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Center for Real
Estate Studies ¨ Cal State Properties ¨ Cal State Investment LTD Partnership
Media Contact: Center for RE Studies For Immediate Release
Comprehensive
Property Analysis Strategies
THE
INTERNAL RATE OF RETURN (IRR) TO AIM FOR
The IRR should reflect the degree of risk you’re willing to
take. The riskier an investment, the higher the IRR. If you’re purchasing a
building that has decreased in value only because of temporary market
conditions, your degree of risk might be considered moderate. Conservative
projections are computed using rental growth and vacancy rates, and they
establish the lower limits of the IRR. IRR projections based on replacement
costs determine the higher limits of the IRR. Analyzing both rates of return
allows you to assess the risks versus rewards relationship of each investment.
REVENUE
ASSUMPTIONS THAT MAKE SENSE
Revenue assumptions play an important part of your analysis.
In addition to the information provided by consultants, check with local rental
firms. They are on top of current trends and demand. Lease agreements should be
verified to actual rents for each tenant. Use rental applications to develop
tenant profiles. Obtain a signed estoppel from each tenant attesting to the
rent paid, occupancy dates, and deposits. Rent raises don’t always occur on the
first day of the month or in the first month of the year. A careful review of
rental agreements will assist in making accurate cash flow projections.
Ideally, try to stagger individual rent raises throughout the year. It is less
disturbing to the entire complex.
Vacancies vary in seasonal locations like college towns and
resort areas. Make provisions for these fluctuations in cash flow projections. Don’t assume income will be received evenly
month-to-month and year-to-year. Projections based on research will result in a
more accurate IRR.
ANALYZE
EXPENSES CORRECTLY
When analyzing expenses, refer to the real estate investment
inspection report. It should detail, by projected date the costs, repairs and
replacements for each unit and the entire building. Using a comprehensive
computer program will produce accurate operating budgets.
Mechanical equipment such as water heaters, dishwashers,
garbage disposals, and pool equipment, for example, have estimated life spans. Major repairs and replacements on roofs, plumbing,
decking, and cement should be detailed by estimated costs and the dates work is
to be started and completed.
As with income, expenses do not occur evenly throughout the
year. For example, in cold climates,
utility bills are higher in the winter than in the summer. With grounds and
pool maintenance, it is just the opposite.
Expense figures should be compared with those published by
the IREM. All sizable discrepancies must be explained.
Do not make flat rate projections. Don’t apply inflation
rates across the board. Projections should be made on an item-by-item basis
using the best information available. For example, if the inflation rate of 5
percent is used in one year, don’t use it again unless it applies. Actuals should
be used whenever possible.
USE
THE FEEL-AND-TOUCH ANALYSIS
As part of the analysis, we at calstatecompanies believe
that absolutely nothing beats the feel-and-touch approach. A physical
inspection of the real estate investment and the neighborhood will confirm your
consultant’s reports. Critical words like good, bad, best, worst, bright, dull,
a lot, and a little are subjective. Make sure everyone’s singing from the same
hymn book when praises to your real estate investment are being sung!
Ask yourself the following questions when evaluating the
area as part of the physical inspection:
• Would you
be willing to live or at least collect the rents in
this neighborhood?
• What’s the graffiti index?
• How does the landscaping of the
other properties compare with the one
you’re considering?
• Is there debris in the streets?
• Are there cars on blocks?
• Is it completely off the beaten
path to major shopping and
Work centers?
• Is the community growing
favorably in the direction of your real
estate investment?
• Are transportation lines readily
available?
• Are schools and recreational
facilities nearby?
• What is the ratio of renter- to
owner-occupied buildings?
The greater the rental population, the more transient the
area be-comes and the greater possibility of it being left unkempt. The
physical test will give you that personal viewpoint necessary to complete the analysis.
Even in depressed markets you should look for properties in
good locations. A cardinal rule is to buy the worst property in the best location,
not the best property in the worst location. Buying the poorest real estate in
a good location, at least gives you the opportunity to upgrade it. Whereas,
upgrading an entire neighborhood could be difficult, if not impossible. When in
doubt, a drive through will help. Contact
your local real estate investment management company or real estate licensee
for assistance.
ABOUT THE AUTHOR: Eugene E. Vollucci,
is considered to be one of the foremost authorities on real estate taxation and
investing and has authored books in these fields published by John Wiley &
Sons of New York. He is the Director of the Center for RE Studies, a real
estate research organization and President of calstatecompanies. To learn more
about the Center, please visit our web site at http://www.calstatecompanies.com
