investment property analysis | InvestingInProperties.com

Bricks And Mortar versus REITs

And the survey says…

A recent survey undertaken by overseas lender Homeloans Ltd. finds that real estate investors tend to choose bricks and mortar properties over Real Estate Investment Trusts (REITs) as the primary vehicle for their property investment funds. The singular reason? Most investors buying rental property prefer the “comfort factor” that a physical property affords them. Read: they want the feeling of security that controlling one’s own rental properties affords.

What the findings mean for small property investors

According to this report, the Homeloans Home Buyer Barometer, about half of property investors who took part in the survey preferred investing in rental property over purchasing shares in a REIT, regardless of the type of REIT (residential, commercial, or mixed). The comfort factor means that rental property buyers feel more secure in navigating their own destiny, rather than leaving it up to other real estate investment professionals to do so for them. They also want to realize a greater chance for capital growth returns, as well as higher cash flows from rentals that these real estate investments provide them.

Location is critical

As usual, the survey indicated that most property investors choose bricks and mortar rental houses that are close to transportation, jobs and local amenities. Naturally, this means central cities are the most popular spots for purchasing rental properties, followed closely by suburban bedroom communities. Rural communities rank last in desirability for rental property acquisitions. This is because rental demand is completely predicated on the proximity of services and amenities for prospective tenants. This also plays a major role in the ability for property investors to have an easier time of selling their properties when they deem it necessary to do so.

Additional findings of the report

The report went on to say that most investors would be in the market to purchase a rental property at some point in the next year. In addition, some 34% of the survey takers claimed they will be making their first rental property buy during this time. Some other highlights of the report indicated that close to one quarter of the respondents had bought their first rental property when they were between the ages of eighteen and twenty-nine. In addition, more than 50% had bought a detached house as their very first rental property.

Many prefer to buy close to where they currently live. About one sixth of respondents wanted the ability to drive by their rental properties on a regular basis to keep an eye on them. Also, about two-thirds of survey takers said they use a property manager, while a third self-manage their own rental properties. And finally, the average number of rental houses owned by the respondents was 1.6 properties.

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Real Estate Investing Trade-offs

Analyzing risk versus reward…versus stupidity

How far would you go to get a great deal when investing in real estate? This story ripped from today’s headlines shows that most property investors (OK – no property investors to date) want to risk everything (and by everything, I mean their lives) to obtain a “killer” of a deal when buying rental property.

As reported in Forbes.com (“Investment Opportunity: Possibly Booby-Trapped Property Remains Unsold,” by Kelly Phillips Erb, 8/15/14), the following investment property recently came on the market, and was advertised as such: “For Sale: Home on 110 acres in Plainfield, New Hampshire. As is.* Minimum bid: $250,000. * Property may be booby-trapped.”

No winning bid?

As Ms. Erb wrote: “surprisingly, when this property went up for auction recently, it didn’t attract a winning bid. Crazy, right? I mean, who wouldn’t be interested in purchasing a “fortress-like” home on more than 100 potentially life-threatening acres?” She goes on to tell the story of self-professed tax protestors Ed and Elaine Brown, who were recently found guilty of defrauding the U.S. government, as well as tax evasion, among other numerous counts.

Apparently, the Browns had a unique defense involving self-jurisdiction. As Ms. Erb went on to explain: “at trial, the Browns argued that they were not required to pay taxes. They firmly believe that the federal government does not have jurisdiction to tax money that they earn and used the courtroom to explain, claiming, “We will once and for all show beyond the shadow of a doubt – not reasonable doubt, beyond the shadow of a doubt – that the federal income tax system is a fraud.””

The bottom line?

The Browns eventually decided not to attend the rest of their trial, and fled to their property, where they proceeded to booby-trap it. When federal authorities eventually caught them and subsequently placed the property on the auction block for property investors to snatch up, no assurances could be given any potential investor that all the booby-traps had been found and removed. Hence – a bit of a sticky wicket for any property investor. Make a potentially lovely deal while investing in real estate, or die trying.

Fixer-upper to the max

Quite frankly, I don’t understand why some real estate investor didn’t decide to buy the property as is, and then throw in as part of their “fix-up” costs a team of well-trained security bomb experts to locate any potential booby-traps. As Ms. Erb reported about the marketing of the site: “at auction, there were no winning bids. And by “no winning bids,” I really mean, “no bids.” And by “no bids,” I really mean no bidders. Despite the fact that the property was listed for auction, not one potential bidder showed up in the courtroom in Concord, New Hampshire, just an hour and half away from the property.”

