Friday, December 21, 2012

Rental Property Investing - Establishing Objectives

Assuming you are considering rental property investing as a way to make
money, then the next step is to establish a set of objectives. If you know what
you want in terms of investment properties – you should try to focus your efforts on the best options within the market that fit.

Typical investment objectives should include:

Type of Property – residential, commercial/office/retail, vacant land
Types of Tenancies  – single/freestanding building, multi-tenanted
ROI and CAP rate expectations
Growth/Appreciation expectations
Capital Available to be invested  (aka – down payment)
Risk Issues – personal liability/financial guarantees/level of acceptable risk
Locational Preferences – core district, new/growth area, transitional area
Quality of the Buildings – older, newer, potential rehab and improvement costs
Management – self manage vs. professional management
Hold Strategy – buy & hold, buy/renovate/sell, buy&flip

This list should help you paint a pretty good picture of what sort of rental property best ‘fits the bill’. As with everything in the business world, compromises must and will be made. But this will allow you to search the rental property market from the outset, with a defined set of objectives.

Just a final note as you investigate your market of choice - all markets are local and operate based on their own local set of dynamics. Your investment objectives should be based in reality, to the market you are looking to invest in. It never hurts to review recent rental property sales, to see how likely you are to succeed - based on the set of objectives which you’ve established.     

Again, seek out experienced commercial realtors to match your investment objectives to the rental property market in your area.

Wednesday, December 12, 2012

Rental Property Investing - Confirming the Data

When we consider investment property options, doing the math is generally straightforward as we determine  ROI’s, cashflow projections, and the like. It’s how those numbers are arrived at and the ‘legitimacy’ of them, that is the next important exercise.

On the income side, we need to review the current lease agreements in place and confirm the rental amounts, in order to reconcile the gross revenue numbers which are represented.  The lease will contain the balance of the term(s) remaining with the lease - including future increases, balance of time  remaining, renewal details, and deposits which may apply. As a matter of best practice, time should be taken to review all leases in their entirety, to ensure there are not provisions which you may not be aware of (ie. early termination clause, additional rent caps, expiration of personal guarantees - just to name a few).

On the expense data, year end reports are typically provided and are ok for the initial review.  But best practice is to verify the amounts against the owner’s income tax return(s), depending on the corresponding years being considered.  Three years history is probably a reasonable period and again, we are looking for the figures to balance against what has been represented.

Just a further note on the tax return request – this would generally be something that would be incorporated in to the Offer to Purchase and form part of the Due Diligence process. The Seller needs to know that a deal is at hand and that the providing of such confidential details, is ultimately leading towards a sale of the property.  Strict confidentiality provisions may also be required by the Seller.

In any type of rental property investing, as they say -- ‘the devil is in the details’.  Make sure you verify those details, before proceeding to finalize any purchase.

Next up…discussing strategies and objectives with rental properties. Again, seek out experienced commercial realtors within your market to assist in finding the best rental properties available.

Wednesday, December 5, 2012

Rental Property Investing - Return on Investment (ROI)

Return on investment on rental properties, is a calculation which measures the profit a real estate investment will generate. It is then compared to the amount of capital initially invested, to give a percentage yield on an annual basis. As a simple example consider the following -- a fully occupied commercial plaza sells for $500,000 with a net operating income (NOI) of $50,000.  Based on an all cash purchase, the (ROI) is 10%. Not bad in today’s low interest rate environment.

But consider the effect of arranging a 1st mortgage on the purchase of $350,000.  Again for illustration purposes - let’s assume a mortgage rate of 5.5% and an amortization of 20 years. Going back to our plaza purchase above, annual mortgage costs amount to $28,740/year, leaving a net income (after debt service) of $21,260. The yield now on the cash invested, is + 14.2% ($28740/$150,000).  Welcome to the world of LEVERAGE!

In the case of part 2 of our example (after arranging a mortgage for the purchase), we can actually increase the rate of return on our cash invested by 4.2%.  In essence, we are increasing our yield through the use of borrowed money.  With this analysis, we are only looking at the existing cashflow (rental stream), which the property provides. We’ll take a further look at ‘leverage’ in future blogs, as we factor in price appreciation/growth and other strategies. 

Just a further comment on the initial cash investment (beyond the actual downpayment) -  be sure to include closing costs, land transfer tax, immediate capital improvement expenses etc.  Essentially calculate the total estimate of your upfront cash requirement to take on the property.

Next up…sifting through the financial data and ensuring its accurancy & reliability.  Again, seek out experienced commercial realtors within your market to assist in searching out quality rental properties to invest in.