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Here are some quick search tips that will keep you pointed in the right direction when trying to locate your next piece of investment property. Trite but absolutely true, finding the worst property in the best neighborhood is axiomatically better than locating the best property in the worst area…regardless of the absolute price. Most beginner investors get too hung up on the bottom line price they’ll have to pay. Instead, worry about whether the cash flow will throw off enough return on your investment.
Cash or Mortgage
You should also be concerned about your ability to finance the project. While having enough cash on hand to pay the freight for the entire purchase is nice (and will always yield you the most advantageous negotiating position to obtain the best price on any piece of investment property), having the ability to finance and obtain a mortgage on a property is much more important. Leverage is the key, and you will not be using any leverage when you buy all cash. That said, keep in mind that you could employ the strategy of buying all cash in order to obtain the best deal on any given property, then finance it with a mortgage after you’ve purchased the property: in effect, the best of both worlds. Keep in mind though, that most lenders will require some form of “seasoning” (or amount of time for you to actually own the building) until they are able to give you a loan on it. Seasoning traditionally can be a year or more, depending on the lender.
Avoiding negative cash flows
Keep in mind that your pro forma cash flow will tell all you need to know about whether a potential investment property will be a good deal or not. You’ll certainly want to avoid any negative cash flow scenarios (also known as negative gearing), unless you have deep pockets, and are pretty sure you can turn the property around by raising rents substantially in a short period of time to drastically increase your cash flow…either through repairs – or through being able to replace existing tenants with below-market rents, with those that pay market rent.
Creating your pro forma income statement
Your pro forma income statement (also known as your pro forma cash flow) needs to reflect actual expenses on the potential property you’re considering making an offer on. Never take the word of the seller. Do your due diligence, and get confirmation of every figure a seller gives you. Pour over each lease. See each expense item bill for the last year or two the seller gives you. Talk to your insurance agent for accurate figures on what new insurance will cost you – and make sure you have enough of both property insurance, as well as liability insurance.
Make sure you can ascertain exact figures for the current rent roll, as well as common expense items such as taxes, fuel (whether oil, propane, or some other source), sewer and water charges, trash collection fees, electricity charges and insurance. Naturally, you’ll also need an accurate number for your projected monthly mortgage payment if you will be obtaining one.
Oh, and don’t forget to add in an amount for vacancy. While it is wishful thinking to create a pro forma cash flow based on 100 % occupancy, it’s not reality. You always need to build in some vacancy rate. The standard is 10% of the total rent roll. Depending on the area, and the ease or difficulty it may be to rent out a vacancy, the 10% figure can be tweaked up or down a couple percent. But the norm is 10%. (It’s just really hard to replace a tenant without some down time in between.) Also, don’t forget to add in the expense of .maintenance. This also is usually a small percentage of total rent roll (you can plug in any number you like – from 2 or 3 percent up to 10 percent , based on how liberal or conservative you’d like to plan for emergencies – like a burst pipe, for example…
Just make sure you don’t skip any steps, and do your homework, diligently. In this way you can best protect yourself – and identify the best investment properties on the market that are ripe for acquisition.
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