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How Successful Investors Prepare Their Real Estate Analysis

Successful real estate investors never rely simply on what others tell them. Once a prospective real estate investment has been located, prudent investors conduct a close examination of the rental property’s income, expenses, cash flow, rates of return, and profitability. Regardless what overzealous agents or sellers say, vigilant real estate investing demands a validation of the numbers.

To achieve this, real estate 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 real estate investing circles is perhaps the Annual Property Operating Data, or APOD. This is because an APOD gives the real estate analyst a quick evaluation or “snapshot” of property performance during the first year of ownership. It does not consider tax shelter, but an APOD created correctly can serve as the real estate equivalent of an annual income and expense statement.

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 a real estate analysis is the Rent Roll. This is because a property’s sources of income and income stream are vital to making wise real estate investment decisions. A rent roll typically lists currently occupied units with current rents along with vacant units and market rents. During the due diligence, of course, rents shown in the rent roll should be confirmed by the tenants.

Rates of Return

Capitalization rate, or cap rate, is one of the more popular rates of return used by real estate 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 real estate investors to compare the profitability of similar income-producing properties and investment opportunities quickly.

Internal rate of return is more complex because it requires a computation for time value of money and therefore 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 a real estate 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.

Take the time to conduct a thorough real estate analysis. Create the reports and returns and hold the numbers up to 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 real estate analysis correctly you’ll know whether the investment makes good financial sense or not, and almost certainly guarantee your real estate investing success.