Valuable Information On How To Analyze Real Estate Deals And Understand Their Attractiveness

An investment property is a huge step. It will affect the life of a small investor owning just 1 property object in the most dramatic way – for decades to come. This means you have to be very wise when calculating profitability and other numbers associated with your investment. How to value real estate and what exactly you should calculate? We’ll review everything in this article.

How to analyze real estate deals

Every investment deal should bring you profit. So you should rigorously estimate every object based on several basic criteria (indices) that we’re considering below. Throughout this text, we are going to bear in mind a multi-unit property, which is estimated very differently from the one made for 1 family.

Basic data a.k.a. real estate metrics you have to collect are as follows:

• Property detail: number of units, footage, condition, location
• Purchase cost
• Financing details – which part of the money to buy a property will be financed from your own costs and which one you’ll have to get from the bank
• Income from the object
• Expenses for the object.

For the sake of avoiding specifics of any market, let’s just consider some 8-apartment place with a code name “Watermelon” (simply because we love this berry).

The basic data about this real estate object is as such (to make the entire set of calculations for the real estate deal analysis):

A gross income is the sum of all monthly rent payments from all apartments of Watermelon plus all additional incomes that you receive from laundry, parking, kitchen, bar, and other services. In Watermelon, we have 8 apts. each paying on average $650 monthly ($650*8*12) + $4,500 other = $62,400 a year.

What does ARV mean in real estate

ARV is the first of the important metrics. ARV is the cost of the property after renovation/rehabbing (to make it feasible to live and enjoy). For Watermelon, ARV is the price + improvements + closing costs = $524,000. ARV defines the entire cost of the object that you’ll bear upon the purchase and turning it into a full-value cost.

Net operating income and expenses

A net operating income a.k.a. NOI is what you have left on a yearly basis after you deduct the total yearly expenses (TYE) from the vacancy-rate adjusted gross income (VRAGI).

NOI = VRAGI — TYE

In Watermelon,

VRAGI = $62,400*vacancy rate (12.5% annual on average) = $59,100

TYE = taxes + insurance + maintenance + advertising + utilities (let’s consider that “utilities” include everything a landlord pays in general for the residential object during its running like utility bills for a manager office (if it exists) and the rest of the place in general, which would include water, gas, electricity, heating, fixing, repairs, trash, snow removal, sewer, pest control, cleaning, cable, Internet & TV, car expenses, office supply, telephony, technology, software, lawyers, pool maintenance and heating, lawn care, and plumbers) = $16.000. We normally consider that unit-specific utilities are paid by tenants.

Watermelon’s NOI = $43,100.

That means you earn a net operating income per year of $43,100.

But if you have to calculate the real estate discount rate as well, you should be based on NOI and deduct the yearly depreciation from this number. That will depend on your particular type of premises and yearly norm of deduction, which could span from 1 through 5, 10, 15, 27.5, to 39 years. That would also depend on your type of repairs and improvements that you do in your real estate over time. For instance, if you consider the complete depreciation of the Total Cost (after repair value) of $524,000 through 27.5 years, the yearly number would be $19,054.55. And then, the discount-adjusted yearly NOI for Watermelon will be $24,045.45.

Cash Flow

Another important thing is the cash flow. Cash flow is the income minus expenses minus taxes & vacancy rate. We also include right now your financing cost since you have it.

So, to make the full stop in our particular Watermelon issue in Cash Flow, since we have bank installments, we have to find out, what we really earn. We, mean, REALLY. Let’s look at the numbers for Watermelon:

Here, you see that we have a financed part to buy the property of $410,000. With a calculated interest rate of 6% and 30 years of mortgage, our monthly installment is $2,458.16, which makes it $29,497.92 yearly.

So, the cash flow for Watermelon is $43,100 minus the mortgage’s yearly payment = $13,602.08. This is what you have left on your hands for real.

ROI

ROI is the return on investment. Its formula broadly varies depending on the source conditions in each and every market. Most generally, it tells about how many years and months your investments fully recoup. For Watermelon, it is expedient to consider that you will have spent the ‘Cash outlay’ to purchase the object and you will be recouping it with the real cash flow.

That is, Watermelon’s ROI = $114,000/$13,602.08 ≈ 8 years 5 months.

We do not consider bank investments since we’re only interested when we ‘get our own money back to us.

COCR (cash-on-cash return)

Last but not least – cash on cash return is, basically speaking, the profitability of your cash investments on a yearly basis. This indicator does not include your bank installments since it is bank-neutral (applicable for both people investing in real estate with and without the bank’s input).

Watermelon’s COCR = NOI (not discount-adjusted) / Cash outlay *100% = 43,600/114,000*100% = 37.81%. Not bad! Sure, you could calculate the discount-adjusted yearly NOI for Watermelon, why not! Then the result will be 21.09%, which is also not bad at all.

As we can see, our hypothetical Watermelon investment is significantly more lucrative than a certificate of deposit, high-interest savings account, or even the stock market’s average ROI.