"72 Thing"
I was reading through some of the posted strings and a formula (rent multiplier) came up in a few of them. "Rent x 12 months x 6 years = maximum purchase price".
This is a great formula, but I guess I don't understand why it goes this way and if it's a realistic measure...Can someone give me their thoughts about it?
It is a rough guestimate of value. It should not be your only method of determining value.
Keep in mind that there is a big difference between buying a house for you and buying property as an investment.
Larger properties tend to be priced according to gross rental revenues.
There are no magic formulas for estimating the value of income property but I will share with you what I do.
Keys to my purchase of investment property are: (I review each one in depth)
History of Sales and Listings
Tenants and Leases
Local Market Conditions and Trends
The Neighborhood or District
Boundaries and Easements
Planning and Zoning
Access and Utilities
One big key factor for me is The Americans With Disabilities Act of 1990 (ADA), which became effective January 26, 1992, requires many types of commercial buildings to accommodate people who use wheelchairs, are blind or have other types of disabilities. You should contact your local building department or hire an expert in the field of ADA compliance for specific requirements.
I normally use what is called The Cost Approach when purchasing multi unit investments because it is a method of estimating value by combining the site value with the depreciated replacement cost of the buildings and other improvements. The cost approach can be useful for appraising properties which are unusual or complex, and when there are no comparable sales or income data.
I find that comparable sales are hard to come by with multi units as well as the income data provided in most cases is somewhat exaggerated.
I some times find that for some income properties, the sales comparison analysis provides me with enough information on the purchase because it uses units of comparison, such as price per apartment unit or price per square foot of rentable space.
I then determine the property's Net Operating Income (NOI). I then estimate the capitalization rate (Rate of return) that I could reasonably expect. NOI is the amount of the return and the cap rate is the rate of return.
I also want to know my Gross Operating Income
You take the Gross Scheduled Income this is the property's annual income if all units are rented and all of the rent is actually collected. You would subtract from this amount an allowance for vacancy and credit loss. And this is your Gross Operating Income.
Now I deal with my operating expenses but I deal with real operating expense not marginal expenses just for tax avoidance!
"An item must be necessary to maintain a piece of a property and to insure its ability to continue to produce income. Loan payments, depreciation and capital expenditures are not considered operating expenses."
Utilities, supplies, snow removal and property management are all operating expenses. Repairs and maintenance are operating expenses, but improvements and additions are not they are capital expenditures. Property tax is an operating expense, but your personal income-tax liability generated by the property is not. Your mortgage interest may be a deductible expense, but it is not an operating expense. You may need a mortgage to afford the property, but not to operate it.
Now I subtract the Operating Expenses from the Gross Operating Income and I have my NOI.
Now I have to deal with capitalization
A property’s simple capitalization rate is the ratio between its net operating income (NOI) and its present value:
Cap. Rate = NOI/Present Value
I use capitalization to predict value:
Present Value = NOI/Cap. Rate
It gives me the projected value in any given year and is equal to the expected NOI divided by my capitalization rate.
It all the numbers look good I buy it. "Welcome to my crazy world".
[addsig]
I appreciate the responses! Great information here... I figured that there would be several expenses associated to any given property that I will want to own and lease to others. This formula seems to help with the offer portion.
On a similar note, I was able to get a copy of "the formula" which calculates monthly expenses for income properties that I would rent out and it seems like around 70 + % of my gross will go to cover these expenses. This seems a little high, any thoughts about that?
Keep in mind that I am a real rookie, but I want to be careful. I don't have a problem starting once I feel that I've covered my bases somewhat...
It depends on what you are calling expenses. Remember, debt service is not included as expenses. JohnMichael's explanation is a good thorough explanation on how to calculate value. If the expenses not including debt service is 70% that seems high. Normally a mis-managed multi family will be around 50%, and your goal is to get it below 30%.
John,
Thank for the information, you sound very comfortable with the process.
Can you please explain some of your response material in more detail, because it kind of went over my head! LOL
I'm not sure how to use any of the results for them, etc.
1. For the "History of Sales Listings" - what should I be looking for?
2. For "Local Market conditions and trends", where do I get the data and what percentage of rental, etc is considered a good rental market (i.e. 15%, 25%..)
3. Finally, how do you use the site value and depreciated replacement cost to come up with a figure, meaning do I add them up and divide by two (sorry about the lame example), but you probably get the idea.
Hard money loans. Usury laws cap the rate at 18% and investors get that everyday. Situation goes like this- you have other investors that need loans quickly. Bank financing is a slow process and if someone finds a great deal, they need to move fast before it gets scooped up. So you have an investor, with a great deal, looking for quick money. Enter the hard money lender. The HM lender checks out the property, does their own assesment/appraisal, then loans the investor about 70-80 % of the value, charges about 18% with points and takes the property as collateral. The HM lender really makes out on these deals, and they happen everyday. One pitfall though- if the investor defaults, you take the property. This is great if you're interested in owning it- so you need to approach every deal with the mindset that the property may be yours someday. You can use this method of investing with homeowners in need to help them, but I wouldn't recommend it. If they're struggling, chances are they will default and put you in the hard situation of choosing whether to help them or yourself. Foreclosing and evicting someone is much harder than foreclosing on an investor.
Good Luck
Thanks Heather!
It will be some time until I can actually loan out money. One day though.
Sounds like your wanting to bird dog. The investor pays you a fee for bringing them a deal.