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Call the Right Shots with These Real Estate Investing Tips

by Randy Gridley

Real Estate Investing Tips

 

Investing in real estate can be a lucrative venture. However, it can also be a venture in which things go wrong. An investor stands to lose thousands if not hundreds of thousands of dollars if unnecessary risks are taken. Even if an investment looks promising from the start and the investor has performed due diligence prior to making a purchase, things can still go south.

Here are some tips to help ensure that the investments you make are as sound as possible. You want to take the following measures before, during and after you acquire various properties. These measures include:

Analyze Cash Flow

Do not take unnecessary financial risks. Do not buy a property sight-unseen or one that is clearly going to net a negative cash flow. Always run your numbers carefully before signing a deal. Make sure that you get your invested funds back in addition to earning a profit. 

Pass On a Fixer-upper

It is all right to buy properties that require a little work, perhaps a touch of paint or a new window here or there. Anything that needs a total rehab or comes without kitchen or bathroom fixtures should be avoided at all costs. Everyone needs somewhere to live. If you buy a property that is not perfect but can be spruced up for small change, you have little to worry about. You will find someone to rent it from you if need be. Leave the big rehabs to the experts. 

Obtain Long-term Financing

Do yourself a favor and finance once per property. You could refinance down the road, but this is more costly for you. You would have to pay for additional loan charges and that will eat up the returns you would get if you stuck to paying off your initial loan. If you can, finance one time only so as to keep your investment cash flow at its maximum. 

Get All Title Documents in Order

Be sure to review and organize all title documents upon closing. If you need to, go over any questionable items that come up on the title and resolve them prior to taking the deed over. You may also want to conduct your own survey of the property after reviewing the title work to secure your investment.

File the title binder away where you have easy access to it. Also, be certain you have all pages for the title insurance policy, title abstract, and the schedule of exclusions. Your title insurance agent can review them all with you just after your purchase is complete.

Insure Your Property with Liability Coverage

Insure your property properly. Make sure you have enough insurance on it to protect the property and your invested funds in it. Your insurance agent can help you determine the right coverage limits to purchase. The coverage should protect your investment if you are ever hurt in an accident or otherwise injured or incapacitated. 

Manage the Properties Properly

If you are renting properties and you live close to them, you can opt to manage them yourself. However, it is more financially sound to hire a professional that you can trust to do the work for you. This way, you can spend more of your time finding other properties in which to invest.
 
Take the above measures and enjoy limiting the financial risks that could impact your real estate investment. The above tips are going to help you save time and money. Speak to other long-time real estate investors and get their advice about all the ways you can make more financial gains in real estate. 

If you each work together, you might be able to benefit financially from everyone’s knowledge, contacts and expertise. Always keep learning, and real estate investing will be a successful field for you.

Series Part 5: Real Estate Investment Deal Analysis - An Introduction

by Randy Gridley


 

Cash-on-Cash Return (COC) 

In the same way there are multiple measures of income, for example Cash Flow (financing dependent income) and NOI (financing independent income) there are multiple measures when it comes to returns as well. As mentioned before, the theoretical return on the fully paid property (or financing independent rate of return) is known as the Cap Rate. In addition to this, there is the real rate of return - in other words, the non theoretical return. Since this return is directly related to the amount of cash you put into the investment, it is known as the Cash-on-Cash or COC return. 

As an example, we went over the fact that putting $100 into a savings account would give you a return of $4 per annum - also known as a 4% ROI. The COC is the same measure, except it relates to the return you would get from putting that $100 into a property instead of a savings account. 

This is how the COC is calculated: 

COC = Cash Flow divided by Investment Basis 

In the example we used, the annual Cash Flow is $11,621 while the cash that we had to invest in advance on the property was $98,000 - which includes the closing costs and improvements as well as the down payment. So, in this case, the COC is: 

COC = Cash Flow divided by Investment Basis 

= $11,621 / $98,000 

Which comes to a COC of 11.86% 

Since the COC is directly comparable to the return on a savings account, it is clear that in this case the property offers a better return than the savings account. In addition to this, although there is a lot more energy and time involved in the property investment, the return is higher than that of a diversified stock portfolio. 

Although it is naturally up to you what rate of return you require when purchasing a property, it is clear that if the COC is less than 10% it is probably not worth it, and you may, in that case, be better off investing that money in the stock market, which requires a lot less work. 

However, it's important to not make any final decisions based only on the COC since there are other aspects to consider that will affect your bottom line other than the COC. 

Total ROI 

The other key financial considerations to take into account, that will affect the performance of a property are as follows: 

Tax Considerations. You may lose or gain money on taxes, depending on your individual situation. 