Second chances abound…

But not to worry…a second auction is being planned. So if you missed out on the first one, and your appetite for risk is at hunger level, gung-ho property investors may certainly like to consider fully analyzing the potential risk versus rewards of this particular secluded New Hampshire retreat. Of course, like with any real estate investment – you could make a killing in the process…

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REITs Show Their Appreciation

A different property investment approach

As mentioned in several other articles here before, Real Estate Investment Trusts (REITs) offer a nice alternative to property investors who do not want to become landlords or physical property owners themselves. REITs allow property investors great liquidity as opposed to normal property ownership in residential or commercial (retail, office, industrial or warehouse) real estate investing. REITs can also help you in diversification of your investment portfolio. They offer a direct, but smaller corollary to stock indexes, such as the Standard and Poors 500.

Many REITs qualify for federal tax break incentives if they distribute at least ninety percent of their taxable income through dividend offerings. Of late, many REITs have been performing better than ten year Treasury notes, on average. As a class of portfolio investment, REITs have been attracting more and more investors looking to find better returns than the bond market will allow in recent years. So, the growth in REITs (especially niche REITs that specialize in only one type of real estate segment, such as retail malls or office buildings, for example) has been great in the last couple of years especially.

REITs versus bonds

Investors should also understand that increasing yields through acquisition of REIT stocks is not the same as the acquisition of bonds. That’s because bonds as an asset class behave in a far different fashion than REITs. In general, over the last few years, REITs were approximately twenty percent more fluctuating than the Standard and Poors 500. They were about six times as volatile as the bond market in the U.S. too. The major risk factors for REITs include any potential for interest rate increases in the U.S. economy, as well as any slowdown in the current hot real estate market. Any new credit crunch will have another adverse effect on REIT prices. So one has to be wary about the predictions for REITs given the current slowing down in the overall pace of the previously hot real estate market.

Things to consider first

If you’re someone that does not feel they would be temperamentally suited to direct real estate ownership and landlording, whether commercial or residential, then REITs may be an excellent alternative for you. However, keep in mind that investing in a bundle of property stocks, regardless of the REIT niche you purchase in, the greater overall risk you’ll be afforded relative to safer investments such as bonds or Treasury bills. As usual, it’s the old risk-reward trade-off. Be sure to match your personality to your property investing style to make a good match.

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The Great Investment Property Search Time Saver

Lessons for free

Finding a contractor you like, can work well with, who also has a flair for creativity, and makes money-saving suggestions is a real boon in the search process. If you can work with a contractor exclusively, you can narrow your search process down to several top picks, then ask him to ride along to view them, offering his opinions along the way. You’ll also be able to learn from his expertise as you go from house to house, picking them apart for what work needs to be done to them.

Avoiding the wrecks

Any good contractor can help you identify any foundation or structural issues with any given property. They can also help identify which flooring is badly sagging and in need of fixing. In addition, they can help point out any mold or mildew problems you may miss, that are not so obvious. Naturally, they’ll also search for any cracking in the walls or around windows, and will be able to teach you the difference between vertical, horizontal and sloping cracks – and what they each mean. They’ll also be able to help you cost out in rough estimates how much it will be to repair each item on the house to-do list.

Armed with this information, you’ll be able to identify which homes are best left for an investor with either deeper pockets, or who is more gullible and less savvy than you. Remember, you’ll need to keep it simple…create a renovation/repair budget and stay within it…before you even start your investment property search.

An acquired skill set

Knowing what your ballpark figure for renovation costs will be on any given property is a skill you need to acquire. It takes time, and can be learned with the help of a trusted contractor. Once learned, you’ll find that you really won’t need the contractor to identify all the major issues with any given potential investment. Then, you’ll be able to create your own ballpark estimates to narrow your search down. When you find the best property to make an offer on, you can always then call in your contractor to double check your renovation problem areas, and your cost estimates. Then, and only then, should you be considering making an actual offer on any given piece of investment property.

