HMW #108: Will this rental property cash-flow?

alan corey evaluate a property long-term rentals real estate 101 Jun 28, 2023

Read Time: 5.25 minutes

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How do you know that rental property you have your eye on will actually cash-flow?

Sizing up properties quickly is a real estate investor super-power. I'm here to give you guidance to make sure you aren't wasting your time with over-priced junkers.

Sizing up potential investments quickly is a great skill to hone so that you can find winners and make offers before other investors beat you to it.

You don't want to spend hours researching a home and finding out it's never going to make money, do you?

So are you up for a quick 3 step process on how to size up deals in jiffy?

Ok, ok, I'm trying to save you time here! I didn't know you were this impatient. Fine, I'll make this quick.

Most people size up a rental property in one very big wrong way:

If the listing photos look nice then it would make a good rental.

Or they make these other conclusions on if a property is a potential investment:

"No, I would never live there."
"OMG, that bathroom is too much!"
"It's off-market so it must be a deal!"
"Oh, that school district is great, must buy!"

Well, your snap judgements are going to lead to a quick death to your real estate career.

Let's maybe do a little evaluation using some real life math to determine if a property is worth investing in.

Don't worry, this is elementary school level mathematics. Don't get intimidated just yet.

Understanding these 3 steps will help you easily size up the best deal within your buy box:

Step 1: Find out what it can rent for

You need to know what kind of money it can make in it's current as-is condition. Houses can be ugly in the street as long as they are sexy in the spreadsheet. That's all that matters.

Has an outdated bathroom? House is in a flood zone? A ton of crime in the neighborhood?

There can be a gold mine in all these situations.

Remember you will not be living there. Someone else may consider that 70's wood-paneled bathroom with shag carpet an improvement from their previous home. And sometimes they will happily pay over-market rate rent for it.

To identify these opportunities, you need to first size up your competition, or other rentals available for rent right now.

There are 3 quick ways to find rental comps:

Pretend you are a tenant and search on Zillow for like-kind rentals in same neighborhood. It has to be same bedroom and bath count and similar square footage and condition. Bracket the property you are considering with two other rentals currently on the market. One needs to be slightly better and one needs to be slightly worse. Yours will most likely rent between these two anchor comps that you have just found.
Search rental data on Rentometer.com. This is considered a reliable resource for rental prices and has a small fee to run multiple reports, but it's just one of many resources and approaches I would use to get quick rental data on an area.
Ask a real estate agent with access to the MLS to run a free rental comp report for you. They have data at their finger tips and will most likely help you evaluate a property as long as they are investment-minded (which thankfully you already know how to find investment minded agents.)

Any of the above should be able to give you expected rental income of the house you are looking at and only take minutes. You have at least a few minutes to spend on this exercise, right?

Oh, I'm sorry. I'm just trying to help you make some money here. Give me a break.

Step 2: Estimate the expenses

Real estate investing is not just all income. Even with a paid off property you have taxes, insurance, and utility bills to pay. You need a good handle on expenses in order to make sure the income we just calculated can cover them all and more. That "more" is the most important part, that's going to be your cash flow!

Here is the one back-of-the envelope math expenses that you need to know: 40%. On most my properties, about 35% of all income I take in go out to expenses. But I plan for 40%.

This 40% includes 5 things and you can give them whatever percentage you like to add up to 40%:

5% vacancy
5% property taxes
5% insurance
10% repairs
15% capital expenditures

So if I know after doing Step 1 above that a property rents for $2,400. I'll assume 40% of that, or $960 a month, is going to cover all the business expenses of running that property.

Again, 40% is conservative, and once I have that calculation I move on to the next step in the process.

See, I told you the math isn't too hard on this. Maybe even a little fun?

Ok, don't get carried away. We've got one more step to go and you need to remain focused on real estate and not damaging your Realtor's car.

Step 3: What your's mortgage payment going to be?

This is the final step. Talk to a mortgage lender and confirm the down payment you will need to make on a property. And then we are going to let a calculator do the math on this last part to give your brain a break.

Just go to Google's Mortgage Calculator and fill out the 3 values you see here:

Loan amount - This is not purchase price, this is loan amount. You typically have to bring 15-25% of purchase price to close on an investment property.
Loan term - Always go for 30 year fixed. A lesson we will cover another day.
Interest rates - This is probably going to be 1% higher than you are seeing primary home buyers getting because investments are considered slightly more risky to lenders.

There you go!

In this scenario, we just walked you through, you found a property that will probably rent for $2,400. Expenses are going to be around $960. And your mortgage payment is going to be around $1,000.

Now it's simple subtraction:

$2,400 - $960 estimated expenses - $1,000 in mortgage payment = $440 of cash flow.

Ideally you have a minimum of $200 cash flow per door, so this is a great start. You have to have the cash to make up the difference between the purchase price and the loan amount you put in to pull this deal off.

But the big win? You just ran your first numbers on a real estate deal! I hope you didn't think it was going to be harder that that. Now do you feel like this is something you can do on your own moving forward?

Wonderful! But do seem a little upset that you have to do a little work. But the best news of all, it only took 7 minutes of read time out of your busy schedule. Not a bad use of the day for the Busiest Person in The World.

Now with all your extra time you can go listen to the House Money podcast, read my book "House FIRE", and also follow the House Money Twitter account.

Ok, I can work with baby steps. I had to shoot my shot, you know. You go at your own pace and just know I'm here when you are ready for more.

Summary

Learn simple quick math to size up a deal.
Rental comps online will give you idea of rental income
The 40% rule will give you a good estimate on expenses
Use the Google Mortgage Calculator as final step to see potential cash flow

Are you a newer investor looking for some guidance?

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