Analyzing a Real Estate Deal - Part 1
When contemplating the purchase of a property, most real estate investors try to analyze the deal to determine if it will make a profit or not, on a cash flow basis for rental properties, or an appreciation basis for flips. With so many software packages available, most of them American and with varying levels of complexity, it can be tough to decide what sort of analysis to perform.
We thought it would be useful to provide some insight into how we invest. This is the first in a series of articles explaining exactly how we analyze our deals. You'll recognize some of the numbers because they come straight from our 'Cash Flow Proforma' for our Joint Venture deal cards. Visit the Real Estate Deals section of our website for a detailed example that should help understand some of the elements below and in future articles.
For rental properties, we are usually concerned with the property's income and expenses. We want to ensure there is enough cash generated by the property to ensure all the expenses are paid, with a bit extra for paying ourselves and our investors.
Income
The following are typical income items we look at when evaluating a property:
- Rent - Include the actual rent from all units in the building. Note that some sellers will try to base the selling price on potential rents. Don't fall for this!
- Parking - This is an often overlooked source of income. If the seller doesn't have any, can you add some? Is there a garage that could be rented to the tenant?
- Laundry - Smaller buildings don't usually have this, but larger units do. You won't usually make alot of money from this, so don't bank on it to make your negative cash flow property positive.
- Other - Are these any other potential sources of income? On larger buildings, can you sell billboard rights for the side of your building?
In a perfect world, tenants would move in, stay forever, and always
pay their rent on time. Unfortunately, this is never the case! So we
have to subtract an amount for vacancy. We usually use 5% of the
Gross Operating Income.
Subtract the vacancy amount from the GOI, and the result is called
Effective Gross Income (EGI). Why are strange terms being used to
describe these various totals? Because they are industry standard
terms used by the banks and lenders, so it is good to have an
understanding of them.
Just to recap...
GOI means Gross Operating Income
EGI means Effective Gross Income
How does this look in a formula?
GOI - Vacancy Amount = EGI
Take a look at one of the Cash Flow Proformas in the
Real Estate Deals section of our website to see this formula being used on a
real-life property.
In the next article we will discuss expenses in detail, as well as the verification
process of both income and expenses.
This article is copyright © 2004-2010 Spirepoint Properties. All rights reserved.
Paul Blacquiere and Joanne Beehler are full time real estate investors and have been investing in Ottawa, Ontario, Canada since 2002. They are owners of Spirepoint Properties, a Canadian real estate investing company dedicated to making real estate investing easy.
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