How to Analyze a Rental Property

we’re gonna talk about the Foursquare method on how to analyze a rental property so you can understand the numbers I did not create the Foursquare method but I did copy it from a couple of people who I really respect and who are actually successful real estate investors I’m proud to say that I don’t want to reinvent the wheel if they already know what they’re doing so this is the easiest way for a newbie or a beginner to really understand each of the four components that go into a real estate deal so I’m gonna jump right into the numbers and I don’t want to waste anybody’s time so let’s get to it so as you can see here in our first square we have what’s called income so income is pretty obvious it means the money that the property generates so most people think that income comes from rental income obviously that’s probably gonna be one of your biggest sources of income but we also have things like laundry if you have a coin-operated machine or if you have laundry on site that can be a source of revenue you can rent out a garage monthly whether it’s for a car or for storage you can rent that out and increase your revenue that way and then miscellaneous there’s a multiple multitude of ways that someone can monetize an income property and those are just some of them so let’s take some hypothetical numbers here I live in Northeast Ohio you can get a duplex here for pretty cheap I’m gonna say hypothetically say that I’m in a B Class suburb so let’s say that you can get a duplex for about $200,000 that’ll bring in right about a thousand dollars per side or per door as investors like to call it so one thousand times two equals

two thousand dollars a month and rental income just for simplicity’s sake I’m gonna assume that we don’t have a laundry the garage comes with the property we’re not charging any extra for that and let’s say miscellaneous income is zero as well so with that being said the total monthly income that this property is bringing in is $2,000 a month

so now with income there’s obviously the opposite of that which are expenses so what are some expenses that you can incur so you can have tax there’s tax on the property there’s gonna be insurance there’s gonna be your utilities so utilities include things like gas water sewer electric garbage things like that so you can be in an HOA an HOA stands for homeowners association these are typically monthly or yearly fees things for taking care of common areas if you’re in a condo you can help pool and money in the condo association and the board can make decisions but for the sake of this example let’s pretend that this house is just a regular house not in an HOA so some other expenses you can have landscaping or snow removal you can have a vacancy factor so what a vacancy factor is is typically people use five percent I’ll use that for this example but vacancy factor you have to assume that you know a little bit of the year there’s not going to be a tenant in that house so there you’re not going to be getting the full amount of rent that you would appear you have repairs okay then we have capex so calf X stands for capital expenditures these are typically expenses that you save for over the long term like a roof replacement or a driveway replacement you know that you’re not gonna replace the roof every through every year but you know that after 20 30 years that will need to be replaced eventually

so this think of this as kind of like a savings account for the property itself finally we have p.m. which stands for property management this is typically 10% of whatever your gross rents are and then you finally have the mortgage or debt service so I’m gonna go through and give realistic numbers for each one of these let’s say that the taxes each month are gonna be right around a hundred and fifty dollars insurance is going to be right around $100 utilities the thing with utilities is that although there’s many of them you can actually put that on the tenant so you can make the tenant responsible for that so not only are they paying the rental income to actually live in the property you can actually assign them hey you’re gonna put the utilities in your name and you’re gonna be responsible for that and that typically is a pretty big motivator because if the utilities are in their name that affects their credit if that makes sense so let’s just say in this lease agreement we’re putting the utilities on the tenant so that’s going to be zero as I mentioned earlier this house is not in a homeowner’s

association so that’s zero the

landscaping and snow removal and the grass cutting and all that you can actually put in the lease for the tenant to be responsible for that and that’s what we’re gonna do in this house so that’s going to be zero as well vacancy factor like I said we’re gonna use a vacancy factor of roughly five percent and 5 percent of $1,000 is going to be excuse me five five percent of $2,000 sorry about that

and then the repairs let’s just count for one hundred bucks a month that’s just miscellaneous stuff you know someone puts a hole in the drywall or something needs done with the bathroom let’s just all account on average for a hundred bucks for repairs per month now capex this is gonna be $100 as well this is not a number that’s set in stone but again over the

force of X amount of years there may be some big things that go wrong with the property so you want to just be able to set this aside so property management like I said property managers typically charge 10% of the gross rents so 10% of 2,000 is 200 bucks and the mortgage or the debt service like investors like to call it what I did was I took the property that’s hypothetically $200,000 we’re gonna put down a 20% down payment so what’s 20% of 200,000 that’s gonna be 40 grand so the mortgage we’re taking out is $200,000 minus 40 grand

we’re putting down 40 and taking out a mortgage of $160,000 so if I did a 30-year mortgage at 5% on $160,000 it comes out to be right around eight hundred and sixty dollars per month so I went a little bit high on that interest rate of 5% right now we’re probably in the neighborhood of 4.4 at the time of this recording but just to make just a future-proof this video because we know interest rates are going up I just did a 5% so if we add up all of these expenses we’re going to come to a total monthly number of one thousand six hundred and ten dollars that’s a good estimate based on all these numbers that were

