Real Estate Investment Analysis: A How-To Guide

Most people know investing in real estate is a great way to increase financial stability. Whether you’re looking to acquire a single investment property or build wealth through an entire real estate investment portfolio, knowing the essential steps of real estate investment analysis will help you properly evaluate properties, understand all your financial metrics, and choose the right investments for your portfolio.

Understand your investment goals

There are some questions you’ll want to ask yourself as you outline your investment goals. This helps you understand what you want out of your investments, and what it’ll take to get there. Do you want short-term or long-term gains? Are you after residential or commercial properties? And with that, what kind of strategy are you interested in? Single-family rental (SFR) properties, flipping properties, real estate wholesaling, real estate debt, or something else? 

There are so many options when it comes to real estate investing, it is important to evaluate cash flow and short-term rentals (vacation rentals), long-term rentals, fix and flip, or even wholesaling.

By answering these questions to help guide your investment strategies and get you the most bang for your buck.

Research the Market

Before making your investments, you’ll want to do your research. Generally that starts with taking a hard look at your local real estate market to see if it’s a viable option. And then subsequently exploring other markets to see what is the most viable for investing based on your risk tolerance and desired returns.

When researching a particular market, you’ll want to study things like job growth, economic stability, and population trends. Cities with a growing population generally offer stronger investment opportunities because things are moving forward or you could use a tool like Privy, a platform uses real-time data from successful investors, and uses their strategies to immediately identify profitable investment opportunities anywhere in the US.

Research doesn’t stop there. Studying historical property value data, rental costs, and current and past occupancy rates will help you suss out trends and inform future profits. And this isn’t always a generalization. Different neighborhoods in the same city can have widely varying statistics based on hyper-local factors like crime, rating of schools, and active development projects.

Identify potential properties

Now that you know your goals and have chosen your market, you can start identifying the properties that will bring you the highest level of success. Using the right tools (such as Privy.Pro) can help you through this process, delivering potential investment properties instantly to your inbox, so you can create your own list. 

Additionally, real estate agents, and investor networking can also assist in lining up potential properties. Sometimes the thing you are looking for is something that another investor passed up because it doesn’t meet their specific criteria.

Conduct financial analysis

Everything else before this step doesn’t include much math. But you are going to need to perform a bit of analysis if you want to figure out if your potential real estate investment is the right investment. There are six steps to performing a rational and critical financial analysis of your chosen investment. Let’s look at an example for a long-term rental strategy:

1. Determine purchase price and opening costs

Here you’ll want to determine your total initial spend. This includes the purchase price of the property, the closing costs, any renovation and repair costs, and any interest or loan-related costs associated with financing (if you are financing anything). 

2. Add up potential rental income

If your investment is in rentals, then you’ll need to estimate that income. This can be done by researching the local market, similar properties often offer similar rents (though not always, as it can vary street-to-street in some cities). But if you add or remove enough amenities, you can generally match up with whatever else is available in the area.

3. Figure your operating expenses

Whatever the property is, it’s going to come with some ongoing costs. There’s no getting around things like property management fees, regular repairs and maintenance, property taxes, insurance, and your utility bills. These costs are not mysterious or hidden, but you’ll certainly want to include them in any calculations.

4. Do the math on your net operating income (NOI)

Having an accurate understanding of property management costs is essential to your success and ability to generate long-term cash flow. Metrics like gross operating income and net operating income (NOI) help you determine your property’s profitability before any financing costs. You can calculate NOI by subtracting all operating expenses from the total revenue, or estimated revenue, generated by the property. Higher revenues and lower costs result in greater profitability and increased cash flow. 

5. Cash flow analysis

After you’ve paid all your expenses, mortgage payments, and whatever else there’s a bill for, whatever left over is your cash flow. So the formula for that is subtracting your debt service from your NOI to get cash flow. 

You can add up your debt service by looking at principal and interest payments on any loans you might have. A potentially great investment (or at least good) will show more income than operational costs.

6. ROI and Cap Rate

Finally, within your deep financial analysis dive you’ll look at the wonderfully effective metrics of return on investment (ROI) and capitalization rate (cap rate). These two metrics are huge drivers to determining the profitability of any property.

Divide your annual cash flow by your total investment cost, then multiply that answer by 100 and you have your ROI. Divide your net operating income (NOI) by the original purchase price and multiply that answer by 100 and you have your cap rate.

So how do you use ROI and cap rate? ROI shows the efficiency of your investment, and cap rate is a quick way to compare the income potential of different properties.

Assess the Risks

Of course, anything we do concerning great deals of money in tandem with property comes with its own set of risks. Some risks you may face along the way include changes in the local market affecting demand, your rental property remaining vacant, unexpected repairs, and variable-rate interest rates. 

The best way to mitigate these risks is by being prepared. Either with some funds set aside to cover surprise costs, fully screening your rental clients, and keeping up-to-date on all local and state market trends that may affect your portfolio. 

Make your decision

Now that you have your analysis, your investment properties, and a wealth of market data, you can decide if this investment is right for you. Comb through all your data and double check that this particular property meets your goals, and any potential profit is worth the equally potential risks.

Keep an eye on your investment

Now that you’ve purchased the property, it’s time to walk away and move on to the next one right? Nope, you’ll want to continuously manage your property, especially if it’s a rental as it comes with so many variables. This feeds into your overall strategy, especially if you want to build a portfolio of viable properties with a high resale value.