Property Appreciation. It is not always possible to predict this, but if you are able to, it is worth taking into consideration. 

Equity Accrued. Since your tenants are paying off your property for you, it is worth taking this into account. 

There is an important difference between Total ROI and COC. COC refers only to the financial impact of Cash Flow on your return; Total ROI takes into account all of the factors that will affect your bottom line. Calculating Total ROI: 

Total ROI = Total Return / Investment Basis 

Total Return is the combination of: Cash Flow; Appreciation; Taxes; and Equity Accrual. 

Let's look at the following example of a Total Return calculation. 

We'll say the appreciation on the value of the property this year is 2%, based on the improvements that we'll be making after the purchase. This means the appreciation figure will be $8,360. 

The equity accrued in the first year of the mortgage comes to $3,251. 

For this example, we'll assume that there are no tax breaks or extra tax due if we own this property. 

So, the calculation of the Total Return of this property for the year is: 

Total Return = $11621 + $8360 + $3251 + $0 = $23,232 

Which makes the Total ROI: 

Total ROI = Total Return / Investment Basis 

= $23,232 / $98,000 

Total ROI: 23.71% 

Not bad! 

SUMMARY OF FINANCIAL ANALYSIS 

It's important to bear in mind that although we have all of the data we need in order to assess the value of the property, the assessment only refers to the first year of ownership. The return on your investment may increase or decrease over subsequent years due to changes in the variables. For example, expenses may rise due to inflation, while accrued annual equity will increase. Rental rates may decrease or increase according to the market, and your tax situation may change. 

Although it is not possible to predict the future, it is a good idea to use trend data or demographic data that indicate inflation and the direction of the market etc, in order to extend your analysis a couple of years further. 

As an example, this is a full financial analysis of this specific property, using a spreadsheet I've created which enables you to easily put together a financial model for the property of your choice. You can either click on the link or paste it into the address bar of your browser: http://www.biggerpockets.com/renewsblog/wp-content/uploads/2010/06/analysis.jpeg 

You can see from the example that if the revenue increases by 3% per annum due to rental rates rising, and operating expenses increase as predicted by 2% per year due to an increase in cost of services and inflation etc. the cash flow will also increase each year, along with the rates of return. If you were to carry out a more in-depth analysis, taking into account factors such as taxation issues, including deductions you would probably receive on the interest portion of your loan, you would find that your return could be even better.

 

Best Rates Of Return
As you probably know, cash flow is not the most important factor when it comes to analyzing the value of a property. The rate of return is more important, (also referred to as your ROI or return on investment). You should think of ROI as the amount of money you will receive in comparison to how much money you actually invested at the onset (your basis). From a mathematical perspective, that would be:
ROI = Money / Investment Basis
When thinking about ROI, it should be obvious that it will be much higher when either one, or both, of the following concepts is true:
The amount of your cash flow is going to be higher, or your Investment Basis will be much lower. As you can see, referencing the equation that we have just given. Making more money with a smaller investment makes it even better!
What is a reasonable ROI?   An example would be putting your money in a savings account with extremely high interest.  Your return (which would be your interest rate in this particular scenario) would be 5%. Mathematically speaking, if you are able to invest $100, you will get about five dollars back by the end of the year: In this scenario, we have an investment getting 5%. If you have a CD, 5% ROI is what you should expect. With some research, you will see that if you invest in the stock market itself, you are going to nearly double this.

What is the ROI with a property?
When looking at this, you will see that there are three numbers related to ROI that you should think about; let's examine each of these independently.
Capitalization Rate (Cap Rate)
NOI or key income value is independent when looking at financing. The ROI is independent of the buyer and details area the value is called the Cap Rate which can be calculated like this:
Cap Rate = NOI / Property Price
When looking at a financial analysis pertaining to any type of property, such as a rental property, this might be the rate. It has nothing to do with financing or the buyer and is simply an indication of how much money you will earn.
The following is the Cap Rate for the property we are discussing:
Cap Rate refers to an all cash deal where you paid for everything. This is different from cash flow. By paying all cash you are maximizing your returns, and the Cap Rate isn't the highest amount of return you can get. The Cap Rate refers to how much you invested for the full price of the property itself, and in our discussions of ROI, the investment amount will actually be reduced.
When it comes to looking at Cap Rates, which one is best? It depends on the location of country you are in and also the maximum Cap Rate which could be as high as 12%. When looking at a single family homes or other similar properties, the value of this investment, in regard to the Cap Rate, is found by looking at the other properties. On average, the Cap Rate is about 10%, which means you should be searching for a property that can generate 10% (of course excluding any other considerations and situations that may arise) which is most definitely a much better investment when compared to a simple savings account with a lower interest rate which makes this a much better investment to consider when you are using your money.

