How Successful Investors Conduct A Real Estate Analysis

Individual investors who succeed at real estate investing never rely simply on the numbers they're handed regarding a rental property. Once a prospective real estate investment has been located, smart investors always conduct their own close examination of the property's income, expenses, cash flow, rates of return, and profitability.

Regardless what sellers or agents claim, smart real estate investing always validates a property's numbers.

To achieve this, smart investors rely on a variety of reports and rates of return to measure an income property's financial performance. And in this article, we'll consider a few of these reports and financial measures.

Reports

The most popular report used in a rental property analysis is perhaps the Annual Property Operating Data, or APOD. This is because an APOD gives the analyst a quick evaluation or "snapshot" of property performance during the first year of ownership. Although tax shelter isn't considered, an APOD can serve as the realestate equivalent of an annual income and expense statement if done correctly.

A Proforma Income Statement is also popular amongst analysts. Although comprised of speculated numbers, a proforma provides a useful way for real estate investors and analysts to evaluate an investment property's future, long-term cash flow performance. Proformas regularly project numbers out over a period of ten to twenty years.

Certainly one of the most important documents for an investment analysis is the Rent Roll. This is because a property's sources of income and income stream are vital to making wise investment decisions. A rent roll typically lists currently occupied units with current rents along with vacant units and market rents. Rents shown in the rent roll should, of course, be confirmed by the tenants during the due diligence period.

Rates of Return

Capitalization rate, or cap rate, is one of the more popular rates of return used by investment analysts. This is because cap rate offers a quick first-glance look at a property's ability to pay its own way by expressing the relationship between a property's value and its net operating income. Cap rate also provides real estate investors with an easy method for comparing similar properties.

Cash-on-cash return measures the ratio between a property's anticipated first-year cash flow to the amount of investment required to purchase the property. Though cash on cash return does not account for the time value of money or for cash flows beyond the first year, this shortcoming is often overlooked because it does provide an easy way for individual investors to compare the profitability of similar income-producing properties and investment opportunities quickly.

Internal rate of return is more difficult because it requires a computation for time value of money which in turn requires a financial calculator or good real estate investment software. Nonetheless, it is widely used by analysts because internal rate of return reveals in mathematical terms what an investor's initial cash investment will yield based on an expected stream of future cash flows discounted to equal today's dollars. In other words, internal rate of return converts tomorrow's dollars to today's dollars and then computes your return on investment.

Here's the point.

If you're planning to make an investment in real estate, be sure to do your homework and conduct a thorough real estate analysis. Create the reports and returns so you can examine them in the light. This is the only reasonably certain way of making the right investment decision on any prospective real estate investment. If you do your property analysis correctly, you'll know whether the investment makes good financial sense (or not) and almost certainly guarantee your real estate investing success.