Rental Property: Test Financing and Cash Flow

Check the advertised income against the signed leases

A rental building is sold on its advertised income, but it is bought on its proven income. The signed leases give the real amounts, the end dates and the vacant units. The listing sheet often gives the seller's ambition. The gap between the two routinely runs to thousands of dollars a year. Then calculate the working income cautiously: the rents in the leases, minus a realistic vacancy allowance, which is one month per unit every two years in a normal market and more in a softer area. Leases nearing expiry deserve particular attention, since a departing tenant can reveal that the recorded rent was above market. That cautious income becomes the only basis for every calculation that follows.

Price the expenses in full

Listing sheets show the municipal and school taxes and often stop there. The complete picture adds rental-building insurance, which costs more than residential insurance, routine maintenance, estimated at about 1% of value per year, snow removal and grounds upkeep, the services included in the leases (heat or electricity as the case may be) and a management provision, even if you manage it yourself. Your time collecting rent, showing units and handling emergencies has a value, and it will become an expense the day you delegate. The reserve for major repairs completes the list: roof, balconies, windows and furnace will eventually give out. Their provision belongs to operating costs, not to surprises.

Test the financing and its own rules

Financing an income property follows different rules from financing a residence. The required down payment depends on the number of units and on whether you occupy one of them. The lender counts only a fraction of the rents toward qualification, using its own method, often half or less for buildings not occupied by the owner. Ask precisely about these two rules before setting a maximum price, since they determine the amount you can really borrow, often well below what gross income suggested. The lender's appraisal can also differ from the negotiated price, and the gap is covered in cash. A preapproval based on the target building, and not just on your salary, avoids bad surprises between the offer and the disbursement.

Simulate the quarter without rent

The deciding test runs on a realistic adverse scenario: three months without rental income for one unit, a tax increase and a major repair in the same year. If the mortgage payment then requires the credit card or the line of credit, the price is too high or the reserve too thin. This test sets the reasonable maximum price, often clearly below the asking price, and your offer starts from that figure rather than the listing's. Set up the repair reserve before taking possession, not after the first emergency. A building bought without a reserve puts every surprise on the owner's personal credit. A building that passes this test at your price becomes an asset. One that passes only at the seller's price remains a bet. Test at your own number.

Checklist

• ✓Rebuild the income from the signed leases
• ✓Subtract a vacancy allowance
• ✓List every expense the sheets omit
• ✓Add a management provision even when self-managing
• ✓Verify the down payment and counted rent fraction
• ✓Test the payment with no rent for a few months
• ✓Fund the repair reserve in advance
• ✓Derive the maximum price from the math
• ✓Offer on the calculation, not the listing