So you want to be a landlord?
So you've decided you want to be a landlord. You've picked your niche and you've found a couple potential properties. But are they going to be money makers?
Valuing income producing properties is very different from non-income producing properties. Even a single family home should be analyzed based on its cash flow. Therefore traditional methods of Comparative Market Analysis are not useful for income producing properties.There are essentially five methods of valuing income properties.
Price per Unit
This is a great "in the field" analysis. If you're looking at a 6 unit apartment building that's selling for $180,000, then the Price per Unit is simply $180,000 divided by 6 or $30,000. This is a great way to quickly compare properties in similar areas but have more or less units. This is great for your very basic analysis...but obviously a deeper analysis is required.
Price per Square Foot
Very similar to the price per unit, to compute P/Sq Ft. you simply divide the price by the number of square feet. So our 6 unit building with a price tag of $180,000, was 5,000 sq ft... that means the price per square foot is $36. For income producing properties...I don't really like this method. There are simply too many variables to be considered to simply use a price per sq foot method. For non-income producing properties...this method still works.
Gross Rent Multiplier
Gross rent multiplier is another good field analysis tool because it's easy to calculate. Just divide the property's price by its expected gross income. So our $180,000 6 unit building has a gross yearly rent of $46,800($650 per month per unit) and a gross rent multiplier of 3.9. Again this is a great method of comparing several buildings of varying types and sizes.
To dig down even further than the last 3 methods...you need more detailed rent information and cost information. Cap Rate takes into consideration the costs and income of a potential property. Cap Rate uses Net Operating Income(NOI) instead of Gross Income like we use in the Gross Rent Multiplier. To get to the NOI, we simply subtract all operating costs(taxes, insurance, owner paid utilities, lawn service, trash removal, expected vacancy,etc) from the yearly income and dividing it by the purchase price. So using our example again, our $180,000 6 unit building has a gross income of $46,800....but we have $7200 of yearly expenses. So our NOI is $46,800-$7200 = $39,600...so our Cap Rate is 22%. The only difficult part is really drilling down the actual operating costs.
For most beginner investors...Cap Rate is pretty useless. What really matters to the beginner investor is "Am I going to have have anything left after I make my mortgage payment?". The calculation is very similar to the Cap Rate. But we are only looking at real $...not percentages. To do this we need to know our expected mortgage payment. Then simply subtract your monthly rent, taxes, insurance, owner paid utilities, vacancies, lawn service, etc. Whats left over is your cash flow. Does that end number match your requirements? Some investors only want to break even, some want $200 per month per unit of free cash flow. That's for you to decide...
Analyzing rental properties really isnt difficult. Most of it can be done sittig in your car in front of the subject property using the calculator on your cell phone. Before long-doing the calcualtions in your head become second nature and you'll quickly be able to compare properties with confidence.
Also Check out: So You Want to be a Landlord? Pick a Niche...