Create a pro forma income statement for each rental property you plan to own before you make any offer
OK – so you’ve located what you feel is a great rental property. You feel it’s being offered at below market value, you live close by to it, the building is in a desirable spot, close to transportation, shopping and schools. Now it’s time to crunch the numbers to see what kind of offer you should be making.
Here are a few items you’ll need to either research or guesstimate in order to come up with a rudimentary pro forma income statement. As an example, it will look something like this (I prefer yearly amounts – you can break it down into a monthly statement if you so desire):
Pro Forma Income Statement
Total Yearly Income $ 36,000
Mortgage $ 12,000
Vacancy (@10% of gross rent) 3,600
Net income (before depreciation) 14,600
You can certainly ask the seller for his current figures for income and expenses. You’ll also want to speak with your mortgage broker to discuss those figures, and see if the lender agrees and feels they’re in line. Most banks will only offer loans based on 75% of the actual rent-roll of the building. If there are vacancies, the bank may impute a far lower number for projected rents.
I will leave discussion of depreciation to a later segment. (I would not use it in the valuation process prior to making an offer, since it represents a paper loss.)
Once you have a net income figure, you can guesstimate a market valuation for the property using multipliers for your area. Most value multipliers for rental investment property represent what’s going on in a specific geographic area. In general, real estate multipliers tend to run between 8 and 12 times gross income for the property. In hot markets and top geographic locales, the multiplier will tend to be at the higher end of the multiplier spectrum. And likewise, in soft markets, and/or very depressed or blighted areas, the multipliers will be at the lower end of this range. You can use this approach to come up with a ballpark estimate of valuation prior to making an offer. You’ll also want to compare this figure with your anticipated profit level and return on investment (ROI) for the property. Once you’ve done your homework, go on and make your initial offer on the property.
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