- Why is the property for sale? If the seller is motivated, the purchase price may be negotiable.
- Does the seller have other properties; if so, are they for sale? Find out why this particular property is being sold as opposed to other assets. You may be able to buy multiple properties at a discount.
- What have other properties sold for recently? This gives clues regarding the seller’s perception of property value.
- What is the market rental rate, vacancy and cap rate? These numbers determine what you should pay for the property.
- Who manages the property? If the seller is also the manager, he may be paying himself a salary above or below market, or nothing at all.
- What are the capital expenditures for the past five years? Every property needs regular maintenance. If none has been done, chances are you’ll be doing lots of repairs if you buy.
Never buy on a whim; analyzing the data you’ve collected is essential. Each investor must decide for himself if a property suits financial goals. Let the numbers, not emotions, be the deciding factor. The following are some of the most common financial techniques used when analyzing a deal:
Cash-on-Cash Return—The annual before-tax cash flow received. This simple calculation should tell you right away whether to proceed with the project. It is derived through a two-step equation:
1. Net Operating Income - Debt Service = Net Cash Flow
2. Net Cash Flow/Equity = Cash-on-Cash Return
Capitalization Rate (Cap Rate)—Rate of return used to derive the value of an income stream. This is the annual rate of return you’d earn if you were paying all cash for the property. It varies by location, age, operating history and market. As an investor, target a benchmark cap rate for your deals. The equation: Value of Property = Net Operating Income/Cap Rate.
Internal Rate of Return—The true rate of return on equity over a period of time. This calculation more accurately determines the return received over the life of an investment with compound interest factored in. This is a must if you’re looking at a value-add project with varying cash inflows and outflows.
Set a benchmark for each of the ratios outlined above and only invest in deals that meet or beat your goal. Patient investing is paramount.