The investment decision real estate investors make as to whether or not
to purchase a rental property ultimately requires serious number
crunching that measures the property's financial performance.
even prudent calculations without first collecting some raw data
related to the market (to shape an offer) and then about the property
itself (once an offer is written) will not guarantee that the investor
is making the most prudent investment decision.
In this article,
we'll briefly discuss both the market and property data investors must
consider before and during the investment process.
The Market Data
a real estate investor can decide on how much to offer for a rental
property, he or she must understand as much as possible about the
conditions of the real estate market surrounding the property in order
to structure a meaningful offer.
We recommend that investors survey and collect data on at least these three market indicators.
Comparable Sales Conducting a survey to see what other similar income
properties have recently sold for is a proven way to evaluate whether a
seller's asking price is in line with realistic property value. Keep
the sold comparables as recent as possible (perhaps within the past six
months to one year) and the properties themselves as comparable as
possible. You want to look at rental properties similar in usage,
location, size, and condition to the rental property you are
considering. Real estate agents are generally prepared to do this for
you, or you can conduct your own survey by researching the public
records at local tax assessor's office or making a call to several real
2) Rental Rates and Expenses Conducting a
survey to see what tenants are willing to pay for space and owners are
obliged to pay for operating expenses in the surrounding area for
similar kinds of rental property is also valuable information. Just be
sure that the rents you survey reflect similar unit configurations such
as number of bedrooms and baths, size, and so on as well as property
location, condition, and amenities. It would be misleading to think
that the subject property (say, an apartment complex in a C location in
poor condition) will generate the same rents as a recently remodeled
apartment complex in an A or B location for instance.
Capitalization Rates Knowing what the typical capitalization rate is
for a particular kind of property inside a market area is very helpful.
By knowing at what cap rates other similar rental properties have been
selling for gives you a hint on how to structure an offer. If you
aren't aware of what a cap rate is, or how to calculate it, you should
find out because cap rates are one of the more important returns used
in real estate investing; a qualified broker with knowledge about real
estate investing or various resources online should provide the answers
The Property Data
Once you have an
acceptable offer, it is then incumbent upon you to be sure that the
numbers used to make the subject property's cash flow calculations are
truthful and correct. Remember, real estate investors purchase an
investment property's cash flow (or income stream). We recommend that
you validate the accuracy of at least these elements during your due
diligence; obtain from the seller or in some cases indirectly from
1) Leases and Rental Agreements - You become
subject to the terms of the leases and rental agreements if you do buy
the property, so examine tenant agreements closely. What do they say
about rental rates, renewal options, and termination? How long does
each lease run? Do they agree with the seller's representation of the
property's income? You must be able to count on the current figures to
make forecasts about the rental property's future performance.
Property Tax Bill - By looking at the property's tax bill, you can
confirm the accuracy of this expense. You might even uncover whether
some sort of tax abatement granted to the current owner that might
expire or not apply to you as the new owner, or maybe some other tax
issue that could impact you negatively.
3) Utility Bills - At
least spot-check what the owner has been paying for gas, electric,
water and sewer. Most utility companies will give you usage information
if you call, and the information can be a useful way to discover
discrepancies in the operating expenses presented you for the property.
Maintenance Records - Look for how much and where the owner has been
spending money to maintain the property. Normal wear and tear can be
expected, but repetitively having to replace broken windows, for
example, can be an indication of tenant or neighborhood problems.
Seller's Schedule E Tax Return - This information is helpful because
you see the income and expenses the seller has been reporting to the
IRS about the property. It's quite unlikely that an owner will claim
too much income or too little expense on a tax return, so this can be
an illuminating source of information. Just be sure to include a
request to see the Schedule E in your offer because most owner's are
reluctant to provide it unless it's been made part of the offer.
now re-create your real estate analysis using the data you discover at
odds with your original number crunching, and there you have it.