Strange as it might seem, some numbers used in a real estate analysis, if “real”, can actually skew the bottom line and hurt an investor’s chances of making the best real estate investment decision.
In this article, we want to consider three of those numbers.
1) Vacancy rate – the tendency for many is to show a vacancy rate based on the past performance of the rental property—sometimes even at zero percent! This is not realistic, however, because market conditions, property wear and tear, rent increases, and even a change of ownership can (and often do) cause vacancies. It is always prudent in real estate investment analysis, therefore, to include an allowance for vacancies characteristic to the local market.
2) Maintenance and repairs – it is a mistake to show the amount actually spent over the past several years for maintenance and repairs. It is helpful for a real estate investor to know what an owner has done to upkeep the property, but past expenditures are not necessarily relevant to what a new owner might spend in the future. The current owner, for example, might be a repair person capable of keeping maintenance and repair costs reduced, whereas the new owner might be required to contract it all out at top dollar.
3) Replacement reserves - most tend to ignore this altogether because reserves for replacements are not a fixed reoccurring expenditure like property taxes, utilities, or trash. It is, however, wise to include an allowance for reserves in a real estate analysis because it provides for future replacement of worn out items an owner must eventually pay for, and therefore it’s best that an investor plan ahead to spend it.
A local real estate appraiser or real estate agent who understands rental property can advise you concerning these numbers. Here’s what you want to know. (1) Typical vacancy rates in the area for whatever-type property you want to analyze; (2) Typical percentage used to estimate maintenance and repairs (you should get one percentage for brand new or newer units and another percentage for older units); (3) The dollar amount per unit per year to include for replacement reserves.
Don’t hesitate to call and ask them. Because if you’re serious about working with real estate investment property, and want to present a real estate analysis with the most meaningful numbers and returns, it’s imperative that you avoid these rookie mistakes.
