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We all want to make a profit from our investment, this is the reason why we invested, correct? But like in the stock market not all Real Estate Investments are profitable. Knowing what and when to buy can be achieved through some analytical and investigating effort to become our magic formula for success.
In addition to the first truth in Real Estate, location, one has to analyze the operating expenses and interest rates to determine the property value and not just rely on the appraised value of the property. Appraisals are done by individuals and their work performance is also subjected, like any other job, to the individual´s ability to make the correct assessment. Be responsible with your money and put an additional fifty cents of effort to arrive at you own conclusion will pay in the end.
Analyzing the financial statement of the property you want to buy may yield some confusing results, so one has to look in more places to determine what values were used as the true operating expenses and what expenses were considered. Ideally, one should be able to form a baseline adjusted to the specific market. For example if you are interested in buying a rental apartment building you will also have to look at the tenant occupancy rate to see if this investment will truly yield at least an 8 to 10% return on investment.
How will you arrive to this conclusion? Here you will put the additional fifty cents of effort and follow these steps.
1.- Review the Operating Expenses BOMA and IREM. They publish a book with updated information every year.
2.- Talk to an appraiser; comparing what income and expense items are used for that area will help you see what information is not listed in the income statement of the property you are analyzing.
3.- Ask for financial statements for the last 3 years. Review the operating costs and see the capital expenses. Real Estate is a wearable asset and you must maintain the property, such as roofs, HVAC, paint, carpet, baths, and faucets all fall into this category. You must establish a fund to be financially prepared for these expenses. Remember Murphy´s Law. So don´t be caught off guard.
4.- Visit similar properties. By doing this you will get additional information about what they include in their pro-formas and establish a baseline. This will also allow you to see how long is taking them to find new renters giving you a true inside look at the market. Comparing the numbers and items from the property that you are looking to buy with these numbers will be very useful.
5.- Review rent numbers. Drive around the neighborhood; call other Real Estate agents and brokers to see what similar rentals go for. Check the incentives given to new renters since in the past this has proven to be, the quintessential skeletons in the closet, where hiding.
6.- Ask to see the Schedule K of the take return. This is where the truth lies, but very seldom the seller will allow you to see it.
7.- Check the vacancy rate. Your lender will seriously look at this, many banks will not loan if the vacancy rate is higher than 5%. If your vacancy rate is less than 5% then question what concessions were made by the previous or current owner. While some properties will perform better than others often depends on the market and type of investment, you want make sure you are evaluating your intended property fairly. If your vacancy rate is over 5% you might be able to secure financing if you remodel the property but assessing exactly what improvements will allow you a higher rental and occupancy rates often depends on the market. Additionally, the benefit of remodeling the property comes in extra time to get more tenants.
We all want to achieve positive cash flow and that should be between 8 to 10% to make it worth the effort. If after making all the adjustments mentioned above the property still performs at this level of return then you should proceed with the purchase. Remember also to add the expenses of your due diligence.
Not buying an overpriced property will make a world of difference and you will reap the benefits of your effort when the property appreciates and you enjoy a positive cash flow.
GBrey | 