This Issue: Analyzing Real Estate for Profit

Answer Three Simple Questions to Analyze Any Investment Property

Many beginning investors have difficulty pulling the trigger on their first deal because they have "analysis paralysis." In other words, they spend most of their time stressing over the numbers instead of making the deal happen.

Here's how you can avoid falling into this trap. Once you find a potential deal, there is a simple method for analyzing almost any deal. Whether you're considering single family homes, apartments, or commercial buildings, you only need to calculate three numbers--which are determined by the answers to the following questions:

1. What can you get it for? (What's the best deal you can negotiate?)
2. What repairs are needed? (And how much will they cost?)
3. What is it worth? (What can you really sell it for today?)

1. What Can You Get It For?
   In order to answer this question, put your negotiating skills to work. In a negotiation, the first person who mentions a number loses. Never mention a number first. Instead, try to find out exactly what the seller wants. When he does mention a number, don't speak right away. Take your time, and then say, "Can you do any better?"
   
   NOW you can mention a number. But make sure that number is lower than the seller's last stated price. Sometimes that will get you an even better deal.
   
   And don't forget: Good terms can make it a deal, not just a low price. Real estate isn't just buying; it's about financing good deals. You can get a good deal by paying the seller's price but getting creative terms.
   
   At the end of the day, don't get stuck on one property. If it's not a good deal, you should move on. Tell the sellers you're looking at a lot of deals. Fear of loss can be a powerful motivator, so let it work for you. Let them know that if you don't do a deal with them, you're going to do a deal with someone else.
2. What Repairs Are Needed?
   
   Getting an accurate repair bid is of prime importance when looking at property. Although life has no guarantees, you can limit the risks you take on repairs and analyze the deal more accurately by:
   
   • Asking other real estate investors for referrals.
   • Only hiring contractors with good references (and call the contractors' references).
   • Making sure they're licensed, bonded, and insured.
   
   
   If you use the least expensive contractor you can find, you may quickly learn why he's the cheapest. Always use referred contractors--just make sure you're getting a fair price.
   
   Detailed List of Repairs
   Break down every repair bid by materials and labor, and determine how long the job will take. If you plan to do repairs yourself, include what your time is worth in your calculations.
   
   Have every repair detailed in writing, listing all materials to be used. Include every ceiling fan, can of paint, and doorknob used. Make sure the contractors understand that you'll hold them to the written bid.
   
   Materials and Labor
   Break every repair bid down into these items:
   
   • Cost of materials. Verify the costs by calling any home supply store.
   • Number of labor hours. Figure out the per-hour fee being charged. If you break every repair bid down by the labor hour, you'll know whether you're getting a fair bid or not.
   
   
   Include a 10 to 15 percent "overage" allowance. If a contractor bids $10,000 and you've gone through all of the details two or three times, put an extra $1,500 in your worksheet for expenses you didn't expect. If you're just starting out in rehabbing, use a 30 percent overage as your cushion until you become more experienced.
3. What Is It Worth?
   Beginning investors often wonder how to know what the properties they are negotiating for are really worth. If you are doing the Comparable Sales Approach, there are two sources that will provide you with plenty of comps:
   
   • Multiple Listing Service (MLS)
     The MLS is primarily used by real estate agents. They can use this system to find recently sold properties that meet your criteria. But as an investor, recognize that not all properties are sold through real estate agents. Some properties are sold by the owners themselves (For Sale by Owner). That means they won't be on the MLS. You'll need to check public records to find those comps.
   • Public Records
     In our country, most real estate transactions are a matter of public record. This is great news for investors! As a result, every county in the United States has a courthouse (or other public/municipal building) where that county's public records are kept. Best of all, because of the popularity and convenience of the Internet, most counties now provide their public records online. Check online with your county tax assessor's web site. It should have comparable sales information. Verify its accuracy with real estate agents, mortgage companies, and other investors.

Now that you've answered the three simple questions, you should have no difficulty pulling the trigger on your first deal. Just make sure there is a real profit of AT LEAST 20 percent in the deal. This removes all the emotion from analyzing your deals so you can make a decision based on the numbers!

Familiarize Yourself with the Three Approaches for Determining a Property's Value

When an appraiser goes to determine the fair market value of a property, he/she will use one of three approaches (or methods). If you are dealing with single family houses, you'll probably only see appraisals that use the Comparable Sales Approach. Nevertheless, it's good business to be familiar with the Income Approach and Cost Approach as well--especially if you graduate into commercial property.

1. Comparable Sales Approach
   Under this method, value is determined based on the comparable value of other similar properties in a given neighborhood. The subject property is compared to others that have recently sold in the immediate area and which have similar property characteristics.
   
   Small adjustments may be made to recent comparable sales to account for any individual differences in the property. Not all sales are considered valid for this process, however. A sale would not be considered for the Comparable Sales approach if it was made under unusual conditions, such as a sale to a friend or family member. Just as another would be ignored if it were made under duress, such as in a probate or foreclosure situation.
   
   For houses, condos, and small rental properties, the Comparable Sales Approach is by far the most common method used.


2. Income Approach
   With this method, a property's value is based on the amount of income generated by the property. The Income Approach is often used to help determine the market value of commercial properties where income and expense statements can be compared to other businesses with similar characteristics. A property's value can be expected to vary slightly from year to year subject to changing market conditions. Any changes would be uniform for other similar properties in the area.
   
   Although generally used for commercial properties, this method is occasionally used for income-generating single family homes where no "comparable" properties exist.


3. Cost Approach
   The Cost approach is the least common method used by appraisers. It a determination of market value based on the current replacement cost of any improvements plus land value. This method is used when a property is unique (often outfitted for a particular type of business use) and there are no comparables. Value is determined based on the cost to replace the improvements (the buildings) to the property.
   
   Improvements consist of development of the land and construction costs. The determination of replacement costs will consider the size and type of construction of any improvements and will also consider its age in order to deduct any depreciation.
   
   Now that you know the three ways property value is determined, you will know how to communicate intelligently to any appraiser who is appraising one of your properties. This is good knowledge to have as an investor.