Please answer a simple question: How much time do you spend picking out clothes every morning? Usually, it’s longer than most investors spend doing the math for real estate investment analysis. Unfortunately, people select deals based not on analytics, but intuition.
Diving deep into the details of deal analytics may feel like a trip to jargon-town. Total return? Cash-on-cash return? NOI? Cap rate? Feeling bewildered? You’re not the only one.
In this article, we teach you how to determine the value of your real estate investment – the preliminary step towards conducting a real estate analysis. Different properties are valued differently. Evaluating a triplex the same way you assess a single-family home will lead to a wildly skewed figure. Here is what you need to know.
Market comparables (comps) identify the value of the investment, single-family homes, etc. These comps are nearby properties demonstrating similar characteristics. They share variables like amenities, garage size, number of bathrooms and bedrooms, floor plan. Generally, a single-family investment home increases in value if a similar home nearby is also increasing in value – and vice versa.
Larger investment properties – those consisting of at least two units, and especially those with over four, are valued and priced differently. The value is directly related to how much profit or income the property generates. It’s possible that an apartment building in a neighborhood where house prices are declining could increase in value.
You can’t compare your apartment building to others down the street to assess how much it’s worth. This is where real estate investment analysis comes in handy. There are several primary factors to take into consideration. However, appreciation and cash flow are the two most important variables. To put it simply, cash flow is the money left after every bill has been paid, and appreciation is referred to as the equity acquired as the value of property increases.
Since there aren’t many ways to estimate future appreciation without a crystal ball, it’s better to focus on the cash flow.
Collecting your information
Good financial analysis consists of feeding a bunch of information into a financial model and using its calculations to determine whether the investment is good or bad – and right for you. Be aware of these variables for the most comprehensive financial analysis of a residential property:
- Property details – utility metering design, square footage, number of units, etc.
- Purchase information – improvement costs or purchase price plus rehab, or total purchase expenses.
- Financing details – loan or mortgage information, like closing costs, interest rate, down payment, and the total loan amount.
- Income – rent payments along with any other income the property generates.
- Expenses – maintenance costs, including maintenance, insurance, and property taxes.
Actual or Pro-Forma Data
Getting good data from your model needs accurate, reliable information. Remember: It is in the seller’s best interest to offer appealing, not precise, numbers. For instance, they may offer high rental income approximations or neglect to mention some maintenance expenses. It is part of the investor’s job to ensure you have the best available information.
Estimated – or pro-forma – data from the seller only kicks off the discussion. Determine the actual numbers before closing. Ask to see maintenance records, property tax bills, and previous years’ tax returns. Hopefully, the actual data resembles the pro-forma data. However, don’t be surprised if it doesn’t.
Don’t forget to check for a prospective surprise
Check for a surprise as well. For instance, when was the last time the property was evaluated for taxes? If it was a while ago, and values have substantially increased, it is possible that the taxes will increase and the property will soon be reevaluated. Even little changes to expense and income numbers can mean significant changes to your bottom line.
Where to look for data?
Confused as to where to track down the necessary information? Begin here.
- The seller must make the property details available. For more detailed, comprehensive information, check with your local records.
- Purchase information comprises any improvement or upfront maintenance work that must be finished before the property’s income potential is met. Have the property inspected to ensure that no hidden problems or issues exist.
- Your mortgage broker or lender may offer financing details.
- The seller directly gives the income details – but don’t depend on pro-forma data. You can also have a chat with the property management firm currently dealing with the property, if one exists, for this information.
- The property Management Company or seller must directly offer expenses. A building inspector can notify you regarding any major repairs that may surface, like an HVAC system or a new roof.