What is a real estate investment analysis? And how can it help you choose the right investment property?
That’s what you’ll learn in this article.
As a seven-figure real estate investor myself, I’ll show you how to analyze deals to maximize your success.
So, if you…
- Don’t love your 9-5
- Want to work less without earning less
- And value long-term financial security
…then real estate investing could be a great option for you.
Quick overview:
- Different property types can offer different levels of risk and ROI
- Investment factors to consider include property value, expenses, and cash flow
- Things like location, condition, and rental potential affect property value
- Use formulas like cash-on-cash return (COC) and rate of return (ROR) to determine performance
What is investment analysis in real estate?
In real estate, investment analysis means evaluating a property’s value based on several specific factors before deciding whether to invest.
So, what are those factors?
According to Harvard professor Arthur Segel, there are four to look at:
- The product: What condition is the real estate in? Where is it located?
- The people: Do you have positive relationships with people involved in the investment, like contractors and neighbors?
- The external environment: What external factors (like weather conditions, demographics, etc.) could impact the property value?
- The capital markets: How will you finance your investment?
Once you have answers to these questions, you’ll be in a better position to choose the right deal.
But what types of properties are there?
That’s what we’ll look at next.
Types of real estate investment properties
It’s no secret there’s money to be made in real estate investing.
Case in point: In 2022, the real estate investment market size was $8,537.74 billion.
With that in mind, here are five types of real estate properties you could choose to invest in:
- Residential rental properties (this is what I do by renting to students, but you can also choose single-family, multi-family, short-term rentals, etc.)
- Hotels
- Office space
- Retail outlets
- Industrial
Ultimately, property types come with different pros and cons, so identify your goals first before narrowing down your options.
Up next: What should you evaluate in a property before investing?
7 key factors to consider when analyzing potential property investments
While there are many factors to consider when doing your real estate investment analysis, you want to focus on the most important.
Here’s what they are.
1. Property value
Several factors impact how much a property is worth. These include the area as well as the property itself.
Let’s start with the area.
Area factors
Here are a few things to look at when analyzing the property’s area:
- What is the neighborhood like?
- How close are amenities (gyms, parks, etc.)?
- What are the public transportation options?
- How might the area change over time? Are there any planned developments that could impact your investment’s value?
- What are the local crime rates?
- What employment and educational opportunities are there in the area?
- And what are the zoning laws?
Once you’ve taken a look at the area you’re thinking of investing in, the next step is to look at the specific property you’re interested in.
Property factors
Here, the most important thing to look at is the property’s condition.
So before investing, make sure to find out details that will help you make an informed decision, like:
- When the property was built
- What renovations have been done
- Expensive things that might need to be repaired or replaced soon (for example, the HVAC, the roof, plumbing, the electrical system, the foundation, and sewage lines)
- How energy efficient it is
- Whether it complies with building codes
But maybe at this point, you’re wondering…
“Ryan, once I’ve done research into the factors that impact a property’s value, what’s a good way to figure out how much I should be paying?”
Great question.
This is where looking at comparables (or “comps”) helps.
Basically, the idea is to compare similar properties to see if you can find a great deal that’s priced lower than the average.
Specifically, here’s how you can run comps:
- Go to Zillow.com, and filter properties based on things like zip code, condition, square footage, number of bedrooms/bathrooms, etc.
- Using the filters you’ve chosen, look at properties that have sold within the last ninety days in the zip code you’re looking at. This will give you a better idea of what the market is like and whether a particular property is listed at a fair price or not.
And for more, I talk about comps in this video:
Ultimately, a property’s value increases based on the selling price of similar houses in the area.
And as an investor, owning property in an area with high appreciation can lead to a bigger return on your investment (ROI) long-term.
2. Rental potential
So, how much could you earn if you bought a particular property? There are a few ways to find out.
For one thing, you can look at rental prices in the neighborhood.
I recommend checking out sites like…
- Rentometer.com
- Craigslist
- And Facebook housing groups
These can give you a good idea of what prices you should expect to charge as an investor.
Also, look at vacancy rates and seasonal demand. If apartments in your area get rented quickly, that’s a good sign.
Another thing to consider?
Your target renters. If you invest in an area with plenty of professional opportunities for high-income earners, you’ll attract better tenants.
Now, let’s go over the expenses you’ll have.
3. Expenses
There are a lot of expenses to consider when doing a real estate investment analysis, and I’ll cover some common ones below.
But keep in mind…
As a real estate investor, you could benefit from tax breaks, which help reduce the financial burden.
With that in mind, here’s what you need to know:
- Property taxes and insurance: This includes local taxes and potential increases, insurance premiums, including insurance for floods, hurricanes, tornadoes, and other natural disasters that can damage your property
- Property management fees: This includes software fees, utilities, routine maintenance, legal fees, marketing and advertising costs, tenant acquisition fees, the costs associated with having vacant rentals, landscaping costs, pest control, bookkeeping/accounting, homeowners association (HOA) fees, and supplemental taxes.
But again, you can write off some of these expenses, which I talk about more in this video:
4. Financing options
Financing is one of the most important things to consider when analyzing a potential real estate investment.
