Evaluating Rental Properties

Rental properties are a great way to earn extra income each month and have a minimal role. Some people consider this ‘true investing,’ since the properties are held for the long term and do not require active, day to day labor. Other tactics, like wholesaling or flipping properties, can still generate income, but they are more labor-intensive. Holding rental properties fits many people’s lifestyles, but not all rental properties are equal, so it is important to evaluate them before you sign the deal.

The bottom line when it comes to rental properties is the Net Operating Income. The NOI is the total amount you will make each month as a landlord minus the expenses and excluding your debt service. It can be determined by adding up all the rents, but the important factor is to accurately assess your occupancy rate and the percentage of tenants that will pay that rent on time. If the NOI covers all expenses plus the ability to pay your debt service, then the property is profitable.

Another common number when evaluating rental properties is the Gross Scheduled Income, or GSI. This number is calculated by multiplying the total monthly rents by the number of units by twelve months (total rent x # of units x 12 months). It tells you the scheduled yearly income, with the operation term being scheduled. Don’t confuse this for reality! It is only the income that is planned. It does not take into account occupancy rates or quality of tenants into consideration, so do not confuse this number with the NOI. Additionally, the assumption is that for calculating the total rents, you have data on the average rents in the area so that the number is based in reality. GSI is useful as a guideline, and can tell you the maximum rent, but don’t solely base the decision off this number alone.

The number which is critically important is the economic income or economic occupancy. This is the realistic prediction for your total rent. It takes into consideration the occupancy rate and the percentage of tenants paying on time. For example, if you have a 90% occupancy rate and assume that 90% of those tenants pay on time, the economic income is going to be 80% of your GSI. You can find out these numbers by asking for the last two years of financial data on the particular property you are evaluating. If it is a new property, then you need to make sure your market research is robust: know the average vacancy rate and average rents, and make assumptions about the tenants off your other properties (if you have any). If this is your first property, then make sure to include plenty of room in your calculations, like over-estimating that 20% of the tenants will pay late instead of 10%.

Eventually, you will start to get a feel for the numbers in a certain market as you look at more data and do more deals. A mentor can give you guidance through the financials, but make sure you’re basing your purchase on math and not on gut feelings.

Jay A. Redding
President
JMJ Services, Inc.
Phone:260-440-7443
Fax: 800-706-3479
www.InvestmentPropertyMadeEasy.com
www.BuyHotPropertiesNow.com
www.FastHomeSolutionsNow.com