Real Estate Property Analysis Explained
People go into real estate investment for different reasons. Whichever way, the usual returns on investment come in the forms of leverage, tax benefits, appreciation, and cash flow. Investing in real estate properties, however, is not a guarantee of good returns. An investor that wants to increase their chances of getting maximum ROI must invest in the right property.
This brings us to the question – what makes a property right for purchase? The right property will show favorable real estate property analysis results. Unfortunately, most real estate property investors, especially the newbies, are unfamiliar with this analysis and how it works.
If this describes you, this article is for you. Read on as we discuss, at length, how you can assess any investment property, to see if it will fetch you good returns, before buying it.
4-Step to Buying the Right Real Estate Property
Step 1 – Do a background check on the rental market.
Location is one of the most significant determinants of how a property will perform. It affects prices, appreciation rate, rental expenses, rental rates, and tenant availability, among others, significantly. This is why you should know how the market in which this property you want to buy works.
At the end of your analysis, the market should show signs of a growing job market, economic stability, population growth, and low property taxes and insurance costs. Any market that offers a different set of results is a bad housing market. Avoid such a property.
Step 2 – Research the neighborhood.
Having established that your potential real estate property is in a good housing market, next is to research the neighborhood it is located in. The essence of this streamlined investigation is to ensure that you will get the best rental investment opportunities from this neighborhood.
How do you identify a neighborhood that is great for real estate investment? The neighborhood should have a good layout backed by necessary amenities – restaurants, schools, hospitals, malls, and others – and public transportation. The crime rate should be considerably low, and there should not be stringent local laws.
More importantly, the neighborhood should have a record of a good average return of investment.
Step 3 – Estimate the essential real estate metrics.
The rental market is good, and the neighborhood has checked all the important boxes. Now, you can proceed to calculate the important real estate metrics. Rental property analysis is only half-done if you have not checked the financial implications of its purchase.
There are some real estate metrics you should consider in this step. We have highlighted the important ones below:
- Cash Flow – Cash flow is coming first for the apparent reason – it is a crucial real estate metric. What you have in the end after removing all the rental expenses from your rental income is referred to as the cash flow.
If you are not guaranteed positive cash flow from a real estate property, it is not a good buy. It means you may end up footing the unavoidable rental expenses using your personal money. This would be a wrong investment choice.
- Cap Rate – The possible ROI on investment property, provided you bought it in cash, is the Cap Rate. Divide the net operating income (NOI) by the market value or purchase price of the property to get the Cap Rate.
The Cap Rate is a comparison metric. That is, you can only deduce that the Cap Rate of a property is good enough after comparing it with that of other properties in the same neighborhood. That said, you should expect a value in the 8-12% range.
- Cash on Cash Return – Are you buying the property via mortgage? If yes, you must determine the cash on cash return – the ratio of the annual pre-tax cash flow to the total cash investment. It is also called the equity dividend rate, and a score of between 8% and 12% is considered okay.
The annual pre-tax cash flow is the net operating income minus the yearly mortgage payment. The total cash investment, on the other hand, includes every money spent on the property, including down payment, closing costs, rehab and repair costs, and other loan fees.
You can either collate the data and calculate these metrics by yourself or hire real estate professionals to do this for you. If you are going down the DIY path, consider using property analysis calculators with predictive analytics online.
Step 4 – Conduct a Comparative Market Analysis
You are probably wondering why there are so many analyses to be done? Not to worry, this is the last. That said, a Comparative Market Analysis (CMA) is all about looking for the fair market value of the property you want to purchase.
You will need to compare this property with rental estate comps, i.e., similar rental properties that were sold recently in the neighborhood. The CMA offers some vital information, including an estimate of the proper rental rate for the property (if you eventually purchase it) and the current state and trends of the housing market in the area.
More importantly, it gives you a clear idea of what offer is ‘right’ for the property in question. After all, you know the market value of this type of property. This way, you eliminate any chance of overpaying.
This is another DIY – with the help of online tools, but you can hire a local agent to look for sales and rental comps for you. Do not make an offer for the property unless the CMA numbers come through.
Final Thoughts
Buying a property without conducting a proper property analysis is like diving into a river without knowing the depth. You do not want to put your life – or your investment – in danger, do you? The property analysis and its findings put you in a better position to decide if buying a particular investment property is a sound financial decision.
Remember, it is not always compulsory that you oversee this singlehandedly. Seek help from experts when and where needed. What is more important is getting the right results that will inform a good decision.
Good luck!
