardless of the type of property you invest in. However, not every piece of real estate pans out. If you choose the wrong location or purchase a property that’s in worse condition than expected, you may end up losing money. It’s possible to ease these concerns and increase the likelihood of a successful deal by analyzing real estate deals before you make them. Here’s what it takes to properly analyze real estate deals.
Five Steps Needed to Analyze a Real Estate Investment
While there are many methods you can use to analyze a real estate investment, the following details five steps that every investor should adhere to.
Check Out the Property Location
The first thing to focus on when buying real estate is location. To understand just how important location is when investing in real estate, you should know that a property’s location determines:
- Type of Tenants the property will attract
- Property prices
- Appreciation of property value in years to come
- The rents you’re able to charge
Before you buy an investment property, make sure that it’s in a great location, which can be done by looking at several market factors. These factors include:
- Economic growth
- Population growth
- Job market growth
- Crime and safety rates
- School ratings
Once you’ve gathered all of this information, you can start analyzing the broader real estate market to determine if the location is ideal for real estate investment. The right location will allow you to obtain higher rents and benefit from low vacancy rates.
Obtain Essential Information
Before you make an investment in any type of property, you should obtain a considerable amount of information about the property you’re buying, which allows you to make a more informed analysis of your investment.
The property data you should look for extends to:
- Listing price
- Property characteristics
- HOA fees
- Rental rate
- Down payment
- Vacancy rate
- Capital expenditures
- Mortgage term
- Interest rate
Calculate Future Cash Flow
Once you have analyzed the location and have gathered the necessary data, you should start calculating your future cash flow, which is possible with the information you have. By renting out your investment property, you should be able to garner a decent cash flow as long as you properly manage expenses. A higher cash flow equates to a better ROI on your investment.
To perform a cash flow calculation, calculate your rental income from the rents that you collect. Make sure that you subtract any rental expenses. If you’ve bought a rental home that only accommodates one tenant, this calculation should be simple and straightforward. The expenses you subtract can include everything from mortgage payments and property taxes to repairs and management fees. Take the vacancy rate into account as well.
Calculate Potential Returns
Along with cash flow, you should also calculate your potential returns, which is your net operating income. Keep in mind that net operating income is reached after subtracting your expenses from your gross income. While this calculation might seem similar to the aforementioned cash flow calculation, the main difference is that net operating income doesn’t take income taxes or property financing expenses into account.
Using this calculation alongside the cash flow calculation allows you to determine how much money you have to make mortgage payments.
Perform a Comparative Market Analysis
It’s highly recommended that you perform a comparative market analysis before going forward with a real estate investment. This analysis allows you to determine if an investment is sound. A comparative market analysis involves comparing the investment property you’re interested into homes that have similar features.
The features you should compare include condition, location, age, and square footage. If a comparable property in your area was recently bought for $50,000 less than the property you’re about to invest in, this purchase might not be worth it. You can also use this analysis to find affordable real estate as well as properties that are being sold below market value.
Analyzing a real estate investment can be done in five simple steps, which involve assessing the property location, obtaining important property information, calculating cash flow, calculating net operating income, and performing a comparative market analysis. Once you perform these steps, you should be ready to determine if a real estate investment is worth the money. More detailed underwriting and analysis should be looked at with your broker or lender.