If you are interested in house-hacking (buying a rental building and living in one unit), or simply buying your first investment property, it can be hard to know where to begin when analyzing it. Evaluating the numbers can be more difficult if you are considering buying a rental building that needs a significant amount of work.
In this post, I outline how to evaluate the numbers on a two to four unit investment property that needs renovation. For most of these numbers, I assume that the renovation work is extensive and the property will undergo a gut rehab. Many of the same principles outlined below apply to smaller-scale renovations as well.
This article teaches how to create an income and expense statement, showing what the income and expenses for the property will look like after the renovation is complete. You always want to ensure that a new property will cash flow positively before deciding to buy it. I am including example numbers for each section so that you can easily see how the numbers all come together to evaluate a property. I have also broken down separate rehab and no-rehab numbers to show examples of how the numbers can change with a fully-renovated property.
I have written a separate article for understanding the costs of buying the property, and the renovation itself, it is linked here.
Jump Ahead to a Section Here:
Income
Analyzing the income portion of a rental property is probably the easiest part. There aren’t that many numbers to understand and include in your analysis. Just be sure the numbers are as accurate as possible so you don’t lose money once you own it.
Income will usually include these items:
Rent
No Rehab:
If you are purchasing a property that is already rented out and you don’t plan to do any work to it, finding this number is easy. Use the amount that the units are currently rented for in your analysis. Often the seller or seller’s agent will state that rents are below market value and can be increased. To run numbers conservatively, ignore that and use the current actual rents. To evaluate whether rents are actually below market value, have your agent run a search for examples of other similar rentals nearby. You can also do this research by searching online for rentals in the area. Keep in mind that active rental listings online aren’t a perfect measurement. You can only see what rent price the properties are listed at, not what amount the unit ultimately rents for. The active listings are usually a decent indicator of rents in the area. Look for apartments with a similar number of bedrooms and bathrooms, similar finishes, and similar floor levels.
With a rehab:
Have your agent run a search for examples of other rentals nearby. The comparable rentals should have similar finishes and amenities to what your units will look like post-renovation (in-unit laundry, central AC, dishwasher, updated kitchen, baths, etc.). You can even do this research by searching online for rentals in the area. Keep in mind active rental listings you find online aren’t a perfect measurement. You can only see what rent price the properties are listed at, not what amount the unit ultimately rents for. The active listings are usually a decent indicator of rents in the area though. Look for apartments with a similar number of bedrooms and bathrooms, similar finishes, and similar floor levels.
Let’s assume you are considering buying a 3-unit building. Example rent numbers are below.
Pre-rehab the current rents could look like this:
Unit 1: $1,000 (1 bed, 1 bath garden unit)
Unit 2: $1,800 (2 bed, 1 bath simplex, single floor unit)
Unit 3: $2,500 (3 bed, 1 bath duplex up, two-floor unit)
Total monthly rent: $5,300
Total Annual rent: $63,600
Post-rehab rents may look like this:
Unit 1: $1,500 (1 bed, 1 bath garden unit)
Unit 2: $2,500 (2 bed, 2 bath simplex-single floor unit)
Unit 3: $4,000 (3 bed, 2.5 bath duplex up-two floor unit)
Total monthly rent: $8,000
Total Annual rent: $96,000
If you plan to live in one of the units, I always recommend running the rental numbers as if you won’t be living there. Ideally, the property should cash flow positively without you living there. Run a separate set of numbers to evaluate it with you living there.
Vacancy
The same vacancy rules apply for turn-key properties and a property you plan to rehab. (The vacancy cost during the renovation is accounted for in carrying costs, see my Cost of Rehabbing article).
Always include a negative vacancy number to account for a rental unit not being rented a full 12 months out of the year. There are many reasons a property could end up with vacancy. It may take time to rent out an apartment unit. The unit may need a deep cleaning and painting after a tenant, etc. Even though I operate most of my rentals in Chicago with 0% vacancy, I always include 3-5% of the rent as a vacancy deduction when evaluating a new property. I’d rather be conservative when evaluating numbers on a new property.
Based on the example building we are using, a 5% vacancy factor post-renovation would be:
Post-Rehab Vacancy:
Monthly: -$400
Annually: -$4,800
Move-in fees
In Chicago, most landlords now collect a non-refundable move-in fee instead of a security deposit. I always assume one-third of the units will turnover each given year. So in a 3-unit building example, you would collect one move-in fee each year. Check other rental listings to see what the going move-in fees are in your area. For this example, we will assume $500.
Total Post-Rehab Annual Move-in fees: $500
Parking
Often parking is included with rent. If that’s typically the case in your area, you can skip adding this income item. If there is more parking than units, or if parking is usually charged separately, include it as additional income. For the example numbers, I’ll assume parking is included in the rent.
