How successful investors prepare their real estate analysis
Successful real estate investors never simply trust what others tell them. Once a potential real estate investment has been located, prudent investors perform a detailed examination of the rental property’s income, expenses, cash flow, rates of return, and profitability. Regardless of what overzealous agents or sellers say, vigilant real estate investing demands a validation of the numbers.
To accomplish this, real estate investors rely on a variety of reports and rates of return to measure the financial performance of an income property. And in this article, we’ll consider some of these financial reports and measures.
Reports
The most popular report used in real estate investment circles is perhaps the Annual Property Operating Data, or APOD. This is because an APOD gives the real estate analyst a quick or “snapshot” assessment of the property’s performance during the first year of ownership. It is not considered a tax shelter, but a properly created APOD can serve as the real estate equivalent of an annual statement of income and expenses.
A pro forma income statement is also popular with analysts. Although meant by speculative numbers, a pro forma provides a useful way for real estate investors and analysts to assess the future long-term cash flow performance of an investment property. Proformas regularly projects numbers over a period of ten to twenty years.
Certainly, one of the most important documents for a real estate analysis is the Rent Roll. This is because the sources of income and the income stream of a property are vital to making sound real estate investment decisions. A rental listing typically lists currently occupied units with current rents along with vacant units and market rents. During due diligence, of course, tenants must confirm the rents shown on the rental register.
rates of return
The capitalization rate, or cap rate, is one of the most popular rates of return used by real estate analysts. This is because the capitalization rate offers a quick, first-glance look at a property’s ability to pay its own expenses by expressing the relationship between a property’s value and its net operating income. The capitalization rate also gives real estate investors an easy method to compare similar properties.
The cash-on-cash return measures the relationship between the anticipated cash flow in the first year of a property and the amount of investment required to purchase the property. Although the cash-on-cash yield does not take into account the time value of money or cash flows beyond the first year, this deficiency is often overlooked because it provides an easy way for real estate investors to compare the profitability of similar properties that generate income and investment opportunities quickly.
The internal rate of return is more complex because it requires a calculation of the time value of money and therefore requires a financial calculator or good real estate investing software. However, it is widely used by analysts because the internal rate of return reveals in mathematical terms what a real estate investor’s initial cash investment will yield based on an expected stream of future cash flows discounted to equal today’s dollars. In other words, the internal rate of return converts tomorrow’s dollars to today’s dollars and then calculates the return on your investment.
Here is the point.
Take the time to carry out a complete real estate analysis. Create reports and returns and hold the numbers up to the light. This is the only reasonably certain way to make the right investment decision in any potential real estate investment. If you do your real estate analysis correctly, you’ll know whether or not the investment makes financial sense, and almost certainly guarantees the success of your real estate investment.
