Just in from Quora: How Do You Analyze Real Estate Properties?
By Tim Moore
As seen on Quora: click here
Michael's answer does contain some helpful formulas that will put you on the right path, but as someone who has worked for legacy real estate families in NYC as well as on the sell side at brokerage, I will tell you that those are not the metrics that we use to analyze properties. Here’s why.
Successful investors are concerned with 2 things primarily: return of capital and return on capital. (The latter being most important because it’s where money is made)
To model these we focus on the following:
Discount rate - Our required rate of return. (We’re the hunters…analysis gives us numbers to negotiate with. It helps set the present value over the total amount of time we plan to hold the property- this detail is what differentiates it from the CAP rate)
Internal Rate of Return (IRR) or Leverage Internal Rate of Return (LIRR)- This is used to forecast the expected rate of return from all cash flows (i.e. more than just rents)
Cash on Cash Return- Exactly what it sounds like.
Cap Rate- The most basic and improperly used. The capitalization rate illustrates the property value per dollar of current income. This is helpful to compare properties in the same asset class in a similar geographic - a quick snapshot of it’s pricing and performance. This can change and the cap-rate an asset is purchased will not necessarily illustrate the future strength or weakness of the investment.
Then there are the multiples - equity multiples, gross rent multipliers. Each have their place in analysis but their major failure is that they do not properly illustrate expenses associated with the asset. Really similar to neoclassic economics- they only show you the upside ad not the expense haha.
The truth about real estate analysis is this - no single formula should make the deal a go or no-go. It should be a sum of the information from multiple formulas for your investment. and some asset classes have their own unique metrics (think RevPar for hotels). Something else that has not been mentioned previously are people, places and policies and how they affect your investment. Are their going to be beneficial zoning changes? Does a certain committee member favor the area? All of this needs to be considered.
As someone who’s worked on the acquisition side, I knew what our criteria was to make a deal happen - as a sales associate, I learned what numbers mattered to what people and how they defined value, and as an analyst- I learned how to paint the best picture possible for my buyer ;). Numbers don’t lie they hide so by understanding your formulas you can uncover the truth behind your investments.
If you need formula sheets for your investment email me at tim@bluehausgroup.co
I have most asset classes pre-made so numbers can be plugged in.
Tim Moore is a 4x startup founder, real estate investment sales specialist and sales & marketing consultant. He writes about startups, sales and marketing. Follow him on twitter here