Working the process

This process will ensure you save yourself and your contractor countless hours of wasted energy trying to properly identify good properties to invest in. When you call your contractor in for “the one,” he knows you mean business. So, remember to use a contractor exclusively. Make sure he’s loyal, an expert at what he does, and creative to boot. Also make sure that he can show you the ropes and give you a good, solid education in identifying problem areas in any given building. And finally, he should be someone you can count on to review your final estimates before you go forward and make an offer on a property. In this way, you’ll really end up saving yourself great time and money as a beginning property investor.

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Quick Property Investment Tips

Advice for the beginner investor

Novice property investors should be cognizant of these quick and simple property investment tips. They will keep you pointed in the right direction. Always refer back to them when you hit a snag in the process… (It also makes sense to try to memorize them, and recall them as you begin searching for new investments to acquire.) In this way, you too, can become a savvy, experienced property investor.

Purchase for retention

Make sure you always purchase rental properties for retention purposes. The longer you hold, the better equipped you’ll be to take advantage of long term appreciation in the property. You’ll also concurrently be writing down any mortgage note you’re paying off, thus increasing your equity valuation in the property. If you make a plan for purchasing a property at set intervals (for example, every couple of years – or yearly, even better), then you’ll be able to slowly accumulate a portfolio of properties (your “stable”) that will continue to throw off ever-increasing amounts of cash flow, as well as capital appreciation.

The power of leverage

Make sure you take advantage of leverage, when possible. While making all cash offers on properties may be advantageous to netting the best price on any one property, it is not advantageous to utilizing other people’s money to grow your investments through the concept of leverage. If you can obtain a mortgage, by all means do so. The greater the loan to value ratio the lender will allow, the better. Just make sure you don’t overextend yourself, and that you’ve double-checked your expense numbers properly. You want to ensure you have a comfortable positive cash flow on any property you’re thinking of acquiring.

Beware the bargain basement

While the concept of “stealing” a house in an auction or other competitive bid situation sounds really appealing, always be wary of the cost of a “steal.” Finding a great bargain in a poor location is like finding fool’s gold: you’ll end up paying for it down the road. Long term difficulties with obtaining market rent, high vacancy rates, and terrible capital appreciation tend to make that “steal” a steal for the seller! So be very, very careful when a deal feels too god to be true. It probably is.

The location axiom

Naturally, more desirable neighborhoods will yield greater upside potential in terms of capital appreciation. This does not mean buying a property in a rundown area is bad. Just be aware that a cheaper price for a lesser neighborhood will require you to understand the vagaries of dealing with the neighborhood…which will probably be run down in five or ten years, or whenever you will be selling the property. Keep your sights set realistically. If a bad neighborhood is all you can afford, make sure you don’t expect much from the property n terms of its capital appreciation over time. Or, at the very least, buy in a changing neighborhood – one that’s experiencing the start of some gentrification. (Hint: let the changing face of local stores be your guide here.)

Cash flow is great, but…

Make sure you always keep an eye on the capital appreciation rate in any given area you’re searching in. It’s the holding and growth of the marketplace of houses surrounding your building that will add value to your property in the long run. Be very mindful of this fact. Your year-to-year cash flow is obviously important to paying the bills and allowing yourself a profit on a regular basis. But it’s when you are ready to sell the building that most of your profit should be made…

Create an individualized investment strategy, and stick to it

Critical to this concept is that you’ll need discipline. In addition, you’ll need a plan. And most importantly, you can’t have discipline and a plan without also being scrupulously devoted to research and numbers-crunching for any potential property you are looking at. Simple math errors, not doing total due diligence on a property, accepting seller information only – these are like death to a property investor. You cannot tolerate mathematical mistakes. If you know this is not your strong point, then enlist the aid of a partner – or at the very least, seek the outside help of a trusted, math-oriented friend. Either way, this is the simplest way to mess up. So don’t.

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CAP Rate For Dummies

Demystification of an important number

Beginning property investors can easily become overwhelmed by the seeming complexity of an array of number crunching analyses experienced property investors run. And usually, the more experienced, the more they run these numbers. Usually, in their heads alone. But novices will need initially at least, have to use pencil and paper…or plug in numbers to software programs (see the Tools section of this site for one excellent calculator).

