A Beginner's Guide To Analyzing Real Estate Investment Deals

Interested in investing in rental property? Real estate investing is a simple way to build wealth. It requires little time, and the only skill needed is the ability to analyze information carefully. Investors look at potential deals they find through word of mouth, their social networks, and via websites like Zillow for residential and LoopNet for commercial property, locate available properties, and determine whether or not the investment will make them money.

Analyzing real estate investment deals like a pro can be overwhelming at first, but with the right tools at your disposal, you’ll quickly learn to streamline a duplicatable process that works for future investments.

Any type of investing requires analyzing. Analyzing real estate investment deals, in particular, requires vocabulary and skill-set that beginners can find daunting. Below, we’ll explain how to begin analyzing real estate investment deals to help you meet your financial goals. Downloading our free cash flow analysis spreadsheet is a great way to get started.

Build a plan for your real estate investment goals

If you’re reading this article, chances are that you are curious about real estate investing, but need to put a plan in place in order to succeed. We’ll do that first. How much money would you like to see come in? How much can you invest? Investors have found creative ways to fund their investments for centuries. Get some ideas at biggerpockets.com.

Think about your finances first. Do you plan to use cash, a loan, or explore alternative sources of funding your project like wholesaling, or partnering with other investors? Do you have a relationship with a trustworthy lender or mortgage broker? Once you have a financial plan for investing, it’s time to consider what type of property you are looking for.

While many investors start small with single-family homes, the majority of real estate investors make their money through rental properties comprised of multiple units, or commercial properties. Multi-family properties can be more economical for the investor. Develop criteria for your real estate investment, and narrow down your list of potential properties.

Next, determine what makes each property value. Experienced investors avoid the temptation to physically look at a property before they have crunched numbers. They know investing is a numbers game, and their first consideration is not their personal connection to the property, which can be deceiving, but rather a system of data analysis that helps them decide on an investment.

Avoid allowing yourself to feel rushed as you examine each deal. Diligent investors know that “once in a lifetime” opportunities often present themselves. Consistency, planning, and realism as you look at the numbers are the key to successful real estate investing.

The research phase in analyzing investment deals

Once you’ve identified a deal that looks interesting, it’s time to crunch some numbers. Pro-forma data is information from the seller, used to determine a baseline for the math you will be doing to analyze your investment. This data may or may not be biased or exaggerated slightly to make the property look more valuable than it actually is.

One best practice is to examine the pro-forma data and then make calls to find out how accurate it is. Who should you call? Start with other investors, and property managers.

Gather information about the property. The county records office is a good place to turn next. You’ll want tax information. Builders and building inspectors can help you find out if the property has any potential large upcoming expenses like A/C replacement or a new roof. Interview tenants so you can learn about vacancy rates, renter satisfaction, and property damage you may not have otherwise noticed. Gathering information is the first step in making a secure investment.

Looking at your numbers

Now it’s time to learn some new terms. Net Operating Income, or NOI, is the value of the property’s income (totally independent from the buyer) minus the property’s expenses. It’s the baseline number to consider when analyzing a real estate investment deal.

A property’s income is assessed by looking at rent, and considering additional fees that come in from tenants. Fees for parking, laundry, a gym or pool that are charged to tenants will be considered a property’s income as well. Make sure to subtract out rent that won’t come in due to vacancies if it hasn’t been considered by your seller’s estimation of the NOI. In order to do this, find out the vacancy rate. It helps to assume the worst in the scenario, so do your research about potential vacancies and turnover rates with tenants.

Next, consider expenses. Landscaping, utilities, property taxes, property management, maintenance, and incidentals or possible additional costs like outfitting the building with cameras should be considered.

Convert the monthly income and expenses to an annual format and use the income - expenses formula to find the NOI and begin analyzing your real estate investment deal.

Understanding cash flow in your analysis

NOI does not include debt incurred from the cost of the loan. It is independent and connected to the property itself, regardless of the owner’s financing. Cash flow is what investors call the amount of the NOI minus the debt service payments from the loan. For example, If you pay cash for a property, your cash flow will never be more than the NOI. If you use financing, your cash flow may be more or less than the NOI. Cash flow analysis will directly influence your ultimate decision to invest.

Getting a return on your real estate investment deal

A return on investment, otherwise known as ROI, is the total amount of money you receive considering the amount you put into your investment. This is another area where things can get tricky. Carefully analyzing your real estate investment deal will pay off every time. ROI is calculated by determination of the Cap Rate, which is the Net Operating Income divided by the property price. In other words, the cap rate is the amount you would receive if you paid for a property in cash.

Average cap rates are directly affected by location, so do some research and learn the typical cap rates in your area. At least try to stick to properties that are in the 8-12% range, which is the national average.

Determining the Return on Investment also includes consideration of the COC, or Cash on Cash Return. This metric is normally used to measure the performance of an investment, and is sometimes referred to as the Cash Yield. It is typically used when financing is involved in the purchase of the property.

While the ROI helps you understand the total return of an investment, COC only considers the return on the actual cash invested, making it an important aspect of your real estate investment analysis. COC is calculated very easily. Divide the cash flow by the investment basis—- the amount the investor initially puts into the property. If the COC is less than 10%, your investment is probably not a good idea.

Divide the total return by the investment basis, and you’ll arrive at the total Return on Investment. This is the foundation for analyzing a real estate investment deal.

Conclusion

As you can see, real estate investing is a simple game of analysis. Having the proper data, and checking and re-checking your initial numbers for accuracy, will help you make your first valuable investment. Analyzing real estate investment deals is a learned skill that requires knowledge of real estate terms and available analytical tools. Now that you understand what’s involved in decoding the data for your real estate investment property, it’s time to take the plunge! If you’re ready to start today, download our free cash flow analysis tool.