Laundry
If the building does not have in-unit laundry, and there are common laundry machines that are coin-operated, then add a bit of extra income for laundry. Most of the buildings I work with have in-unit laundry after I renovate them, so I will skip this line item for the example as well.
Total Post-Rehab Income
Rent: $96,000
Vacancy: -$4,800
Move-in Fees: $500
Total Annual Income= $91,700
Expenses
Some expenses are easy to find an accurate number based on the current building condition. Other expenses may take more educated guessing. Lean on your real estate agent to ensure you have as accurate expense numbers as possible. The expenses provided on the listing usually are not complete. Run and evaluate the expenses on your own, and do not rely on the numbers provided by the seller and seller’s agent.
Taxes
No rehab:
You can use the actual tax number for the property. This number should be on the listing for the property. If it’s not, tax information is in the public record so you can easily find it. Talk to your real estate agent and attorney about any risks of taxes increasing dramatically in the area you are looking to buy.
With a rehab
If you plan to do a large-scale renovation on the property, assume the taxes will go up. In the City of Chicago, you can appeal your taxes based on the purchase price of the property for three years after the purchase. This will help keep your taxes lower for a few years but assume they will likely catch up to the post-rehab value. Look at other similar buildings in the area to estimate what your taxes will be after the renovation. The similar buildings you compare should be similarly updated, and that have been for a few years.
Pre-Rehab Taxes: $10,000 Annually
Post-Rehab Taxes: $15,000 Annually
Insurance
No rehab:
Some listings will include a cost for what the current owner is paying in insurance. If that expense number is provided, you can use it. If no number is provided, ask your real estate agent for a rough cost, or call an insurance broker. They should be able to provide an estimated range.
With a rehab
With a complete renovation that includes new electrical, plumbing, roof, etc., your insurance cost will be lower. If no number is provided, ask your real estate agent for a rough cost, or call an insurance broker. They should be able to provide an estimated range.
Pre-Rehab Insurance: $3,000 Annually
Post-Rehab Insurance: $2,500 Annually
Mortgage
If you bought the property with cash and are paying for the renovation in cash, then this expense won’t apply. Otherwise, if you have a mortgage, that expense should be included. I like to include the full mortgage payment (rather than just the interest portion) as an expense when initially analyzing a property. I want to see what my cash flow will be on a building. This mortgage expense is the monthly payment after the renovation is complete, and any rehab financing has been closed. For more information on the costs of renovation financing, see my article on understanding the costs of the renovation itself; it is linked here.
To calculate your monthly mortgage expense, use a free online mortgage payment calculator, or work with your lender to calculate it.
Post-rehab Mortgage:
Monthly $3,500
Annually:$42,000
Water
If the property has severe deferred maintenance with active water leaks, or if it doesn’t have a water meter, the water bill may be higher than it will be post-rehab. In most cases though, the water bill should be similar for the property in its current condition and for a fully renovated property. The water bill cost may be provided with the listing, if not the seller’s agent should be able to ask the seller for the annual water expense.
Water: $2,000 Annually
Trash
In the City of Chicago, for 2-4 units, trash is provided by the city and is included with the water bill. I did not include a separate line item for it in my expenses. If trash is not provided by the city in the area you are looking to buy, the current owner should be able to provide what the trash expense has been for the building.
Trash: None
Common electric
No rehab:
Often in vintage rental buildings, there is no common electric meter and one of the rental units has an electric account that includes exterior lights, the garage door, etc. If this is the case, technically the landlord should pay for that unit’s electric bill. A tenant should not cover common electric expenses. If there is a common meter, the current owner should be able to provide the average monthly common electric cost.
With a rehab
Although you may install more LED lights or efficient outdoor electrical fixtures, the common electric bill likely won’t change much from the property in its current condition. The current owner should be able to provide the average monthly common electric expenses.
If there was no common meter previously, and common electricity was tied to a unit, then be sure to add a common electric expense to your numbers.
Post-rehab Electric:
Monthly: $25
Annually: $300
Common gas
No rehab:
If the building has a boiler-based heating system, where a boiler heats the whole building, then there is likely a common gas bill that is the landlord’s responsibility to pay. If there is common laundry, with gas dryers, then there is also likely a common gas expense for the laundry. The current owner should be able to provide the average annual gas cost for the building.
With a rehab
After a large-scale renovation, it is unlikely that you will have a common gas expense. Laundry will likely be in each unit, and each unit will have its own gas or electric furnace system. Each tenant then pays their own gas expense, rather than the landlord paying for the building as a whole.
