rental property analysis and due diligence

4 Considerations With Rental Property Analysis and Due Diligence

When performing a rental property analysis there are four major considerations to make. You absolutely must perform due diligence on every property you buy to avoid problems and maximize profitibility.

There are many types of rental property analysis and due diligence that you can perform based on the type of investment property that you plan to purchase. Since my philosophy and this site is focused on purchasing single family residential houses that will appeal to first time home buyers, that is what this analysis will focus on.

There are 4 main areas to focus on your investment property evaluation:

  • Location/neighborhood
  • Condition of the property/environmental issues
  • Market rents Vs Expenses
  • Legal issues

Since we do not focus on multi-unit properties there is not likely to be any financial history to review for our rental property analysis or concern about occupancy rate.

However, for a multi-unit rental property one critical element of due diligence is to look at the last 12 months of income and expenses and have an accountant review this data.

Best Location and Neighborhood for Investment Property

If you are new to the process of investing in rental property will be useful for you to utilize the services of a Real Estate Agents & Realtors. Find properties that are within reasonable driving distance from where you live. Look at sales data for single family homes that have sold in the past 6 months. Look at houses like these:

3 BR
800-1500 square feet
garage or carport

Using a map, plot the location of the properties. The properties that sold in the upper half of the price range for this size property are not going to make you much profit, so you can eliminate these houses from your search. In the lower half of the list of properties will be some that are highly priced in poor neighborhoods and others that are under-priced in better neighborhoods – these are the ones that you want to look at.

Drive the neighborhoods of the bottom half of your list and note how well kept other properties are and if there are adjacent schools that would increase value or factories or areas of decay that would devalue the property.

Take pictures and make notes. With your sales data and driveby you should have a good idea of what is a good value and what is a poor value and know what areas to use as your target markets.

Rental Property Analysis – Evaluating the House

Once you have a few properties in your targeted neighborhood it is time to evaluate the condition and cash flow potential. First, a thorough home inspection is needed. You don’t need a professional inspector at this point, but if you are uncertain, add a contingency clause to the purchase agreement to hire a qualified
Home Inspectors.

Some environmental issues to be acutely aware of when doing your inspection are:

buried heating oil tanks
flaking paint in an old house (lead hazard)

After you’ve done your inspection it is time to get out your calculator to estimate rehab costs. You can use a real estate book like Means or have a general contractor help you. Knowing the rehab costs will help you negotiate a better price.

More importantly, knowing the rehab costs added to your purchase price will help you evaluate whether the property will have a positive or negative cash flow and whether the after repaired value will make the house overpriced or have equity.

Market Rents and Cash Flow

The next step is to do a market analysis of the prevailing rental rates for 3 BR houses. Typically, using our rent to own strategy you will get 20-50% higher rents then prevailing rents, but during your evaluation, use market rents.

Use the rules given under buying rental property to evaluate whether based on rents and PITI payments, the property will produce a positive cash flow. Don’t underestimate maintenance and repair costs – even if the house is in excellent condition.

Use some of the free rental property software to perform a financial analysis of the property.

Legal Issues

Part of due diligence when buying an investment rental property is to make sure that there aren’t any liens or encumbrances on the property. It usually pays to have a professional

Title search done. Finding a lien on the property after closing can cause a major loss. (A too eager seller offering me owner financing almost trapped me when I found a large IRS lien on the property just prior to closing.)

The other professional due diligence to do is a survey. Sometimes previous owners have given “rights of way” to neighbors or companies that will restrict your ownership and lower the value of your property.

What ever you decide, a proper rental property analysis is essential for evaluation of investment property. Doing due diligence keeps much of the stress out of owning rental properties.