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.