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If you're a prudent real estate investor, and we'll assume that you are, then once you locate your prospective real estate investment, you must analyze it carefully and thoroughly. You must verify all the details about the property, especially the income and expenses the seller shows. You must never rely on just what you hear.
Develop a property analysis that includes an APOD, Proforma Income Statement, Rent Roll, and so on. In addition to helping you make a wise investment decision, these types of real estate analysis reports also serve as a reminder for items you want to know, such as type of units, age of the property, rent breakdown per unit, expense items, lot size, property and location features, and so on. You can use a real estate investment software solution to assist you.
Analyze the potential real estate investment using the following list of the various phases. If the rental property doesn't seem to make financial sense after your initial analysis has been made, perhaps altering one or more of these will improve the financial picture and make the property a good real estate investment.
1) Income: Can rents be increased, and can they be increased soon after you purchase the property? Would a change in the type of tenant in the building allow for higher rents, maybe income is suffering because of poor or non-existent management? Can the building be used in some other way to increase income, such as a motel, or small offices? Be certain local zoning allows for any proposed changes. Does the property have a reasonable potential to provide other income such as a coin-operated laundry facility, garages, or storage rooms?
2) Expenses: Take a close look at operating expenses to see whether any of them are excessive. If they are, will you be able to lower them? You may not have control over all of them, but you may save some money if you intend doing your own lawn maintenance and repairs.
3) Financing: You can adjust the return on an investment merely by applying various financing techniques. Whereas one type of financing package might make your prospective real estate investment look unprofitable, another financing package might as easily turn your prospective property into a sound, profitable investment. Try various alternatives in financing to see how the mortgage impacts cash flow, rate of return, and profitability.
4) Cash flow: Don't just consider the before-tax cash flow produced by the investment real estate to determine your overall benefits. Look at the after-tax cash flow and determine what your property will give you in the way of a return after taxes. It's always best to consider the elements of tax shelter such as the paper loss the IRS permits for depreciation (cost recovery). Again, a good real estate investment software solution will make this computation for you, so it doesn't have to be difficult or should it be ignored.
5) Price: Regardless of all other factors, some rental properties simply will not make sense unless you can get the seller to accept a lower price. To increase your chances for success, however, don't simply throw out a number. Sellers who get the impression that you're merely trying to low-ball them will be reluctant to discuss the price with you. Beforehand, tweak the price to see its affect on the cash flow and rates of return, and then select a price based on the reasonableness of the returns. Prepare those figures and discuss them with the seller. You might be surprised to discover a seller willing to listen to reason.
The point is that the numbers must make sense. Never make a decision to purchase investment real estate based on the aesthetic beauty of the building or by using a simple rule of thumb to determine its value. Remember, only women are beautiful, real estate investing is all about the numbers.
Take the time to prepare a property analysis. This is the only reasonably certain way of making the right investment decision on any prospective real estate investment. If your property analysis shows that the property doesn't make financial sense, forget how pretty it may be and don't buy it!