One of the most important calculations any property investor needs to run is the capitalization rate (CAP rate). It will yield a number to be used like the North Star is used for seafarers – a directional arrow to compare potential properties, and to gauge which properties may throw off better future returns, based on a specific price. Thus, the CAP rate will help narrow down choices of different property investments to help you determine the best ones for you to pursue, as well as guide you, like the North Star, towards negotiating a price above which, the property makes no financial sense to continue pursuing.

How the CAP rate works

So let’s break down the CAP rate first. Consider it as a simple tool to measure the annual rate of return on your property investment. Different geographical areas will have different CAP rates. In general, the more in demand an area, the greater the CAP rate. And vice-versa. Thus, higher demand areas will usually yield CAP rates much greater than lower demand areas. CAP rates, in general, tend to run between 4 to 10 percent for investment properties.

Doing the math

The calculation for the CAP rate is easy; simply follow this order: ascertain the annual rent roll from a given investment property (making sure to double check and confirm any seller-given figures). If there are vacant units in the building, you’ll need to ascribe a correct market rent for each unit. Make sure you check out several Realtor’s estimates, Craigslist listings, and have actually visited like units in other buildings to help determine accurate rent roll pro forma numbers. Then add up all the expenses associated with the building, on an annualized basis. Don’t forget a vacancy amount (usually between 5 to 10 percent of total rent roll, as well as maintenance, taxes, insurance, electric, heating, and any other utilities the tenant will not be paying directly for. Of course, unless you’re paying all cash for the property, you’ll need to add in your mortgage payment on an annualized basis as well. Once you subtract the total expenses from the pro forma total income, you’ll have your (hopefully) positive cash flow number. This, of course, is your net income.

Calculating the CAP rate

Now simply divide the net income figure by the amount the seller is asking for the property. (As an example, if a property that throws off $10,000 in net income has an asking price of $100,000, then the CAP rate would be $10,000/$100,000, or 10%.) To reiterate, the greater in demand the area, the greater the CAP rate should be. In addition, you need to set minimum standards for yourself. Some investors won’t buy anything with a CAP rate below 5%. That’s up to you. But be sure to use the CAP rate to help you back into the highest amount you would offer for a property. The CAP rate can represent your rate of return on any given investment property. After you run a few hundred of these calculations, you too will be able to compare properties in your head within minutes.

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Property Investing Analysis Shortcuts

Tips for quick comparison of investment property

All property investors should be able to utilize a couple of quick and dirty techniques to ascertain whether to make an offer on any property. You’ll certainly want to compare comparably priced buildings (comps) to see if their recent sales prices are in line with what you hope the purchase price will be for any particular property. And as you gain experience, you’ll find you’ll get better and better at understanding local comp values in your particular area.

Return on investment

But the most important ingredient in determining the relative value of any given piece of investment property, is the projected Return On Investment (ROI) calculation. Determining the projected ROI on any property will allow you to quickly and easily compare many properties you see in any given day.

To minimize the sheer volume of properties to consider making an offer on, try to figure out the relative cost per square foot for each property you consider worth your while. Using a price per square foot comparison is a good way to rule out obviously overpriced investment properties from your offer list. This will save you time and running around town energy as you search for your next investment property to make an offer on. And it should help you create a range to compare apples with apples for different investments. However, this type of analysis won’t help determine what a good offer price should be.

Calculating ROI’s

The simplest way of calculating the return on any piece of investment property, you’ll need to first gather all the investment costs. These include your total down payment, your loan costs, any renovation/repairs costs, and your property taxes, insurance and mortgage payments. Make a projection for your selling price based on comps, then subtract the loan balance you’ll have left when you eventually sell it.

Once you subtract the loan balance from your sale price when you sell, you’ll have your net proceeds from the sale. Then just divide your total cost into your net proceeds, and voila, you’ll have your total return on investment. Then you’ll be able to compare other possible investment properties one to another. You can then choose the optimum ones to make offers on as you compare apples to apples. With this quick and simple technique, you’ll be able to fly through a large volume of potential investment properties, winnowing them down to a choice few that will provide the optimum ROI’s.

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The One Minute Rental Property Analysis

Numbers crunching on the fly

When searching for residential real estate, you’ll need to go and visit a lot of ugly ducklings to find a white swan. The property that screams out: profitability, high positive cash flow and excellent return on investment (ROI). Therefore, it is crucial that you have a quick and dirty system in place to analyze any given piece of real estate you need to evaluate. A system that can let you know before you even move on to your next potential rental property to examine, if the current one you’ve just toured is worthy of an offer or not.

