How to Analyze a Rental Property in 10 Minutes

Most listings deserve 10 minutes of your attention and no more. The point of a fast screen is to reject the bad ones cheaply, so your hours go to the few that might work. If you want to learn how to analyze a rental property, learn this pass first: five steps, a stopwatch, and one running example. The example is a $220,000 three-bedroom house renting for $2,200 a month. It looks fine at a glance and produces $64 a month once every cost is counted.

All prices, rates and percentages below are examples. The structure stays the same on every deal, and the inputs come from your market and your lender.

Minute 1-2: price, rent, and the ratio screen

Write down two numbers: the asking price and the market rent.

The asking price is on the listing. The rent is not, even when the listing claims one. Listing rents are often a hope, or a figure from a lease signed under different conditions. Get the rent from current comparable rentals: same bedroom count, similar size and condition, within about a mile. A rent estimate tool gives you a fast starting number, and two or three live comps confirm it.

Then divide monthly rent by price.

• Example: $2,200 divided by $220,000 = 1.0%

This is the 1% rule, and it is a rule of thumb. It tells you nothing about taxes, insurance or condition. Its only job is to decide whether minute 3 happens.

Those bands are calibrated to the example rate used below. When borrowing costs are lower, lower ratios work. When they are higher, even 1.0% can fail, which the running example is about to show.

The example passes at 1.0%. Keep going.

Minute 3-5: the six expense lines that matter

Six lines cover nearly all of the operating cost on a single family rental. Two are dollar figures you look up. Four are percentages of gross rent that you set once for your market and reuse.

Gross rent in the example is $2,200 x 12 = $26,400.

Total operating cost is $12,456, which is 47% of gross rent. That sits close to the 50% rule of thumb, which says operating costs on a rental run about half of rent over time. When your six lines total 30%, you have usually left something out.

Three habits keep this step honest.

Include management even if you will self-manage. Your time has a cost, and you may not want to take tenant calls forever. A deal that only works with free labor is a job.

Keep repairs and capital expenses separate. Repairs are the running toilet and the broken disposal. Capital expenses are the $12,000 roof that arrives once every couple of decades. It costs nothing in most years and a great deal in one of them, so you reserve for it every year.

Add lines that apply. Homeowner association dues, flood insurance, or any utilities the owner pays get their own rows. In this example there are none.

Net operating income is rent minus those costs.

• $26,400 minus $12,456 = $13,944

A simplification to know about: managers charge on collected rent, so the fee on $25,080 of collected rent would be $2,006 and not $2,112. At screening speed, the $106 difference is not worth the seconds.

Minute 6-7: debt service at today's rate

Use the rate from an actual lender quote for an investment property loan, which prices above the owner-occupant rates you see advertised. If you do not have a quote yet, get one this week. It is the most sensitive input in the whole screen. This post uses an example of 7% on a 30-year loan with 25% down.

• Down payment: $220,000 x 25% = $55,000
• Loan: $165,000

You do not need a mortgage calculator if you keep a payment factor table. These are fixed math for a 30-year loan, monthly principal and interest per $100,000 borrowed:

At 7%, the loan is 1.65 x $665 = $1,097, and the exact figure is $1,098. Annual debt service is 12 x $1,098 = $13,176.

Notice the spread in that table. Between 6% and 8%, the payment on this loan moves from $990 to $1,211 a month, a swing of $221. That is more than three times this example's monthly cash flow, which is why a screen built on last year's rate is useless.

Minute 8-9: cash flow, cap rate, cash-on-cash

Three metrics, three divisions.

Cash flow. Net operating income minus debt service.

• $13,944 minus $13,176 = $768 a year, or $64 a month

Cap rate. Net operating income divided by price. It ignores financing, so it lets you compare properties with each other and against the local norm.

• $13,944 divided by $220,000 = 6.3%

Cash-on-cash return. Annual cash flow divided by the cash you put in. Count the down payment plus closing costs, here an example 3% of price, or $6,600.

