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.