Continued in next blog article...

Real Estate Investment Deal Analysis part 3

by Randy Gridley


 

Data Gathering

We already talked about the input data you need. Now, you are going to find out where to get the data:

- Property Details: the seller should be able to provide you most of this information, but if you need more details, you may contact the local County Records Office

- Purchase Information: the price is going to be decided upon by the seller. This price should be negotiable. All upfront improvement and maintenance work that needs to be done in order to bring the property to its market potential should be known. In case of properties that are in good condition, there may not be any extra cost related to such works. It is always best to order a detailed building inspection by a specialist in order to discover any hidden problems of the property.

- Financing Details: You must get in touch with the broker or institution that's going to lend you the money for the purchase of the property.  You will need to find out which is the cost of the loan and how big the down payment will be.

- Income: These figures should be provided by the seller.  In order to have figures that you can truly rely on, you have to contact the property management company, if any, and get the exact information.

- Expenses: These should also be supplied by the seller.  Once again do not rely on pro-forma data for your final analysis. If there's any property management company taking care of it, contact them to give you the data. You could also hire a building inspector in order to assess major improvements or repairs that are going to be needed in the future such as a new roof, AC or heating system replacement and other similar things.

Example of Property

This will be a tutorial aimed at giving you the knowledge and the tools to be able to evaluate properties on your own.  I'm going to use a fictitious apartment building for sale. You should go and collect all the real data if you want your analysis to be as close to reality as possible.

These are the high level details of the building. Follow this link to see them: http://www.biggerpickets.com/renewsblog/wp-content/uploads/2010/06/flyer.doc. This document is close to what you might get from sellers as pro-forma data on the property they want to put up for sale. If the seller is professional, the document would probably look much better.

Example of Financing

All data that you will need for your calculations is included in the above flyer. You can go ahead and make your analysis based on it.  Keep in mind you will  need actual data to use in your evaluation before signing the contract. There's one thing the seller won't be able to tell you and that's how your financing in going to be. This is something only the lender or the mortgage broker can help you with, since they are the ones who are going to give the money for the transaction. For our dummy evaluation, let's assume we got in touch with the lender and we've got the following data:
- Price: As listed in the flyer
- Improvements: $10,000, as listed in the flyer
- Finance Amount: 80% of total cost
- Interest Rate: Fixed 7% over 30 years
- Closing costs: 2% of the total property cost

Starting from this set of data, we can do the calculations we are going to need later on in our analysis.  Now that we have all the data, let's proceed to the real evaluation!

NET OPERATING INCOME (NOI)

The Net Operating Income (NOI), is the total value of the income generated by the property after all expenses. This does not include debt service costs.

From a mathematical point of view, we have this:

NOI = Income - Expenses

The basis for calculating the NOI is the monthly income and expense data. Multiply it by 12 and you've got annual figures. Now that we have the formula for calculating the NOI, let's see how to get the data.

Property Income Assessment

The gross income includes rent collected from the tenants, parking fees and other costs such as income from laundry or ironing facilities. Our fictitious example has 8 units renting for $525 to $650 per month.

The laundry facilities in the building bring us an additional yearly income of $2,400 or $200 monthly income. We come to a total monthly income of $4,700, which means $54,000 yearly income generated by our property. This is not bad, but let's see what else is important that we did not take it into account in our calculations.

An important percentage of this amount comes from tenant rent. We need to take into consideration the fact that we might have some unit vacancy.  You can find out the average vacancy rate in that area and estimate yours as being a bit higher, just to make sure you are covered. If can also take a look at your history data and see whether the vacancy rate of the building was higher or lower than the surroundings average. It is always  better to be a bit conservative and assume your vacancy rate higher than the real one. If you assume the opposite, you may end up counting on income you actually don't have. This will generate more problems. Trust me, you will be sorry for your assumptions!

Now you need to assess the total income generated by your property by subtracting from the total figure you already have, the value of the income you won't get due to the vacancies. For the sake of our tutorial, let's assume that in our example property we only have an estimated vacancy rate of 12%. This means $4,160 in absolute value, which we need to subtract from $54,000. This is how we calculated that our total annual income would amount $49,920.

Real Estate Investment Deal Analysis Part 2

by Randy Gridley


 

Deal Analysis In Real Estate Investment Projects

Data Gathering

We already talked about the input data you need, now you are going to find out where to go to get the information:

- Property Details: the seller should be able to provide you most part of this information but if you need more details, you may contact the local County Records Office

- Purchase Information: the price is going to be decided upon by the seller. This price should be negotiable. Moreover, all upfront improvement and maintenance work that needs to be done in order to bring the property to its market potential should be known. In case of properties that are in good condition, there may not be any extra cost related to such works. Nonetheless, it's best to order a detailed building inspection by a specialist in order to discover any hidden problems of the property.