This system, ideally, should be something you can do by rote. You should be able to crunch numbers quickly. If you need to do them on paper, fine. But as you get more experienced, you’ll find you can do the calculations in your head. Ultimately, they should take no more than a minute to analyze, once you’ve asked the right questions, scanned the listing data on the property, actually seen the property, and have done the basic math. Your ultimate goal, of course, is to be able to winnow down prospective properties to the best ones available to make an offer on, in the least amount of time possible. You can always continue the process for any “winning” rental properties in more detail prior to actually making your initial (and succeeding) offers.

Gross rent roll

Here are the main items you’ll need to plug in: On the income side, you’ll need to obtain the current rent roll. If there are any vacancies, you’ll need to ascribe a market rent for them, based on the size and condition of the unit, its amenities, and the overall location of the property. It’s simple enough to come up with a base gross yearly rental amount based on this information. Make sure you consider if the current rent roll is undervalued or not, and if so, what leases the existing tenants are under. In effect, how quickly before you can bump up their rents to full market value? Naturally, you should already have a good idea of your local market rents for like size units in different locales within the area. These must be researched before getting in your car and starting your searches.

Cost structure

You’ll then need to deduct your overall yearly costs in order to come up with a good guesstimate of your annual cash flow. The main items here include property taxes, which should be provided on any listing data given to you. Be sure to check that the property is within an acceptable assessment range. If it looks like the property is currently over-assessed, you’ll want to be ready to grieve the assessment to get your taxes reduced should you actually acquire the property. If the property is under-assessed – beware! You could get socked with a new assessment if the municipality decides to reevaluate the entire town, or if you make any improvements to the building that require a building permit. In either scenario, be prepared to increase the current taxes as you crunch your numbers.

Mortgage costs

You’ll also need to add in your mortgage costs, if you are not paying all cash. Remember that non-owner occupied rental property traditionally have slightly higher mortgage interest rates than conventional home loans do, as much as 1 to 1 ½ percent higher on average. And if your credit score is below the low 700’s, the rates can go even higher. You can also expect to have a higher down payment requirement than a conventional home loan. So instead of 20 percent down for a conventional home loan, non-owner occupied rental property can start at 25 to 30 percent down in most cases. With poor credit, it can go up to 40 or 50 percent down, depending upon the lending institution and their lending standards.

Utilities

Another cost to consider are utilities. Do the units pay for their own electric bills? This is usually the case. However, there may only be one furnace in the building, and you as the landlord will be paying for heating costs for all the units in the building. Are the rents high enough to cover this type of cost? And make sure you get the current seller’s records for heating usage to ensure accuracy. In addition, check to see if there are any other miscellaneous fees that go with the building, such as association fees. You’ll also need to obtain data on the current seller’s insurance costs, and check with your own insurance company to see if they are in line, or if you’ll need to bump up that figure as well. After a while, you’ll acquire a sort of shorthand with your insurance agent, so you’ll be able to estimate rough insurance costs for a year on the spot.

Vacancy rate and maintenance

The last couple of cost items are strictly a function of your gross rent roll. They include a cost deduction for unit vacancy. Usually, if you’re being conservative, you’ll account for 2 month’s worth of vacancy per year for each unit in the building. In a hot rental market though, you can cut this down to 1 or 1 ½ months of your gross rent per unit. And if you’re going to use a managing agent, you’ll have to figure in a cost of roughly 10% of gross rents collected. However, they will take care of all your tenant selection and placement. The final expense to include in your analysis is an amount for maintenance. Certainly, you need to figure on at least 10% of each unit’s gross rent. A more conservative approach would be to use a 15% maintenance figure. This will help cover expected maintenance items like plumbing or handyman repairs. But it should also be enough to cover unexpected emergency repairs.

Perfecting the one minute analysis

Once you’ve done this analysis on paper a few dozen times, you’ll find you’ll be able to run the numbers in your head. And you’ll also find that you will become proficient in doing these calculations while you actually are walking through a prospective rental building. Pretty soon, you’ll find you can get the total numbers crunching done quite speedily. In very short order, you’ll find that you too will have perfected the one minute rental property analysis. Then, it’s on to the next potential white swan laying in wait for you to discover…

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