In my previous post, I ran through a financial analysis for a hypothetical property. In this post, I would like to go through how I narrow down my list of potential properties and the inputs I use when conducting my financial analysis.

To determine which properties are deserving of more thorough financial analysis, I like to start with the 1% Rule. The 1% Rule says that if a property rents for 1% of the total sale price, it is good investment. For example, if a property sells for $300,000 and the expected rent for that property is $3,000 per month, this property would meet the 1% Rule and is worthy of a closer look. The upside of the 1% Rule is that it screens out huge numbers of properties thus making our financial analysis much easier. We no longer need to spend time running a calculation for every property we see on Zillow. 1% Rule properties generally have positive cash flow which is what I want to see when evaluating properties.

The Property Calculator

This is the calculator that I use for my property analysis. I’ve found it to be a great tool in determining cash flow and the annual rate of return. I also suggest building your own calculator in Excel. It’s easier than it sounds and it will give you the peace of mind that your numbers are accurate. It also allows you to save the analysis for individual properties so that you can compare numbers. For the purposes of this exercise, I will use the inputs as described on the PropertyCalculator.co website.

Acquisition Costs

Purchase Price: This one is straightforward. How much is the house listed for? This metric can be modified up or down depending on supply and demand in the area. Properties that have sat on the market for several months without a price cut can likely be purchased for less than the listed price. Areas where properties are being snatched up in under a week…well you likely will need to pay over listing to have a chance.

Closing Costs: Closing costs are the fees associated with borrowing money from a lender and transferring the title from the seller to the buyer. Generally speaking, these costs include lender fees, appraisal, title report and title insurance, recording fees with the city/state government, real estate agent fees, discount point fees, and also any required upfront payment such as homeowner’s insurance or property taxes. You can find a more involved breakdown of what these fees are here. Long story short, closing costs vary between 2 to 3% of the overall purchase price. For our conservative analysis, I use 3%.

Renovation Budget: The renovation budget is simple to understand but more difficult to nail down. Renovation costs depend on how much money you plan to put into the home after you purchase it. If the home is in good rentable shape, then this number may be low. If you’re buying a fixer-upper, this number can be quite high. Even for a property that is in great shape, I like to include at least $7,500 as part of my expected renovation costs. You never know what was missed during the home inspection.

Other/Misc Costs: This may cover costs such as a realtor’s fee, travel costs, or the home inspection. If you are looking at an out-of-state property, here is a good place to enter in your expected travel costs. I generally put around $2,500 to $3,000 here, but it will vary depending on your personal situation.

Loan Type: This is where you enter in your loan type. Do you plan to buy the property with all cash or do you expect to have a loan? This will also vary depending on your personal situation and what loans you qualify for. There are many different types of loans, ranging from needing 3% money down to 20 or 25% money. The typical mortgage loan requires 20% down to avoid paying private mortgage insurance (PMI), so that is the value I use when running my analysis.

One thing to keep in mind on the loan type. If you are purchasing the property as an owner-occupant home, (meaning you plan to live in the house) you only need to put down 20%. If you are purchasing the property as an investment property, mortgage lenders typically require 25% down. You can talk to various lenders to see what their requirements are, but in my experience, they require more money down at a higher interest rate if the property is considered an investment property. Here is a good article describing the benefits of purchasing a property as owner-occupied versus an investment.

The other metrics to enter here are interest rate and loan term. For typical mortgages, the loan term is thirty years, which is what I used for my analysis. As the time of this writing (December 15, 2024), national mortgage rates stand at 6.74%. These rates will bounce up and down depending on the actions of the Federal Reserve and are also depending on your credit score / financial history. Unfortunately, the only real way to determine what rate you will get from a lender is to ask the lender themselves. Lastly, this rate is just the standard rate. You are actually able to buy down your interest rate if you are willing to pay money up front. Here are some numbers I recently received from a real mortgage lender for a $350,000 property:

6.5% – Par

6.375% – .5%

6.25% – 1.125%

6.125% – 1.375%

6% – 1.875%

The first number is the interest rate. The second number is how much you would have to spend to receive that rate. For example, if I wanted a 6% interest rate, I would have to pay 1.875% of the purchase price ($350k), which equates to $6,562.50 down. Is it worth it? If you think rates will stay flat or increase over the next few years, then yes, it’s worth it. If you think rates will eventually fall (and you can therefore refinance at the lower rate), then it may not be worth it. When I run my financial analysis, I typically assume I will buy down the mortgage rate by one quarter to one half of a point. So instead of entering 6.74% in today’s analysis, I might enter 6.375%. However, only you can decide what number you want and whether you want to be more conservative or aggressive.

Operating Expenses

These are the ongoing annual expenses associated with owning a house.

Taxes: The tax rate is dependent on the location of the home and whether you plan to hold it as an investment property or as an owner-occupant. For the city of Minneapolis, (which is my target investment location) the tax rate for owner occupants is around 1.3% and the tax rate for an investment property is around 1.7%. To find out the tax rate in the location where you are looking at properties, search around on the city or county’s website. They typically have some information on what this rate will be. Either way, I would enter in nothing lower than 1%.