- Financing Details: You must get in touch with the broker or institution that's going to lend you the money for the purchase, as you need to find out what the cost of the loan is and how big will the down payment be.

- Income: These figures should be provided by the seller. In order to have information you can truly rely on, you have to contact the property management company, if there is one involved, and get the exact information.

- Expenses: These should also be supplied by the seller.  You should not rely on pro-forma data for your final analysis. If there's any property management company taking care of it, contact them to give you the data. You could also hire a building inspector in order to assess major improvements or repairs that are going to be needed in the future such as a new roof, AC or heating system replacement, and other similar things.

Example of Property

This is a tutorial aimed at giving you the knowledge and the tools to be able to evaluate properties on your own.  I will be using a fictitious apartment building for sale so you can see how it is done.  You should go and collect all the real data if you want your analysis to be as close to reality as possible.

These are the high level details of the building. Follow this link to see them: http://www.biggerpickets.com/renewsblog/wp-content/uploads/2010/06/flyer.doc. This document is close to what you might get from sellers as pro-forma data on the property they want to put up for sale. If the seller is a professional, the document will probably look much better.

Example of Financing

All data you need for your calculations are included in the above flyer. Go ahead and make your analysis based on it the document above.  Keep in mind you need actual data to use in your evaluation before signing the contract. There's one thing the seller won't be able to tell you and that's how your financing is going to be. This is something only the lender or the mortgage broker can help you with, since they are the ones who are going to give the money for the transaction. For our dummy evaluation, let's assume we got in touch with the lender and we've got the following data:
- Price: As listed in the flyer
- Improvements: $10,000, as listed in the flyer
- Finance Amount: 80% of total cost
- Interest Rate: Fixed 7% over 30 years
- Closing costs: 2% of the total property cost

From this set of data, we can do the calculations we are going to need later on, in our analysis. Now that we have all the data, let's proceed to the real evaluation now!

NET OPERATING INCOME (NOI)

The Net Operating Income (NOI), is the total value of the income generated by the property after all expenses, leaving aside debt service costs.

From a mathematical point of view, we have this:

NOI = Income - Expenses

The basis for calculating the NOI is the monthly income and expense data. Multiply it by 12 and you've got annual figures. Now that we have the formula for calculating the NOI, let's see how to get the data.

Property Income Assessment

The gross income includes rent collected from the tenants, parking fees and other costs such as income from laundry or ironing facilities. Our fictitious example has 8 units renting for $525 to $650 per month.

The laundry facilities in the building bring us an additional yearly income of $2,400 or $200 monthly income. We come to a total monthly income of $4,700, which means $54,000 yearly income generated by our property. This is not bad at all, but let's see what else is important that didn't take into account in our calculations.

Since an important percentage of this amount comes from tenant rent, we need to take into consideration the fact that we might have some unit vacancy, case in which we won't be collected the corresponding money. You can find out the average vacancy rate in that area and estimate yours as being a bit higher, just to make sure you are covered. If you want, you can take a look at your history data and see whether the vacancy rate of the building was higher or lower than the surroundings average. As stated above, it's better to be a bit conservative and assume your vacancy rate higher than the real one. If you assume the opposite, you may end up counting on income you actually don't have. This will generate more problems and you will end up being sorry for your assumptions.

You need to assess the total income generated by your property by subtracting from the total figure you already have, the value of the income you won't get due to the vacancies. For the sake of our tutorial, let's assume that in our example property we only have an estimated vacancy rate of 12%. This means $4,160 in absolute value, which we need to subtract from $54,000. This is how we calculated that our total annual income would amount $49,920.

Continued on my next blog

Real Estate Investment Deal Analysis Introduction

by Randy Gridley

 

 

If you always wanted to know what the meaning of a Cap Rate or of a Pro-forma, or how to calculate a NOI (net operating income) or various types of ROI ( return on investments), these series of articles are for you. 

There are also forums available online, such as discussion forums like Bigger Pockets, where people talk to each other about methods of evaluating real estate deals. While some forum contributors have quite a good understanding of the basics of a financial analysis, most people there are looking for help when it comes to basic concepts of evaluating deals.

I  love to answer questions, but it is very time consuming. Therefore, I put together a series of blogs and now I am making my blogs widely available to all consumers.  It is not a comprehensive blog, but it can serve as a very good starting point for beginners. Read this blog and the rest of the series to gain a better understanding of the whole property evaluation mechanism. 

