Evaluating Investment Property Returns
Successful investing begins with a clear understanding of the actual returns an investment is expected to provide. With all the arm-waving and marketing claims we see each day; it can be difficult even for experienced investors, to ascertain the true returns of an investment property. A little basic knowledge and a disciplined approach will go a long way to uncovering the probable returns of an investment.
When dealing with investment property, there are three primary ways that an investor makes money:
1. Cash Flow: The dollar figure net of all expenses provided on a monthly basis from rents
2. Property Appreciation: The increased property value accrued (ie. Equity)
3. Debt Pay down: The amount of rent paid toward reducing the balance due on a mortgage.
Building equity through appreciation and debt pay down are generally well-understood; however, the idea of cash flow can be more difficult to ascertain due to the many variables that influence the outcome.
Conceptually, it seems simple enough: cash flow is simply the difference between the checks you write each month and the income you deposit. However, many sellers of investment property have a much looser definition of cash flow, or make unrealistic assumptions about it, and therefore can easily mislead an unwary investor. The elements that are most commonly misrepresented are overstated rents, and expenses that are understated, or in many cases completely omitted.
The article The Truth about Cash Flow describes in detail how to properly analyze an investment property. It outlines the key elements that must be uncovered and quantified before any return calculations can be done. The Truth about Cash flow shows how to create a simple, yet powerful, cash flow statement that will provide the basis for the analysis of any property, all while ensuring the key expense and income variables are addressed.
There is also an online Investment Property Analysis Tool that incorporates the aforementioned methodology into an easy to use investment property analyzer. This tool allows users to analyze and make side by side comparisons between various investment properties to ascertain the true pro-forma returns.
Jeffrey King, a real estate investor for over 20 years, co-founded Meridian Pacific Properties and helps clients acquire positive cash flow properties for their personal real estate investment portfolios.
Leave a Response