Insurance: Homeowner’s insurance varies dramatically based on the city and state. Bankrate has a good map where they show the average costs for homeowner’s insurance. I suggest using this number as your minimum. Depending if you purchase a multifamly house or a single-family house, the insurance costs may be higher. For the Minneapolis location I have targeted, I’ve received quotes between $2000 and $3000 with varying levels of coverage.

HOA: HOA fees are typically listed on Zillow or any other listing website. If not, you will need to ask your real estate agent to find them out for you.

Vacancy: It is crucial to include some expected lost rent due to vacancy of your unit(s). I tend to be more conservative and include one month per year, which equates to 8.33%. You may be more aggressive if you wish, but I like to be more conservative in my forecasts.

Property Management Fee: Property management is typically around 10% of the rental price. If you expect to rent a home for $2,500, the property management firm will take a $250 cut. However, you can also call around local shops to determine a more accurate number. But for our analysis, 10% is a good starting point.

Capital Expenditures: Capital expenditures includes repairs and other costs associated with the upkeep of the home. These costs will also vary significantly depending on the state, age, and prior maintenance of the house. I like to include at least 1% of the overall purchase price per year. So for a $350k home, I expect to spend $3,500 on repairs. For older houses, I would set this number closer to 1.5%, but anywhere between 1 to 2% is a reasonable value.

Utilities: Do you plan to pay for any utilities? Depending on location, utilities such as water and garbage are handled by the city and utility bills can be added to your overall property tax burden. You can pass these on to the tenant directly or via a higher rent, so depending on your plan, this value may be 0. I, however, like to include around $75 per month to cover trash and water.

Other/Misc: This section includes any other expenses you expect. Are you looking to purchase in a cold climate? You should include funds here for snow removal. Does your property have a yard? You should expect to hire landscapers to clean and trim at least a few times a year. I include $1,500 a year in this input for general upkeep, and even that value might be low. Be as conservative or aggressive as you wish here.

Cash Flow

Now we get to the more fun stuff: revenue and income. Here is where you enter in your expected rents, rental growth, and home appreciation.

Rent Revenue: This is where you enter your expected monthly rent. You should include rent from all units if you are purchasing a multifamily home. This is perhaps the most challenging input to forecast and is often subject to gross optimism. I tend to use Rentometer, Zillow, and Craigslist to determine local rents in the area. Rentometer is good because it will give you median and average rents for the past year. Rentometer only allows you to search for a handful or properties before it locks you out. Pro tip: you can use other devices if you’ve been locked out and want to continue searching. It also resets after a few days. But generally, I use between the 25% percentile and median rent on Rentometer and may adjust depending what I’m seeing on Craigslist. The goal here is not to be too optimistic. If you are purchasing an 80 year old home with limited amenities and upgrades, you should not expect to get the same rental revenue as the brand new apartment complex with a gym, night watchman, and hot tub. I tend to run calculations for homes with multiple rental values just to see how the numbers compare at more conservative and more aggressive targets. You may find it useful to do the same.

CoC Return Goal: This metric is only here as a goal and can be disregarded.

Rent Growth: This is another metric that may be difficult to determine. I tend to peg this at 2%, which is close to the Federal Reserve inflation target. It may be conservative, but that is the point.

Appreciation: I also peg this value at 2%, but it really depends on the area. The appreciation value also heavily factors into your overall annual returns, so you really need to be careful with this number. The historical average for home appreciation is between 3% to 4%. Inserting anything higher than this is risking significantly skewing your model to the upside, so take some care when making your projections. For areas with low population growth or desirability (sorry Midwest), 1 to 2% is a good conservative value. For high desirability locations, you may choose something higher.

Other Costs: This is how much you expect all other costs (such as upkeep, repairs, insurance, taxes) to increase. I like to use 2% here, but 3% is probably more conservative. Generally this value should rise at the same level as inflation and has been closer to 5 to 8% in recent years. As inflation has decreased (and if you expect it to level out), 2 to 3% is reasonable value.

So there you have it. These are the inputs to your financial calculator. If you take nothing else away from this post, remember this: run your analysis conservatively. So many blogs, podcasts, and YouTube videos stress the ease in making money on real estate. But the reality is, real estate investing is not a get-rich-quick scheme. It’s a way to slowly increase your wealth and your forecasts should reflect that reality. By using these conservative estimates, you are calculating a realistic cash flow and a realistic annual return. Anything on top of that is just gravy. And if, after entering your inputs, you are seeing a lower cash flow or rate of return than you expected…that’s good. That’s your reality check that real estate investing is actually not Scrooge McDuck jumping into a pool of gold. Real estate investing is the attempt to beat out the stock market and expecting huge returns and vast riches is probably not realistic. Be aggressive with your forecasts at your own risk.