Investment Property Analysis

This article describes why investment analysis is important and how.

Why is Analysis Important?

Many people claim to offer great investments. Most of these advisors make money sound like it grows on trees?

Here are a few examples of people in my life that made these claims.

My Uncle used to talk about "PASSIVE INCOME" and he would regularly brag about how he bought apartment buildings in Chicago creating a passive income.

My father would go fishing on Tuesdays and claim it was possible because he knows how to "MAKE MONEY WHILE HE SLEEPS".

A smart professor of mine that owned a property investment business told his clients, "I WANT TO PAY YOU TO PARTY".

All three of these people made great investments; each one knew what it took to buy well and work smart.

My Uncle bought multiple apartment buildings in Chicago and he did very well. At a relatively young age he quit wearing a suit to clock in. His investments not only paid for a great life, but he was also able to send his children to the best universities. He wasn't successful because he bought rentals. His success was due to the fact that he bought rentals after he performed an in depth analysis and then purchased at a good price with a good plan.

My father carefully bought rental properties that were very diverse. He wanted a portfolio that would profit in great economies and recessions. My father bought well, planned for any situation and he spent more time fishing than he did in the office. His portfolio included multi unit properties, duplexes, a trailer park and single family homes.

Who Should Perform Investment Property Analysis?

Many investors work providing professional services for others (lawyers, accountants, teachers and salesmen) and do not have time to analyze and search for properties. They rely on a real estate agent that specializes in investment properties.

Investment property analysis should be performed quarterly, but annually is a common practice.

I perform property evaluations for all of my clients in Brevard County Florida. Property investments are great because the investor never needs to see the property, let alone live in the same state. Florida is investment friendly and I would be glad to help, however if you are looking for properties in your community outside of Florida I can recommend advisors in most areas. Submit any requests to Maxfield Home Solutions, we are happy to help.

What is a Property Analysis?

The 5 key aspects of a property analysis include the following:

Time

When to buy or sell, is a very difficult question, maybe the hardest question for investors. Time refers to the year, season and cycle. For example, in the mountains of Colorado it is difficult to buy a home at a good price during the winter or spring. The market usually has a low inventory at those times which increases prices placing sellers in the power seat. Usually, only a local specialist will know how the seasonal trends fluctuate. The only way to estimate the annual trends is with lots of research and planning.

Location

Even a child knows, "Location, Location, Location". However, location truly depends on your goal. Cocoa Beach condos are great for AirBnB or VRBO, but it is difficult to own a house in Cocoa Beach and rent it annually with cashflow. In Garden City, Kansas the property costs are equal to Cocoa, Florida, but the rent is 75% more in Cocoa. More rent with the same cost provides CASHFLOW.

Economy

The economy is important to consider in both a macro and micro analysis. If the national economy is failing like in 2009 there will be ample properties for sale, yet no one will buy them (except smart investors like yourself). This is why it is important to regularly evaluate your investment portfolio and balance as needed (locations, types and rental rates).

Type

There are two groups of residential income producing properties; long-term rentals and short-term rentals. Both groups include apartments, condo's, townhomes, duplexes, multi unit dwellings and single family homes. Each category has its potential depending on the other variables; location, time and economy. I personally recommend 2-4 unit properties, but in Cocoa, Florida, single family homes are very popular and they regularly cashflow. 2 to 4 unit properties are a favorite because these properties can have vacancies yet still cashflow or breakeven. When a tenant vacates a 4 unit property the owner's investment is still at 75% occupied. Whereas, the owner of a single family home is paying out of pocket for the monthly carrying costs until a new tenant has moved in.

Financials

The financials are a very important aspect, but if the other variables are not considered a perfect property can look ugly quickly. For example, Winter Park, Colorado is a beautiful mountain town with a great ski resort. The economy is usually booming but the amount of snowfall from the previous year dictates the following years real estate pricing (and lift ticket prices). If an investor decides to diversify their portfolio by purchasing an AirBnB condo on the mountain following a powder season the numbers will look great. When the following two years are warmer with icy conditions the profits will not be as expected. Even though the financials are perfect it is important to keep in mind that there is more to consider than a short term cashflow.

Valuable Metrics

The metrics are key items that I measure and I include on reports to my investors looking for investment properties in Brevard County.

Property Cost

Initial Cost = Purchase Cost + Annual Expenses + Immediate Repairs + Advertising Costs

Many investors forget to consider their annual expenses and advertising costs into the initial cost. These fees will add up and the investor will not receive a return until a tenant is paying rent.

Monthly and Annual Cashflow

Annual Cashflow = Gross annual rent - all property expenses (HOA, taxes, repairs, advertising fees, management fee, etc.

Cashflow is one of the most valuable metrics. If a property cashflows year after year the investor is receiving both growth and income. Very few investments offer both growth and income.

Initial and Annual ROI

Initial ROI = Initial Cost / Annual Growth and Income

Initial ROI is the first year ROI. Many investors that buy and sell annually to keep their initial costs as low as possible. For example, 10% down with minimal repairs, simultaneously increasing rents, cosmetic updates. For rental properties it is common to double or triple the investors initial investment in less than one year.

Property Price $200,000

Initial Cost $25,000

Resale Price $230,000

Profit: $30,000

Annual ROI = (Annual Gain - Annual Cost) / Annual Cost

Annual ROI is an important metric and properties regularly beat stocks. A diverse property portfolio will balance the swings of each individual property. Annual ROI is a key metric for long-term investments.

Monthly Carry Cost

Monthly Carry Cost = Taxes, minimum utility fees + landscaping + maintenance budget + insurance + mortgage + insurance + management fee + HOA dues + additional expenses when vacant

Monthly carry costs are overlooked. Many investors budget a percentage of annual rent for vacancies but this does not always account for the true cost to carry. Many landlords lost their investments in 2009 due to lack of this metric.

Rent to Price

Rent to Price = Gross Annual Rent / Property Price

This percentage is a great rule of thumb for quickly evaluating properties. When purchasing a property it is important to calculate the current rent to price and the possible rent to price. Depending on the market, 11% or higher is usually a good sign.

Rent to Bedroom Ratio

Rent to Bedroom = Monthly Rent / Number of Bedrooms

The rent to bedroom ratio is valuable when evaluating the economy. If the average tenant is only making minimum wage it will be difficult to get $1,000 per month per bedroom. The second item to consider is, the lower the rate per bedroom effects the quality of the tenant. Slumlords have more problems collecting rent then landlords do with blue collar tenants.

Capitalization Rate

Cap Rate = Net Operating Income / Purchase Price

The cap rate is a common measurement to use as a rule of thumb, however it is not a metric that will influence an investors final decision when purchasing a property. The cap rate is great for identifying possible properties, but it is key to remember that this metric measures someone else's success or failure. A landlord with rental rates lower than the market will have a low cap rate, signaling it may be a bad purchase. This property may in fact have tenants on a month to month lease with an opportunity to increase rent by 30%. Low cap rate yet a great purchase. Real estate agents without investment knowledge will talk about cap rates and ignore cashflow and other key metrics.

If you are interested in buying or selling investments, or balancing your investment portfolio please contact us. Initial consultations are free.

Written by:

Adam Maxfield

Realtor

Keller Williams Space Coast Realty

(321) 423-8283

Adam@MaxfieldHomeSolutions.com