INTRODUCTION

Have you ever thought real estate investments could be a profitable endeavor that would allow you to lead a good life, away from financial problems? If you have, maybe you want to know how to make a good analysis of a property before investing into buying and perhaps renovating it. There are methods to find out whether a deal you've landed is truly a deal or only a rip-off. There are lots of details I won't be touching here, but after you read my series of blogs you'll have the understanding of how to use available data and your brain to evaluate a property.  Be it, a multi-unit residential property or a 500-unit apartment complex. The common denominator is that they all offer living space for one family or more. Properties are often sought after, as they can make excellent long term investments.

These articles help you learn how to perform a financial analysis of any residential property you may intend to buy. The property size affects the analysis, but for this blog's purpose, we can make some assumptions, following that you adjust everything according to the size and the conditions of your property. However, if you are interested in a single-family rental, this analysis will work very well for you also. Single family homes are easier to evaluate, because the market is not affected by the same factors as in case of multi-family properties. Basically, a single family home, whether you buy it to live in or for investment purposes, will gain value if all other properties in the neighborhood gain as well. If these properties lose in value, yours is going to lose as well and there are very few things you can do to prevent this from happening. If a property equivalent to yours in size, number of rooms, number of bathrooms, condition and garage size will sell for an amount of money, you can be almost sure yours is going to be in the same price range. 

Larger residential buildings have other criteria for evaluating their value. This is the result of the total income the property has the potential to generate. The more money it makes the owner, the higher its value of the market is.  That is a given fact. In such cases, comparisons with buildings in the neighborhood don't make too much sense. 

Keep in mind, this analysis is centered on multi-unit residential properties. It isn't totally valid for all types of commercial property. You are going to need more information and perhaps other readable material to teach you how to evaluate industrial or storage space, commercial buildings or retail space. All these are handled differently and they are not factors of this tutorial.

The Information Gathering Stage

Before you buy any type of rental property, you must fully understand the different factors that must be included in any analysis of property value. This type of financial investigation requires putting high-quality information about the property into a working financial model. If both the model and the data are good, you will get the information that you require to tell whether or not a potential investment will be the right one for you.

Here is a list of the type of data that you will need to explore residential rental properties to get the condensed and accurate analysis that you need:

1. Basic Information About The Purchase Price: This includes the asking price and the room for negotiation as well as the cost of remodeling the property and any additional improvements necessary to make it attractive to renters. 

2. Financial And Loan Details: Find out how much of the purchase price you must put down as a deposit, what the actual loan principle will be, and what the interest rate of the loan will be. Find out the dollar amount of closing costs. 

3. Income Generation Potential: Explore the past rental history of the property and find out how much rent you can expect from each unit per month. 

4. Ongoing Expenses: Explore basic costs such as monthly property insurance premiums, property tax assessments, and expected costs of maintenance. 

In order to get reliable information about the income potential of the property, you must have good data to input into your financial model. Not doing your due diligence here might trick you into passing on a great property or getting stuck with a property that drains your pocketbook. 

Actual Data Versus Pro-Forma Data

Multi-unit rental properties are valued according to two things: how much income they generate and how much of that income is retained as profit. For this reason, the information given by the seller should be viewed and used with caution. For example, they may exaggerate how often the units are filled with paying renters, or they may neglect to mention that much of the profit has been made by foregoing needed repairs. These numbers can make a property appear to be worth more than it actually is. 

This problem area in financial reporting means that your job is to filter through the data that you receive to find the true story underneath it. 

You are probably asking yourself how this is done. 

Keep in mind that during the initial stages of negotiation you are receiving pro-forma data from the seller. Pro-forma means that the information is not actual but is estimated instead. It is your job to get the actual figures that reflect both the expenses and the income before you close. The seller should share his maintenance records, property tax bills, and rental income with you. 

If the actual data is the same as the pro-forma and you were already interested, you probably have a good deal on your hands. However, if the actual data makes the pro-forma data seem more creative than accurate, redo your thinking by inputting the new information into your model.

In addition, you'll want to investigate to find out if the property will cost you more in the future than it cost the previous owner. Find out how long its been since a property assessment was done. You might be in store for a big jump in the cost of property taxes. Keep in mind that incremental increases in cost can have a large impact on your bottom line over time. 

Be sure and check my blog for the next article in the series.

Displaying blog entries 1-6 of 6

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Randy & Doyelene Gridley
Silvercreek Realty Group
1099 S Wells St. Suite 200
Meridian ID 83642
Randy's Direct Office: 208-859-7060

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