Post-rehab common gas expense: None
Leasing fees
This cost will likely be the same for a building in its current condition v. post renovation. If you assume 30% of the units turn (turn=a tenant moving out) every year, for a 3-unit building, one unit will turn per year. In Chicago, it often costs one month’s rent to hire a leasing agent to rent the unit. You also have the option to advertise it and lease it out yourself to save on this expense. In other markets, leasing costs may be included in management fees, and they won’t have a separate expense. To calculate this expense, I take an average of all three rents ($1,500, $2,500, and $3,800) and use that number as my one leasing fee for the year.
Post-Rehab Annual Leasing fees: $2,600
Management fees
In smaller 2-4 unit buildings, it is common for an owner to self-manage the property. If you decide to self-manage, you don’t have to budget any expenses for management. A completely renovated property is typically easier to manage. All items from the renovation should be under warranty for at least a year. New mechanicals, plumbing, electric, windows, roof, etc., make it less likely for leaks and maintenance issues to occur, beyond the warranty year.
In Chicago, management fees often range from 5-6% of the rent collected. I am not going to include this expense in my example since self-management is so common in smaller buildings.
Post-rehab Management fees: none
Maintenance
No rehab:
Maintenance expense is a difficult number to estimate. Try to learn how old the roof, siding, windows, appliances, and mechanicals are. The older they are, the more likely they will need maintenance or replacement. Even small items like doors being offline, a lock not working, a broken blind, etc., will require a handyman service call that usually has a minimum hourly rate.
With a rehab
All items from the renovation should be under warranty for at least a year. New mechanicals, plumbing, electric, windows, roof, appliances, etc., all make it less likely for leaks and maintenance issues to arise. This maintenance expense number should be low for the first couple of years.
Pre-Rehab Annual Maintenance Expense: $5,000
Post-Rehab Annual Maintenance Expense: $1,000
Turnover costs
In addition to repairing and replacing items that break, there is also a maintenance cost associated with a tenant move-out. Typically you will need to have the unit cleaned, do paint touch-ups, and do other small repairs. In running property investment numbers, sometimes this will be included in general maintenance, and sometimes it is broken out separately. Again assume 30% of units will turnover, so in this scenario, one apartment will have a move-out. The expense item is an estimate of what it will cost to clean and do paint touch-ups in one unit. The amount of painting needed will likely depend on how long the tenant has lived there.
Post-Rehab Annual Turnover costs: $750
Snow Removal
This is another expense you could save on by handling it yourself. If you plan to hire a company for snow removal, call one for a seasonal estimate. If you pay per snowfall or per push, the expense can vary a lot year over year, depending on how much it snows.
Post-Rehab Annual Snow Removal: $750
Janitorial
No rehab:
It is the landlord’s responsibility to keep shared common spaces clean. If the building has common laundry in the basement or a shared front or back entryway, the owner should clean them. You could decide to handle this cleaning yourself or hire a cleaner to come monthly.
With a rehab
I try to design my buildings without shared entryways or any common space. It eliminates the need for cleaning expenses and common keys. Tenants also gain private entrances to their units.
It’s not always possible to accomplish no common areas, and even with a renovated building, you may still need to account for a common area cleaning expense.
Post-Rehab Annual Janitorial:
Monthly: $75
Annually: $900
Legal/LLC filing costs
If you plan to own the investment property in your name, you don’t need to account for this expense. If you want to have an LLC as the ownership entity for the property, then there are costs associated with filing with the State to keep the LLC active. You can file the renewal yourself or hire an attorney to handle all of the renewals (which is an added cost). I am including an expense number here to account for the cost of the renewal but not for the cost of an attorney handling the filing.
Post-Rehab Annual Legal: $250
Accounting fees
This is another expense you can decide to do on your own to save money. If you plan to use an accountant to file taxes for the property/LLC that owns the property, you should account for that expense as well.
Total Annual Post-Renovation Expenses:
Taxes $15,000
Insurance: $2,500
Mortgage Expense: $42,000
Water: $2,000
Electric: $300
Leasing fees: $2,600
Maintenance: $1,000
Turnover costs: $750
Snow removal: $750
Janitorial: $900
Legal: $250
Total Expenses = $68,050
Income-Expenses= Cash Flow
With all of the income and expense items mentioned above, add them all together to figure out roughly how much cash you will bring in annually once the building is operating normally after a renovation. This should be a positive number! If it is not positive you may want to re-evaluate whether or not you should buy the property.
Income: $91,700
Expenses: $68,050
Annual Cash Flow: $23,650
Outside of considering the annual cash flow of the building once it is operational, there are additional upfront costs to a renovation that should be analyzed. This article outlines the cost of a renovation project.
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