How I analyze Rental Properties
Let’s dive into a case study of a single family house I bought in Savannah last summer. This post is a little higher-level, so I’ve included a glossary at the bottom of the post if you don’t understand some of the terms I use. Don’t be afraid to ask me questions in the comments or on our team’s Facebook.
Location: Largo Drive, near the Lowes/Home Depot/Savannah Toyota
Built in: 1960s
Construction: Wood frame stick built, brick exterior. One story.
Size: 1332 sqft, 3 bed, 2 bath
Condition: Fair. Dated, but functional.
Neighborhood: Working class / starter homes.
Anticipated monthly rent: $1200
Listing price: $115,000 (June 2018)
SWOT stands for strengths, weaknesses, opportunities, threats. It is a framework that I use to quickly screen a deal in order to determine if it deserves more of my attention. I typically exclude wider economic trends from this analysis — I’m interested in one particular property, not the entire Savannah market. The very first criteria I look for in a Savannah buy and hold deal is the rent to purchase price ratio. I typically won’t even look at the pictures on a listing unless I think the monthly rent would be about 1% of purchase price.
I never actually write out a SWOT analysis – it just lives in my head. The day this particular property came on the market, I called up my then-agent (now co-worker) and told him that we had to go see it. We did, and I worked up a SWOT in my head before I hit the spreadsheets. Here’s what it would have looked like had I wrote it down.
Monthly rent is 1% of purchase price
House in good condition – kitchen, floors, bathrooms, HVAC, roof all new or in good condition.
House is on a busy road
Evidence of foundation issues – cracks in walls, uneven floors, doors not square
If updated, house could be sold in the $160k range. Likely cost of updating $25k.
Many houses in the neighborhood had been recently renovated and more are in progress renovations — as the adjacent properties are improved the intrinsic value of mine becomes greater.
House near a 500 year flood zone. If zones are updated to include this property, I would have to buy insurance.
I knew I was going to buy the house before I ever punched numbers into the spreadsheet I use to analyze deals. I knew it would cash flow well, and I liked the fact that I could make a profit flipping it too. It’s a good neighborhood and getting better. But let’s actually run the numbers before we put in an offer:
Purchase Price: $115k
Closing Costs: 2%
Loan Term: 30 years
Interest rate: 5.125%
Gross Rent: $1200/mo
Vacancy rate: 8%
Property Tax: $1200/yr
Capital Expenses: $800/yr
Property Management: 0% (self-managed)
Other Expenses (HOA, utilities, etc): none
Cash outlay: $27,140
Cap Rate: 8.12%
Cash flow/ Cash ROI (year one): $3,737 / 13.77%
5-year total ROI: $38,800 / 143%
Debt Service Coverage Ratio: 1.62
I put in a full price offer and asked for 4% in closing costs that day. They took it, and of course the inspection turned up the foundation issues that we expected. The foundation had been settling, at the sellers had to place piles under the foundation a few years back. This means that the foundation had been stabilized, but you could still tell that it had settled. That didn’t concern me too much (tenants don’t care about that), so I asked the seller’s for some concessions on sale price and they agreed.
I ended up closing the day before I left for my year-long assignment in South Korea, and I had it rented within the week for $1300 — $100 more than my estimate (I always try to estimate revenue low and expenses high.) It’s currently rented at a bit of a discount to great tenants on a two-year lease and I couldn’t be happier about my decision to purchase. Sometime in the next five years I’ll probably completely renovate and sell, but for now I’m happy with the cash flow.
ROI = Return on Investment. The ratio of how much money your investment makes you over a set period of time vs. your cash outlay
Cash Outlay = This is how much it costs you to buy the asset. In real estate, almost all purchases are financed with a loan, so cash outlay is almost never the same as purchase price. The cash outlay is how much a real estate investor has to shell out when he or she buys, and we use cash outlay when we calculate ROI, not purchase price.
Cash ROI = this is your ROI, but only taking into account cash flow. We ignore the pay-down of your mortgage balance and appreciation here.
Appreciation = an increase in the value of your asset.
Cap rate = capitalization rate. This is basically what your ROI would be if you paid for the house in cash.
Debt Service Coverage Ratio (DSCR): this is the ratio of your net income to the loan payment. You generally won’t get a loan if it’s not above 1.25, and I feel most comfortable if it’s over 1.5.
Author: Pat Wilver