• Cash in: $55,000 + $6,600 = $61,600
• $768 divided by $61,600 = 1.2%

One bonus metric takes ten seconds. The debt service coverage ratio is net operating income divided by debt service: $13,944 divided by $13,176 = 1.06. Lenders who underwrite on the property's income commonly want 1.20 to 1.25. At 1.06, the rent covers the payment with 6% to spare, and one bad month uses all of it.

The verdict, and the number that matters more

The running example passed the 1% screen and still fails. A 1.2% cash return does not pay you for the risk, and $64 a month disappears with a single service call.

Do not stop at no. The most useful output of the screen is the price at which the answer becomes yes. Say your floor is $200 a month, or $2,400 a year.

• Debt service you can afford: $13,944 minus $2,400 = $11,544 a year, or $962 a month
• Loan that $962 supports at 7%: $962 divided by $665, times $100,000 = about $144,700
• Price at 25% down: $144,700 divided by 0.75 = about $192,900

So this house is a candidate at roughly $193,000, which is 12% under the asking price. Taxes would fall a little at the lower price, which helps slightly. Whether a seller accepts 12% off depends on days on market and condition. You now know your number, and you got it in under nine minutes.

Minute 10: the kill questions

Five questions can each sink a deal the spreadsheet likes. Each gets a first-pass answer quickly from the listing, the county site or a map.

1. Is it in a flood zone? Check the FEMA flood map for the address. If the property sits in a special flood hazard area, a lender will require flood insurance. An example premium of $2,400 a year would turn this deal's $768 of cash flow into negative $1,632.
2. Is there a homeowner association? Dues are an expense line. Rental caps, minimum lease terms and approval rules can make the property unrentable no matter what the numbers say. Read the rules before you read anything else.
3. Is a tenant in place? Get the lease. Check the rent against market, the end date, the deposit held and the payment history. A tenant paying $1,800 on a lease with ten months left means your first year runs at $1,800 instead of $2,200.
4. What capital items are overdue? Ask the age of the roof, the heating and cooling system, the water heater and the sewer line. A $12,000 roof equals more than 15 years of this example's $768 cash flow. Overdue capital items are a price reduction you negotiate now or a bill you pay later.
5. Are taxes about to reassess? Many jurisdictions reset assessed value after a sale. Suppose the seller's bill is $2,100, based on an old assessment of $140,000 at the example 1.5% rate. At your $220,000 price, the same rate gives $3,300. The listing shows $2,100, and the $1,200 gap comes straight out of cash flow. This is why the expense table above used your price and ignored the seller's bill. Rules vary by state, so check how and when your county reassesses.

A yes on any of these does not kill the deal automatically. It moves a cost into the model or the property out of consideration, and you find out in minute 10 and not at month 10.

When a 10-minute pass earns a full analysis

Most listings die in the first two minutes. A property earns a deeper look when all three of these are true:

• It clears your ratio screen with rent you verified from comps.
• Cash flow meets your floor at the asking price, or at a price within negotiating distance. For most sellers, that means a single-digit percentage off. The example needs 12% and sits on the borderline.
• No kill question returned a cost you cannot price.

The full analysis replaces every estimate with a document or a quote:

It adds the questions a snapshot cannot answer too. What does year five look like if rents grow 2% and costs grow 3%? What is the total return including principal paydown and tax effects? How far can rent fall before cash flow goes negative? In the running example, that last answer is uncomfortable. The percentage-based lines take 29% of rent, so each $100 of rent is worth $71 of cash flow, and a drop of about $90 a month is enough to erase the $768.

Next steps

1. Get one real rate quote for an investment property loan and write your payment factor on a sticky note.
2. Set your four expense percentages for your market and reuse them on every listing.
3. Screen five listings this week with a timer running. Record the price at which each would work.
4. Send the best one to a full analysis.

Everything above is the manual version of what the single family rental calculator automates. Run this same screen on a live listing by hand, then enter the listing in the calculator and compare. When the two agree, you understand the model. When they differ, the gap shows you which line you skipped.