Rental Property Analysis: Evaluating Investment Properties

The difference between a great investment and a money pit often comes down to the numbers. Before you buy any rental property, you need to analyze it thoroughly. This lesson teaches you exactly how to run the numbers like a pro.

The Goal: Positive Cash Flow

Cash Flow Formula: Rental Income - All Expenses - mortgage Payment = Cash Flow

Example:

• Monthly rent: $1,800
• Operating expenses: $600
• Mortgage payment: $1,000
• Cash Flow: $200/month

Step 1: Estimate Rental Income

Research Market Rents

Before buying, know what the property will actually rent for:

Tools:

• Zillow Rent Zestimate
• Rentometer.com
• Craigslist/Facebook Marketplace listings
• Property management companies (call and ask)
• Talk to local landlords

Tips:

• Look at comparable properties (similar size, age, location)
• Consider condition—updated units command more
• Be conservative—use the lower end of the range

Account for Vacancy

No property stays 100% occupied:

Effective gross income: Gross Rent × (1 - Vacancy Rate)

Example: $1,800 × 0.95 = $1,710 effective monthly income

Step 2: Calculate Operating Expenses

Major Expense Categories

1. Property Taxes

• Check county assessor website
• Use current taxes or estimate post-purchase assessment
• Typically 1-2% of property value annually

2. Insurance

• Get quotes before buying
• Landlord policy (different from homeowner)
• Typically $800-2,000/year for single-family

3. Maintenance and Repairs

• Budget 8-12% of rent
• Older properties = higher maintenance
• This WILL happen—don't skip it

4. Capital Expenditures (CapEx)

• Major items: roof, HVAC, appliances, flooring
• Budget 5-10% of rent
• Builds reserve for big expenses

5. Property Management (If Using)

• Typically 8-10% of rent
• Plus placement fee (50-100% of first month's rent)
• Include even if self-managing (value of your time)

6. Utilities (If Landlord Paid)

• Water/sewer often paid by landlord
• Get actual bills from seller
• Tenants typically pay electric/gas

7. HOA Fees (If Applicable)

• Monthly dues
• Check for special assessments
• Review HOA financials

8. Lawn Care/Snow Removal

• If not included in HOA
• Get quotes

The Operating Expense Breakdown

Step 3: Calculate Net Operating Income (NOI)

NOI = Effective Gross Income - Operating Expenses

Example:

• Effective Gross Income: $1,710/month
• Operating Expenses: $810/month
• NOI: $900/month ($10,800/year)

NOI is your income BEFORE mortgage payments. It's used to calculate key metrics.

Step 4: Factor in Financing

Mortgage Payment Calculation

Use a mortgage calculator or formula:

Example Mortgage:

• Purchase Price: $180,000
• down payment: 20% ($36,000)
• Loan Amount: $144,000
• interest rate: 7%
• Term: 30 years
• Monthly Payment: ~$958 (principal + interest)

Cash Flow After Financing

Monthly Cash Flow = NOI - Mortgage Payment

Example:

• NOI: $900/month
• Mortgage: $958/month
• Cash Flow: -$58/month (Negative!)

Step 5: Calculate Return Metrics

Cash-on-Cash Return

Your return on the actual cash you invested:

Formula: Annual Cash Flow ÷ Total Cash Invested

Total Cash Invested Includes:

• Down payment
• closing costs (2-5% of purchase)
• Immediate repairs/updates
• Initial reserves

Example:

• Down payment: $36,000
• Closing costs: $5,000
• Repairs needed: $4,000
• Total invested: $45,000

If annual cash flow is $2,400: Cash-on-Cash Return = $2,400 ÷ $45,000 = 5.3%

What's a Good Cash-on-Cash Return?

Cap Rate

Return as if you paid all cash:

Formula: NOI ÷ Property Value

Example:

• NOI: $10,800/year
• Property Value: $180,000
• Cap Rate: 6%

Cap Rate Uses:

• Compare properties regardless of financing
• Quickly screen deals
• Understand market pricing

Typical Cap Rates by Market:

Total Return (Including Appreciation)

Real estate returns include more than cash flow:

Total Return Components:

1. Cash Flow
2. Principal Paydown (tenants pay your mortgage)
3. Appreciation (property value increases)
4. Tax Benefits (depreciation reduces taxes)

Example Annual Return:

On $45,000 invested = 27% total return

This is why real estate builds wealth—even modest cash flow properties can generate strong total returns.

Running a Full Analysis: Example

Property Details:

• List Price: $200,000
• Monthly Rent: $1,850
• Property Taxes: $3,000/year
• Insurance: $1,200/year
• No HOA

Step-by-Step Analysis:

Income:

Expenses:

NOI: $1,757 - $868 = $889/month ($10,674/year)

Cap Rate: $10,674 ÷ $200,000 = 5.3%

Financing (20% down, 7% rate, 30 years):

• Loan: $160,000
• Payment: $1,064/month

Cash Flow: $889 - $1,064 = -$175/month (Negative!)

The Verdict:

At $200,000, this property doesn't work. Options:

1. Offer $165,000 (if seller motivated)
2. Find cheaper financing
3. Walk away

At $165,000:

• Loan: $132,000
• Payment: $878/month
• Cash Flow: $889 - $878 = +$11/month

Still thin, but positive. Add appreciation and principal paydown, and it could work.

Red Flags to Watch For

Due Diligence Checklist

Before closing, verify:

Property:

• Professional inspection
• Roof age and condition
• HVAC age and condition
• Plumbing and electrical
• Foundation
• Pest inspection

Financials:

• Actual rent rolls (if tenants in place)
• Actual utility bills
• Property tax verification
• Insurance quotes
• HOA documents (if applicable)

Market:

• Comparable sales
• Comparable rents
• Neighborhood trends
• Employment data
• School ratings

Building Your Analysis Spreadsheet

Create a simple spreadsheet with these sections:

Purchase Analysis:

• Purchase price
• Closing costs
• Rehab costs
• Total investment

Income:

• Monthly rent
• Vacancy allowance
• Effective income

Expenses:

• Each category itemized
• Total monthly/annual

Financing:

• Down payment
• Loan amount
• Interest rate
• Monthly payment

Returns:

• Monthly cash flow
• Annual cash flow
• Cash-on-Cash return
• Cap rate

The Bottom Line

Rental property analysis is about being honest with the numbers. Use realistic rent estimates, budget conservatively for expenses, and always calculate cash flow before buying. A property that looks great on the surface might be a money pit—and a "boring" property with modest returns might build significant wealth over time. Master the numbers, and you'll make investment decisions with confidence instead of hope.