incorporating a lot of these are factual because they’re in the lease some of these are estimates like capex and repairs and also we know that property management and mortgage that’s a number that’s set set in stone so 16 10 is a good estimate for expenses so let’s go to the next quadrant of our 4 square method the third square we have is called cash flow this is to see how much money the property is either making or losing per month so this is very simple all you do is you take your income which we know is $2,000 per month which we got from the income square minus your expenses so we know that the expenses are 1610 dollars so this leaves us with a very simple number of a positive cash flow of three hundred and

ninety dollars per month that’s a very simple way to come up with that number so how do you know if three hundred and ninety dollars a month is even a good investment or if it’s even worth your time to invest in these kinds of houses or these kinds of investments that brings us to our fourth square called the cash on cash return on investment so the way to figure this out is a cash on cash essentially means it’s the money that you made on the money that you invested so it’s cash on cash return so let’s figure out how much money we have in this deal to see if this three hundred ninety dollars a month in cash flow is even worth it so let’s start down with the down payment okay we know that we put down forty thousand dollars for the mortgage okay the second factor our closing costs so we never talked about how much it actually costs to acquire this property so closing costs these are things like title work dealing with any commissions and a real estate agent since we’re the buyer we’re not really going to be dealing with a commission so to speak that the seller actually pays most of those but this could be you know title work paperwork lending fees you know rip mortgage origination things like that so let’s just assume for this example that these closing costs were three thousand dollars the next line item is the rehab budget so say this property wasn’t perfect or wasn’t tenant to ready I’m not saying that these properties have to be perfect for these people to live in but they should be suitable and they should be safe nice properties for a family or a person to live in so with all that being said let’s take a rehab budget and this property let’s say each side each door needed thirty five hundred bucks it’s a total of seven thousand dollars and rehab maybe we did some floors maybe that we did something to the bathrooms or the kitchens whatever we have seven thousand dollars in rehab fees so miscellaneous this all depends on what else you want to do to the property or if you incurred and you expenses for this example just to keep it simple

we’ll say that these are zero dollars so the total in terms of money down that we have here is $50,000 okay

and since I’m running out of room to write just remember that all of these expenses combined forty plus three plus seven that’s 50 grand now what you do is in order to find out the fourth square or the cash on cash return you take your three hundred ninety dollars a month okay and I hope you guys can still see this 390 per month so you want to find out what you make in an entire year okay so this is an annualized cash on cash return 390 times twelve is four thousand six hundred and eighty dollars per year now some of the people that are pretty good at math already know what the next steps are so what you do is you take this money that this that you make in one year so this for forty six eighty what you do is you divide it by the money that it took to get this returned okay so this forty six eighty divided by the 50k that we used up here all the money in the deal actually gets us a return of nine point three six percent so how do we know if nine point three six percent is even a good deal or a good cash on cash return well I would compare it to other available

investments at the time so take a look at your savings account right now in a money market you’re probably going to be making one point five percent if that so this is an investment that’s about eight times better than that

okay if you’re looking at the stock market the stock market has historically returned right around ten percent some years it’s been a lot more some years it’s been a lot less so this is may be comparable to the average of the stock market if you want to get into something a little bit more riskier obviously you need to be compensated for that risk so high risk

high-reward this right here if you do the numbers and you keep good property management and good tenants and don’t have a lot of turnover this is a pretty good number for a relatively low-risk investment and you are being compensated for that risk with nine point three six percent of return now let’s talk about the last factor that the Foursquare doesn’t address we know that we bought this duplex for $200,000 right

we never know or we never talked about how much we’re gonna sell it for so what if in five years this duplexes worth $300,000 now we’re getting into a different metric called IRR that’s internal rate of return you have all the money you made in terms of the cash flows which we have 390 a month and those are going to go up as well because as a landlord we want to raise those rents every year by you know 2 3 4 percent and you have the difference in equity of what you bought it for which was $200,000 and when you sold it for which was 300 so after all the realtor fees and all that good stuff you’re taking in the cash flows and also the appreciation of the equity and that number is obviously going to be higher than nine point three six over time but that number could also be lower if you’re selling it or you have to sell that duplex at a number less than $200,000 does that make sense so I hope everyone got good value out of this video this is my first real estate investing video but I do own three units myself I have a duplex and also a single-family and I just I used this for my numbers obviously I used something a little bit more sophisticated like a spreadsheet but this is a good way for new investors to really dig into the numbers and see if an investment would be profitable or not so if you got any value out of this video please share this with one friend like and subscribe if you haven’t already and most

importantly have a prosperous day and another expense that you may have is if your tenant is a piece of trash and he hasn’t paid rent in three months and he’s milking the Invicta process because you’re in a landlord unfriendly state and it’s costing you not only income from the property but court fees lawyer fees legal fees don’t you just love real estate investing.

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