The Data Investors Require for Prudent Real Estate Investment Decisions

The investment decision as to whether or not to purchase a rental property always requires the real estate investor to measure the rental property's financial performance with some serious number crunching inside a good cash flow and rate of return analysis.

But even prudent calculations without first collecting some raw data related to the market (to shape an offer) and then about the property itself (once an offer is written) will not guarantee that the investor is making the most prudent investment decision.

In this article, we'll briefly discuss both the market and property data investors must consider before and during the investment process.

The Market Data

Before a real estate investor can decide on how much to offer for a rental property, he or she must understand as much as possible about the conditions of the real estate market surrounding the property in order to structure a meaningful offer.

We recommend that investors survey and collect data on at least these three market indicators.

1) Comparable Sales Conducting a survey to see what other similar income properties have recently sold for is a proven way to evaluate whether a seller's asking price is in line with realistic property value. Try to find properties sold within the past year (the more recent the better) and the properties themselves as comparable as possible. You want to look at rental properties similar in usage, location, size, and condition to the rental property you are considering. Real estate agents are generally prepared to do this for you, or you can conduct your own survey by researching the public records at local tax assessor's office or making a call to several real estate appraisers.

2) Rental Rates and Expenses Conducting a survey to see what tenants are willing to pay for space and owners are obliged to pay for operating expenses in the surrounding area for similar kinds of rental property is also valuable information. Just be sure that the rents you survey reflect similar unit configurations such as number of bedrooms and baths, size, and so on as well as property location, condition, and amenities. It would be misleading to think that the subject property (say, an apartment complex in a C location in poor condition) will generate the same rents as a recently remodeled apartment complex in an A or B location for instance.

3) Capitalization Rates Knowing what the typical capitalization rate is for a particular kind of property inside a market area is very helpful. By knowing at what cap rates other similar rental properties have been selling for gives you a hint on how to structure an offer. If you aren't aware of what a cap rate is, or how to calculate it, you should find out because cap rates are one of the more important returns used in real estate investing; there are resources online as well as knowledgeable real estate brokers that can help you.

The Property Data

Once you have an acceptable offer, it is then incumbent upon you to be sure that the numbers used to make the subject property's cash flow calculations are truthful and correct. Keep in mind that you are buying the cash flow (or income stream) that the rental property generates. It is recommended during your due diligence that you confirm the accuracy of these elements at least; obtain from the seller or in some cases indirectly from other sources.

1) Leases and Rental Agreements - Once you buy the property, bear in mind that you become subject to the terms of the leases and rental agreements, so examine them carefully. What do they say about rental rates, renewal options, and termination? How long does each lease run? Do they agree with the seller's representation of the property's income? You must be able to count on the current figures to make forecasts about the rental property's future performance.

2) Property Tax Bill - By looking at the property's tax bill, you can confirm the accuracy of this expense. You might even discover some sort of tax abatement granted to the current owner that won't apply to you as the new owner, or maybe some unfavorable tax issue that impacts you negatively.

3) Utility Bills - At least spot-check what the owner has been paying for gas, electric, water and sewer. This information can help you discover discrepancies in the operating expenses presented you about the property and utility companies are generally willing to give you usage information if you call.

4) Maintenance Records - Look at the amount and items where the owner has spent money to maintain the property. Normal wear and tear can be expected, but repetitively having to replace broken windows, for example, can be an indication of tenant or neighborhood problems.

5) Seller's Schedule E Tax Return - This information is helpful because you see the income and expenses the seller has been reporting to the IRS about the property. It's quite unlikely that an owner will claim too much income or too little expense on a tax return, so this can be an illuminating source of information. Just be sure to include a request to see the Schedule E in your offer because most owner's are reluctant to provide it unless it's been made part of the offer.

Okay, now re-create your real estate analysis using the data you discover at odds with your original number crunching, and there you have it.