http://www.rentincome.com/real-estate-analysis.html Real Estate Analysis Blog en-us Mon, 6 Feb 2012 02:20:13 MST Mon, 6 Feb 2012 02:20:13 MST Free Real Estate Investment Property Analysis - Actuals, ProForma Statements, Analysis, Research, Calculators and More http://www.rentincome.com/article/378/Internal-Rate-of-Return-in-Real-Estate-Analysis Internal rate of return (IRR) is one of the rate of return measurements more widely used during a real estate analysis for good reason: The aspect of time value of money associated with internal rate of return considers that the timing of receipts from the investment property can be as important as the amount received.

Unlike some other popular returns used by investors to analyze the performance and profitability of rental income properties that don't account for the time value of money such as capitalization rate and cash on cash, IRR does.

As a result, internal rate of return is generally more popular amongst real estate investors than other rates of return because it calculates for time value of money and provides a linkage between present value (PV) and future (FV) of any benefit stream.

The idea is straightforward.

Because a dollar in the hand today is preferable to one a year or five years from now, real estate investors want to take into account both the timing and the scale of cash flows generated by the income-producing property to determine what that rental income stream is worth today. Internal rate of return reveals the rate at which future cash flows must be discounted to equal the amount of investment exactly.

How IRR Works

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, not tomorrow's dollars.

Consider this.

When you make a real estate investment, you are investing cash in order to receive a series of future annual cash flows resulting from rental income plus a tidy profit when you sell the property.

The challenge for real estate investors, then, is to discover what rate of return the investor's initial equity will make based upon those periodic future cash flows at the same time it considers the number of time periods (years) under consideration in the holding period.

The internal rate of return model meets that challenge by creating a single discount rate whereby all future cash flows can be discounted until they equal the investor's initial investment.

How to Calculate

Calculating IRR manually is not practical because the calculation involves tedious mathematical solutions that take a lot time. Even the most skilled investment real estate specialist will typically use a financial calculator or real estate investment software program to compute it.

So we'll ignore the formula (you can find it online if you really care to know it) and instead consider what it signifies.

Say you have $100,000 to invest in a rental income property and plan to hold it for five years. During those years, you plan on receiving five annual cash flows and then an additional amount from the sale of the property (also known as reversion). When you find the unique rate of return that discounts the sum of all those future cash flows until it equals your initial investment, you will have the internal rate of return.

In other words, it shows you what your cash investment will yield for those cash flow projections based upon today's value of the dollar, or as if those cash flows were collected today rather then in the future.

Of course, no single element of a real estate analysis should determine an investment decision to the exclusion of other factors and measurements. But internal rate of return can help guide your purchasing decision so plan to use it.

One final thought. If you are serious about real estate investing, then it is highly recommended that you invest in a real estate investment software solution. In this case, you not only will get a wide range of essential returns that includes IRR, but also benefit from all real estate analysis features that quality investment software provides.]]> Mon, 12 Oct 2009 11:00:00 MST http://www.rentincome.com/article/378/Internal-Rate-of-Return-in-Real-Estate-Analysis http://www.rentincome.com/article/377/Investment-Decisions-for-Real-Estate-Investors 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.

But 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

Before 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.

1) 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 estate appraisers.

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.

3) 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 you require.

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 other sources.

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.

2) 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.

4) 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.

5) 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.

Okay, now re-create your real estate analysis using the data you discover at odds with your original number crunching, and there you have it.]]> Wed, 23 Sep 2009 15:07:13 MST http://www.rentincome.com/article/377/Investment-Decisions-for-Real-Estate-Investors