Now, that doesn’t mean you need a huge upfront investment to get started.
But it does mean you need to know your options.
Funding your downpayment
So, how are you going to fund the downpayment on your investment?
Well, you could…
- Use money you’ve saved from your W-2
- Partner with someone who has the necessary funds to be your co-signer
- Use seller financing, where the seller handles the financing instead of a bank
- Househack, where you rent out spare rooms in your house and use the rental income to reduce (or eliminate) your mortgage payments
- Use private funds (which I’ll talk about in a bit)
- Use a HELOC or cash-out refinance from an existing property
Securing your mortgage or loan
Want to get a mortgage or loan? In that case, here are some of your options:
- Investment mortgage: This is a mortgage specifically designed for real estate investors, but it comes with stricter terms compared to traditional mortgages. That’s because lenders consider real estate investing riskier than lending to homeowners with stable incomes.
- Conventional loan: A conventional loan isn’t backed by the federal government, which makes it harder to qualify for. But if you do qualify, one benefit is that you’ll pay less interest compared to other mortgage options.
- DSCR: A DSCR (debt service coverage ratio) loan is based on your rental property cash flow rather than your income.
- Commercial loan: If you want to invest in commercial properties, like retail outlets or warehouses, you could get a commercial loan. These types of loans will have shorter terms (usually 5-20 years).
- Private money lender: As the name suggests, private money lenders are generally friends or family who lend you money to finance your investment (but you can also find private lenders who aren’t part of your network).
Also, when you’re ready to start looking at properties, think about who benefits from current market conditions. In other words, is that the seller or the buyer?
Here’s why that matters…
If interest rates are high and there aren’t a lot of buyers, sellers will be more willing to negotiate the sale price. Which means? You can get great deals just by negotiating.
I once used this strategy to save $83,000 on an investment property.
More on that in this video:
Now, let’s talk about risk assessment.
5. Risk assessment
How can you estimate the risk involved in real estate investing?
Here are a few factors to look at that can help you make good investment decisions:
- Market risk: Markets fluctuate, which means you can invest in a property and end up losing a lot of money because property value and rent prices tank.
- Economic risk: Economic changes affect interest rates, which is outside of your control as an investor.
- Property risk: Unexpected repairs or damage can quickly eat into your profits and even lead to negative cash flow. This happened to me with my first property because I didn’t screen it properly, which resulted in over $40K in repairs.
- Natural disaster risk: Environmental disasters (like floods, hurricanes, and earthquakes) are a bigger risk in certain parts of the country, which is an important consideration when evaluating risk.
6. Cash flow
In a nutshell, cash flow refers to the spending and income you’re getting from your real estate investment.
So, you can have positive or negative cash flow, but positive is essential for profitability.
Here’s a handy calculation you can use to figure that out:
Total rent – Mortgage payment – Expenses = Cash flow
Want an example of how this works?
Total rent: $3,800 – mortgage payment: $1,527 – expenses: $300 = cash flow: $1,973
Using this calculation, you can see that I earn almost $2,000 per month on this property alone, even after factoring in my mortgage and other expenses.
7. Return on Investment (ROI)
What ROI can you expect in the short and long term? This is a key profitability metric to check before investing. To find out, you can use methods like…
- Cash-on-cash return
- Capitalization (Cap) rates
- Cash flow
- Gross rent multiplier (GRM)
- And internal rate of return (IRR)
I’ll talk about a few of these in a minute, but here’s a basic calculation to find out the ROI on rental properties:
(Rental property income – Expenses) / Investment cost x 100 = ROI
Want a more in-depth explanation? Check out this article.
Alright, now that we’ve talked about key factors to consider before investing, let’s talk about performance metrics you’ll need to consider in your real estate investment analysis.
Common performance measurements in real estate
In real estate investing, there are a few common performance metrics that investors like me use to determine if a particular property could offer a good return on investment.
Here are a few to know about.
1. Cash flow
As I mentioned earlier, cash flow refers to the expenses and income generated from your real estate investing. So, it’s money moving in and out of your account, also known as negative or positive cash flow.
Again, here’s how to calculate it:
Total rent – Mortgage payment – Expenses = Cash flow
2. Rate of return (ROR)
A rate of return (ROR) measures an investment’s net gain or loss over a certain period of time. The rate is displayed as a percentage of the investment’s original cost.
Here’s how to calculate it:
(Current value – Initial value) / Initial value x 100 = Rate of return
3. Capitalization rate
The capitalization rate, or cap rate, measures the expected rate of return on your investment property.
Here’s how to calculate it:
Net operating income (NOI) / Property value = Cap rate %
4. Cash-on-cash return (COC)
Cash-on-cash return (COC) measures the amount of cash earned based on the amount of cash invested.
Here’s how to calculate it:
Pre-tax cash flow / Cash invested = Cash-on-cash return
Next steps
And now you know what a real estate investment analysis is and how it can help you invest in the right property.
So, want to start investing but feeling a bit overwhelmed?
As a real estate investor who started from scratch and built a seven-figure portfolio, I know what that’s like, and I’m here to help.
