Do you know how to analyze a property? Success in this business requires at least becoming familiar with several financial measures or formulas to decide if the property under consideration will meet your financial objective; otherwise, how will you know whether it is a worthwhile investment?
How do you know whether properties A, B, or C will be the best investment?
Taking time to run the numbers will make a difference, but unfortunately, far too many do not take the time to evaluate which is the quickest route to disaster. The biggest blunder anyone can make is chasing the deal and paying too much for the property. "Falling in love with the deal and not the property is critical.
1. Analyzing a single-family dwelling is straightforward. The most common way to determine the value of a house is a CMA (Competitive market analysis). Your real estate agent can get it for you.
2. For example, a property can be purchased for $120,000 and require $15,000 of improvements, while comparable properties in the same subdivision are sold in the $155,000- $170,000 range. It will need $15,000 worth of repairs, bringing the total investment to $135,000. It still sounds like a good deal to me. Would it be worth your while to get $25,000-$40,000 in equity?
3. Always remember who is making this payment for you(tenant); the amount leftover from the rent payment is the cash flow. How much monthly cash flow is acceptable? $100, $200, $350, or more? and your #1 objective.
4. If wealth building, retirement income, and financial freedom are your BIG, WHY is that a reason not to buy the property if it still cash flows? For every $10,000 less or more, it will be an additional $50 on the mortgage payment.
5. However, a multi-unit property (two or more units) is valued differently from a house, and the value is related to income and expenses.
6. What if two identical multi-unit properties are for sale one block apart? Property A has deferred maintenance and rents well below market, and Property B is in excellent condition and at market rents. You are considering writing an offer but want to determine how much you should offer and which property would be a better investment. You are seriously thinking of writing offers on both. Can you see why running the numbers is essential?
7. Would it be possible for a multi-unit to increase in value in the same general area as the example above while houses are declining in value? Yes, because the value for multi-units is based a lot on the income approach to determine the fair value.
8. Every investor has different goals. To some, cash on cash is most important. To others is the CAP rate, break-even ratio, operating ratio, cash flow before and after taxes, etc. What is important to you?
9. Commercial-type properties, such as large apartment buildings, industrial properties, strip centers, etc., require detailed information before the analysis can be done and is not advisable for beginners.
10. Remember to love the deal rather than the property and avoid making costly mistakes. Many inexperienced investors tend to overpay, often overvalue rental income, and undervalue expenses.
Some of the most common mistakes made are listed below. (You can think of others.)
Mistake # 1: Analysis paralysis Many people never take the first step toward building wealth or living in real estate because they have analysis paralysis. Whether you are in a seller's or a buyer's market, a property that is considered a deal will not last It is essential to get the property under contract before you put much time and effort into analyzing it.
Mistake #2: Fudging the fix-up cost Some investors underestimate the fix-up cost to talk themselves into moving forward with the purchase, while others overestimate it to justify backing away from the deal. Investors may also forget to include the carrying costs, insurance, interest, taxes, and so on and ensure the fix-up fee. Are realistic. Do not fudge the numbers to make the deal cash flow or the rehab pay off. Buying or not buying without helpful information or facts does not make sense. Take time to perform the appropriate due diligence.
Mistake #3: Overestimating the rent Sometimes rents are overestimated. What is the current market rent for the area? Is the estimated rent above or below market rates? If it is under the market, can the rent be increased? Is it better to buy a property with below-market rents than above-market rents? When a unit becomes vacant, will it be easy to rent, or will the rent be reduced?
Mistake #4: Overestimating the property's value Do not overestimate what the property is worth. Can the property be purchased at a drastic discount or perhaps a few thousand dollars less than the asking price? Plan for the unknown and be conservative in your estimate. Knowing the area and the prices for comparable properties should be easy to determine whether the property is a good deal. If it is a multi-unit, varied factors will come into play.
Mistake #5: Failing to recognize a great deal. A deal is a deal, any way you look at it. Learn how to spot a great deal and act on it. See mistake #1.
Mistake #6: Not paying attention to a property's location Remember the adage about real estate's three most critical features: location, location. Is the property in the A, B, C, or D category? Failing to consider where it is located could be the costliest mistake. If an investor is selling the property and it is such a good deal, why are they selling it? They want to make a quick profit. They want to pass on the deal to another investor who can take the project to the next level. They just purchased it last week and are wholesaling it. I bought several properties listed on the MLS and made $10,000 in a few days without doing a thing to them.
Mistake #7: Underestimating the time required to fix up a property Some investors underestimate how long it will take to fix and flip a property; therefore, the project's objective may be in jeopardy. It is always better to plan for the unexpected.
Mistake #8: Letting fear hold you back Nothing ventured, nothing gained. Arm yourself with knowledge and act quickly when you spot a great deal. Money and wealth are found on the other side of fear.
Mistake #9: Doing everything yourself The biggest blunder of all is for the investor not to utilize the services of a knowledgeable real estate agent. I listed properties purchased from "for sale by owners" that needed much work, and they overpaid. What they thought would be a profit-making proposition turned out to be the opposite. Ouch!
The value of a property is closely tied to how much income it produces. Knowing this, some sellers will provide inaccurate financial information. For example, they may overestimate rental income and neglect to mention that the maintenance expenses are much higher than estimated. This scenario makes the property seem more valuable than it is.
The NOI, net operating income, is one of the most important measures for determining property value.
The more complete the information you have gathered, the better your chances of making a good decision. How can you ensure that you have the information needed? Actual data is critical for a good analysis, but some things can easily change the picture. Initially, you may use the pro forma data, but accurate numbers are best to analyze at some point.
One common way to verify the information is to ask the seller to provide the schedule E 1040 return and maintenance records. What about if the seller refuses? (a red flag should go up).
What happens if the property's assessed value goes up or down? A significant difference will make the property valuable. Lower taxes mean higher income, and higher taxes mean lower income. Minor changes to income and expenses can make the difference between a poor, okay, or excellent investment.
Anyone contemplating the purchase of investment property should seek the advice of a competent and knowledgeable attorney and tax advisor.
Key points to remember:
• Become familiar with various financial measures to determine whether the property under consideration will meet your financial objectives. • You should base your decisions on whether the property will make you money or not rather than emotion. Remember, always fall in love with a deal rather than a property. • Having a gut feeling about whether a property will be a good deal is not enough; you need to run the numbers even if you are not a "numbers person." • Some information you require for evaluating a property's investment potential will be easy to find, while other data types will be harder to track down. • You should also be confident that the real estate agent you are using will at least have the same knowledge but hopefully more about financial terms if you are a seasoned investor. • Investors have different goals, and what is good for one may not be suitable for another.