One of the biggest questions I’m asked is how do I go about analyzing a property once I find it. There are several things I do and look at with any new property potential, but the most important is the numbers. If the numbers aren’t good, I run.

What numbers do I run? For me, the most important factor is cash flow. What determines cash flow? Simply, income and expenses.

Figure Out The Monthly Income (Gross Income)

This will either be rent the current tenants are paying or the asking rent. I highly recommend that you talk to a local property manager, one such as those working for Pyramis Company in San Antonio, as they are the experts. Do not rely on a general practicing real estate agent who does not specialize in property management, just ask Craig Acord, President of the Pyramis Company as he can provide you with many horror stories on how investors have been misled by a general practicing agent who did not have experience within this highly specialized field.

What Are The Monthly Expenses

Property taxes, insurance, property management fee, mortgage or financing, homeowner’s association fee, vacancy, and repairs are all expenses to be considered.

• Repairs– If a home is fairly new and in good shape, I use 10% of the monthly rent. If the property is not in above average condition, conservative could mean closer to 25%.
• Vacancy– I conservatively estimate 5 to 10% of the monthly rent towards vacancy expenses. If you have a great property management company such as the Pyramis Company in San Antonio, I would go with 5%.
• The HOA can have an adverse effect on a property’s cash flow. Get this in writing from the homeowners association.

Calculate Net Income

Subtract the Monthly Expenses from the Monthly Rent. This is your monthly cash flow. With any luck it’s positive. If not, sprint.

Calculate the Returns

I use the following to evaluate my return on investment; Cap Rate and the Cash-on-Cash Return.

• Cap Rate – This gives me an idea if I’m buying the property at the right price. It basically compares the return on investment (ROI) to the purchase price.

The Cap Rate equation: Net Annual Income / Purchase Price = Cap Rate … I don’t include the mortgage payment in this calculation.

The lowest cap rate I would consider for any residential property is 8%. The lowest I would want to see on a residential rental property in this market is 6% and even then, there better be a good reason it’s that low (property in a highly desirable area). Anything over 8% you are doing well.

• Cash-on-Cash Return- This number is how much return you are getting on the money you invest. If you pay all cash for a property, this number will be the same as the cap rate. If you are financing, this number is the most accurate way to see the actual return you are getting on your cash-in. The equation, and remember to include the mortgage payment since this one is totally driven on financing:

Net Annual Income / Total Cash Invested = Cash-on-Cash Return

Understand the difference? One is a measure of how good of a deal you are getting on the purchase price and the other tells you the exact return on your money you are getting. They are the same for an all-cash buy but can be very different for a leveraged purchase.

If you compare the Cash-on-Cash Returns of an all-cash buy versus a financed buy. You can quickly see the benefit of leveraging!

Running the numbers on a potential rental property purchase is easy. If you can remember what numbers you need to know it will take you no time at all to do this for every property you look at. Write down the expenses on a piece of paper or that serviette we talked about earlier, fill in the numbers, and calculate your cash flow. If you’re not buying a property in “move-in” condition, consider expenses for rehabs or any work that may have to be put into the property once it’s purchased.

In actuality of a property acquisition, it may turn out to give you a far different set of numbers than what you initially calculated. Point is, don’t ever just go off the numbers on a property, but the numbers are the most important. If you don’t have a solid reason to believe you will be getting positive cash flow consistently out of a property, don’t bother with it and move on to the next deal.