A real estate investment analysis gives real estate investors a basis for setting rent schedules, estimating income and operating expenses, and provides a detailed description of the income property’s physical layout and marketplace position.
Fair enough.
So let’s take a look at what an investment analysis should address and answer before an investor makes a real estate investing decision to buy an income property.
1) How Does the Property Compare to the Market?
This is a fairly straightforward assessment. This is where real estate investors consider how the property is currently being used and then compare it with other similar-type income properties in the local market.
For example, if the subject property is a multifamily apartment building then you would want to know how the subject property measures up to other multifamily apartment buildings recently sold in the local market. Namely, is it as good, inferior, or heads and shoulders above the rest? Does your assessment apply to the property’s current condition or with minimal alterations?
2) What Is Expected During the Holding Period?
This concerns the real estate investing objectives set by the investor and the period of time that he or she expects to hold the real estate investment.
Some real estate investors, for example, might simply want to add value by increasing the rents and then re-selling the investment for a profit immediately. Others might have their sights on retirement and are looking for long-term ownership as a means to generate future supplementary income.
If your real estate investing objective is to buy and sell immediately then you must be certain that the numbers support a profit after all costs to acquire, perhaps rehab, and then re-sell the property and that the marketplace would in fact favor a sale. In the case of long term ownership, you must be sure that your cash flow projections are reasonable (not overly optimistic) and will likely produce the amount of income you desire.
3) What are the Physical and Economic Characteristics?
This concerns the type of rental agreements already in force that might impede or inhibit the real estate investor from making substantial improvements to the property.
If the subject property has long term leases already in effect, for instance, you get some amount of financial security but essentially cannot as readily make improvements that might warrant higher rents and perhaps add value to the investment property. Whereas month-to-month rental agreements might not feel as financially secure but at the same time they offer you an opportunity improve the space when they become vacant and in turn to seek out tenants willing to pay higher rents perhaps on longer term leases.
4) How Does the Property Stack Up to the Competition?
This concerns the subject property’s location, age, type of construction, condition, unit size, amenities and features with an eye upon specific differences compared to other similar rental property in the area.
In this case you need to evaluate those issues about the subject property that cannot be changed along with those that can in order to determine the impact they might have on your profitability.
Issues like location, for example, are unchangeable, therefore you must make an evaluation whether the location is a positive feature or will continually present challenges for you to keep the units occupied at market rents? The subject property’s condition, on the other hand, can be dealt with but will it improve the property’s position in the market, and at what cost?
5) What are the Operating Expenses?
This concerns those expenditures that keep the property in operation such as utilities and trash, repairs and maintenance, advertising expenses, licenses and fees, and so on.
This is vital for you to know and validate because operating expenses directly affects cash flow and profitability. In this case, you want to be sure that your investment analysis relies on realistic numbers for all your projections. The current owner might indicate an operating expense ratio of 40%, for example, whereas you might discover upon closer evaluation that the operating expense ratio is more realistic at 44%. Without a sound investment analysis to validate the property’s operating expenses you could make an unwise investment decision that will end up biting you in the wallet.
