How to Analyze Rental Property Profitability: Foursquare Method Guide

Investing in rental properties can be a fantastic way to build wealth, but how do you know if a deal is actually profitable? If you’re new to real estate investing, diving into the numbers can be intimidating. That’s where the Foursquare Method comes in—a simple, straightforward way to break down the key components of a rental property deal to understand its profitability.

In this blog post, we’ll walk you through the four key squares of this method: Income, Expenses, Cash Flow, and Cash on Cash Return. Plus, we’ll touch on the importance of considering appreciation and long-term returns. Stick around for a detailed, easy-to-follow explanation that will help you analyze your next rental property like a pro.

What Is the Foursquare Method?

The Foursquare Method is a popular and beginner-friendly system to analyze rental properties. It breaks down real estate investing into four simple components or “squares,” making it easier to understand the financials behind a deal. This method wasn’t invented by one person, but rather adopted from successful real estate investors who have mastered these key metrics.

The Four Squares of Rental Property Analysis

1. Income: What Money Is Coming In?

Income is the total revenue generated by the property. Most people immediately think of rental income, which is usually the largest source, but there’s more to it than that. Here’s what counts as income:

Rental Income: The monthly rent paid by tenants.
Laundry Revenue: Coin-operated laundry machines or onsite laundry services.
Garage or Storage Rentals: Renting out parking spaces or storage areas separately.
Miscellaneous Income: Other smaller sources such as vending machines or advertising space.

Example:
Imagine you buy a duplex in a B-class suburb of Northeast Ohio for $200,000. Each side rents for $1,000 per month, so your total rental income is $2,000 monthly. For simplicity, assume no laundry or garage income and zero miscellaneous income. Your total monthly income is therefore $2,000.

2. Expenses: What Does It Cost to Run the Property?

Expenses are all the costs you incur to maintain and operate your rental property. Understanding these is crucial because they eat into your profits. Typical expenses include:

Property Taxes: Monthly or yearly taxes on the property.
Insurance: Homeowner’s or landlord insurance.
Utilities: Gas, water, sewer, electricity, garbage; sometimes passed on to tenants.
HOA Fees: Applicable if your property is part of a homeowners association.
Landscaping & Maintenance: Lawn care, snow removal, repairs.
Vacancy Factor: The percentage of time the property is expected to be vacant; typically estimated at 5%.
Repairs: Regular maintenance and small fixes.
Capital Expenditures (CapEx): Large, infrequent expenses like roof replacement or driveway repairs saved over time.
Property Management Fees: Usually 10% of gross rents if you hire a property manager.
Mortgage/Debt Service: Monthly mortgage payments if you financed the property.

Example Expenses for Our Duplex:

Taxes: $150/month
Insurance: $100/month
Utilities: $0 (tenant pays utilities)
HOA: $0 (no HOA)
Landscaping & Snow Removal: $0 (tenant responsible)
Vacancy Factor: 5% of $2,000 = $100
Repairs: $100/month
CapEx: $100/month
Property Management: 10% of $2,000 = $200
Mortgage (30-year loan at 5%, $160,000 principal): approx. $860

Total Monthly Expenses: $1,610

3. Cash Flow: What’s Left Over Every Month?

Cash flow is simply your income minus your expenses. This tells you how much money you’re making (or losing) on a monthly basis from your rental property.

Formula:
Cash Flow = Income – Expenses

Example:
$2,000 (income) – $1,610 (expenses) = $390 positive cash flow per month

Having a positive cash flow means the property is generating income after covering all expenses, which is exactly what you want as a landlord.

4. Cash on Cash Return: Are You Getting a Good ROI?

Cash on Cash Return (CoC) measures how much cash you’re making relative to the cash you invested. It’s a critical metric because it helps you evaluate if the property’s return is worth your money.

Formula:
Cash on Cash Return = (Annual Cash Flow / Total Cash Invested) × 100%

Calculating Total Cash Invested:

Down Payment: 20% of $200,000 = $40,000
Closing Costs: Estimated $3,000
Rehab Budget: $7,000 (for repairs or upgrades)
Miscellaneous: $0

Total Cash Invested: $50,000

Annual Cash Flow:
$390 × 12 months = $4,680

Cash on Cash Return:
$4,680 / $50,000 = 0.0936 or 9.36%

Is 9.36% Cash on Cash Return Good?

To put this into perspective:

Savings Account or Money Market: Usually around 1.5% or less.
Stock Market Average: Historically about 10%, but with higher volatility.

A 9.36% return on a relatively low-risk asset like a rental property is pretty solid. It significantly outperforms savings accounts and offers a more predictable income stream compared to stocks. Plus, you get the added benefits of property appreciation and tax advantages.

Beyond the Foursquare: Considering Property Appreciation and IRR

The Foursquare Method focuses on cash flow and immediate return, but long-term wealth in real estate also comes from appreciation—the increase in property value over time.

For example, if you buy the duplex for $200,000 and after five years it’s worth $300,000, that’s a $100,000 gain in equity. When combined with your cash flow over those years, this significantly boosts your overall return.

This leads to the concept of Internal Rate of Return (IRR), which factors in both cash flows and appreciation, giving you a more comprehensive picture of your investment’s performance.

Real-Life Considerations and Risks

While the numbers look promising, every real estate investor must be aware of potential pitfalls:

Tenant Issues: Problem tenants can cause vacancies, damage, and legal headaches, especially in landlord-unfriendly states.
Legal and Court Fees: Evictions and disputes can be costly and time-consuming.
Unexpected Repairs: Major repairs can quickly eat into your cash flow.
Market Fluctuations: Property values can go down as well as up.

Good property management, thorough tenant screening, and maintaining a financial cushion can help mitigate these risks.

Final Thoughts: Master Your Rental Property Analysis

The Foursquare Method is a fantastic starting point for new and seasoned investors alike. It breaks down complex real estate deals into manageable parts and helps you quickly assess if a rental property is worth your time and money.

By understanding your income, expenses, cash flow, and cash on cash return, you’ll be able to make smarter investment decisions and start building your wealth with confidence.

If you’re interested in diving deeper into real estate investing or want tools like spreadsheets to automate these calculations, keep exploring and learning. And remember: successful investing takes patience, education, and a willingness to do the math.

FAQ

Q1: What is a good cash flow for a rental property?
A: Positive cash flow is good, but the amount depends on your investment goals. Generally, aim for at least a few hundred dollars per month after expenses.

Q2: How do I estimate vacancy rates?
A: A common rule of thumb is a 5% vacancy rate, but it varies by location and market conditions.

Q3: What’s included in capital expenditures (CapEx)?
A: Expenses for long-term repairs or replacements like roofs, HVAC systems, or major renovations.

Q4: Can I pass all expenses to tenants?
A: Some expenses like utilities or lawn care can sometimes be passed on if included in the lease agreement, but property taxes, mortgage, and insurance cannot.

Ready to analyze your next rental property like a pro? Start with the Foursquare Method, crunch those numbers, and make smart investing choices that work for you!

How to Analyze Rental Property Profitability: Foursquare Method