Investment property analysis: Rentals.
Rental properties are among the best investment options available to investors at about every income level imaginable. Rental properties bring in monthly revenue, and can be managed fairly easily. This, combined with the power of appreciation, leverage, and tax deductibility, makes real estate the ideal investment. One of the most important things any investor must do in the course of his business is to determine the actual value of any property considered for purchase. There are certain things that every investor should look into before purchasing a property in order to make sure they are truly getting a solid investment.
Investment property analysis: The property itself.
First and foremost is to run the numbers. Add up the monthly rent and subtract the monthly expenses such as the mortgage (if you did not pay cash), property taxes, insurance, water/sewer, etc. If you can get a profit after deducting all the expenses, the property in question can be put on the proverbial short list. You will also want to look at other similar houses for sale in the area to make sure you are getting a fair price.
Investment property analysis: You get what you inspect.
Another critical task is to coordinate the property inspection. The idea is to hire a licensed inspector to make sure the property does not have any hidden problems. These people are trained to look for warning signs and damaged areas of the building. They will be able to tell you whether there are any major structural problems with the property that will affect its value. This is critical because you do not want to get stuck with a structurally questionable property. You will also want to factor in the amenities available in the property. Things like appliances, landscaping, extra closets, a nice yard, a garage, etc., will all improve the perceived value of the property. Tallying up the value of these amenities, along with your analysis of the numbers and the property inspection, should provide everything you need to know about the property itself to make an informed decision.
Investment property analysis: The surrounding neighborhood.
Another factor that impacts value is the neighborhood in which the property is located. Few people want to move into a neighborhood with properties located near railroad tracks or busy streets. It is always smart to take inventory of these types of annoyances and statistics into consideration when determining a property’s true value.
Another way to evaluate the desirability of a neighborhood is to analyze the number of jobs available in the area. If there are a lot of jobs, the area will be stable and will have enough renters too. Most people don’t want to live far away from where they work, so they will be willing to pay more money each month to live somewhere more convenient. If the property is located near a lot of important sectors and business areas, then the value of that property will usually be much higher than it would otherwise.
Investment property analysis: Metrics
Here are just a few metrics to use when doing investment property analysis.
- Gross Rent Multiplier:
- Investment or rental properties should produce income which usually comes in the form of rent. To quickly and efficiently compare properties, we will make all the figures annual. The total annual expected rent is the Gross Income. This is also called Gross Scheduled Income because it assumes the investment is always rented. You do not place a vacancy rate on this set of metrics. Many investors look at the Gross Rent in connection to the price to get a ratio called the Gross Rent Multiplier (GRM). If you divide the value or price of a property by the Gross Rent you get the GRM. We use this metric as a first look. Once the first look is promising, then we dive into deeper metrics.
- CAP Rate:
- The capitalization rate or Cap rate is the rate of return on a real estate investment property derived on the income that the property is expected to generate. Keep in mind that a property’s cap rate is simply its annual net operating income (NOI) divided by purchase price, and represents the unlevered annual return on the asset. For example, if a building is purchased for $5,000,000 purchase price and it produces $500,000 in positive net operating income (the amount left over after fixed costs and variable costs is subtracted from gross lease income) during one year, than: $ 500,000/ $5,000,000 = 0.10 = 10%. The asset’s capitalization rate is ten percent; one-tenth of the building’s cost is paid by the year’s net proceeds.
- Cash on Cash return:
- The cash-on-cash return is the ratio of annual before-tax cash flow to the total amount of cash invested, expressed as a percentage. Cash on cash returns is commonly used to evaluate leveraged transactions. This metric also could be used to evaluate non-levered deals. In reality, I personally use this metric the practically, in my day to day real estate investing. Whether it’s a flip or a rental property. For example, when an investor purchases a rental property, she might place down only 10% for a cash down payment. Cash-on-cash return measures the annual return the investor made on the property in relation to the down payment only.
Investment property analysis: The bottom line.
Determining the value of an investment property is easy if you know what to look for. Obviously, any property considered for purchase must be fairly priced, and be able to cover the monthly expenses. Beyond that, make sure the property is structurally sound and the neighborhood is desirable, and you will be well on your way to determining true value. Investing in real estate requires extensive research and knowledge of what’s going on in the current real estate market. It is important to determine the value of the property. In many case,s the price of the property does not represent the valu ofe the property. The value for an investor is what it yields. When your investing strategy is focused on the price another person would be willing to pay. This activity more resembles speculation than investing.
At Steelbridge Realty we are very knowledgeable and have a deep experience in investment property analysis.
Steelbridge Realty LLC is a Licensed Real Estate Brokerage that utilizes cutting-edge marketing techniques and data-driven Real Estate solutions in today’s ever-changing environment. Our group of professionals have decades of experience and have navigated through many business cycles. Our diverse background gives us the tools to guide people towards successful decisions.
During the beginning of the housing downturn, Steelbridge Realty LLC was the Brokerage arm of several private equity entities. We assisted them with asset modeling and market metrics. Many prominent local commercial projects were included in this scope of transactions.
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