By JODI SUMMERS
Whenever you review an income and expense analysis for a property or six, you realize how difficult it is for the average investor to digest the information and make an educated purchase decision. Much like the stock market, what makes a great real estate investment is keyed into timing and interest rates as much as it is to the true operating costs of a property.
In the current market, if you’re looking for portfolio properties that have a return on investment, you either need a big down payment or to buy outside of town — Texas, Arizona, Idaho and New Mexico are current favorites. Certainly SoCal has offered a lot in property leverage and appreciation over the years, but at the end of the day the cash flow is what is really sexy to a property investor, and why so many have been buying out of state.
Again comes the almighty questions, “How do I know what to buy?”
Real estate analysts offer the following suggestions for using a cash flow analysis in making investment property purchase decisions: ■ Examine many similar properties at the same time.
You can ascertain how accurate an income and expense statement may be when you compare it with income and expense statements from other properties. One document may leave out a vacancy rate; the other might exclude property maintenance components. Know vacancy rates in the neighborhood and find out the average time to find a new tenant. Contact lenders and property managers in the area and get their feedback on your potential purchase. ■ Review operating expenses and cash flow for the past three years.
Many financial analysts’ reports will exclude capital expenses. Bear in mind that you need a reserve for property maintenance. If you review three years of income and expenses, you will have a much better idea of real expenses, as well as vacancy rates. ■ Obtain comparable rent income numbers.
“Each property has a different set of numbers and they are not always accurate. How do I know what to buy?” — an investment buyer recently said
“I’ve been wanting to buy a shopping center, but every time I start analyzing the numbers, I get a headache,”
Drive around the neighborhoods where your potential property is located. Call the phone numbers on available properties and confirm the rental rates. Are there any concessions being given on lease space? Use the information to verify the figures you received for the property you wish to buy. ■ Examine the vacancy rate in the market place.
Each market and specific type of real estate investment has a vacancy rate. Even desirable locations like the westside require a minimum of 3 percent factored in for the vacancy rate. In harder-to-rent areas, look for concessions and rebates being offered by property owners. How might those concessions affect your cash flow? Is your property rented at fair market value? Banks are hesitant to loan on properties with a high vacancy rate. They will, however, offer construction loans if you are renovating the building. This may give you some time to find tenants to fill a building, otherwise you will be forced to guarantee the rents, which means more money to the bank and less in your pocket. ■ Talk to an appraiser about the market-place.
Appraisers are paid to know median incomes and expenses in any given market-place. An appraiser offers accurate information so you can make an informed decision. ■ Review the IREM and/or BOMA expense analysis books for the marketplace. The Institute of Real Estate Management is a professional real estate management association serving both the multi-family and commercial real estate sectors. The Building Owners and Managers Association (BOMA) assembles a report that details income and expense statements for office buildings throughout North America based on members’ responses to a standard survey. The books are updated every year and offer an in-depth look at how properties are operating. ■ Ask for schedule “E” tax return information for the property.
Schedule “E,”a.k.a. form 1040, is the supplemental income and loss from rental real estate, royalties, partnerships, S corporations, estates, trusts, etc. It is the information the current property owner gives to the IRS. Keep in mind some property owners keep two sets of books — one for themselves and one for the IRS. Some pay a handyman on the premises for repairs and very little of anything is ever reported.
If you do your homework, you will have a clear idea of a property’s value. Then read the reports. Analysts suggest an 8 to 10 percent positive cash flow after all deductions.
Beyond cash flow, there are several other indicators you can compare and analyze when pursuing your investment strategy. They include CAP rate, cash-on-cash return, debt coverage ratios, price per square foot for comparable properties in the same mar-ketplace, percentage of expenses — are they in line or understated? Also factor in financing and due diligence costs as part of your transaction spread sheets.
For more on Southern California commercial properties, there is a great information blog at www.socalindustrialrealestate-blog.com. (Jodi Summers is director of the investment division at Boardwalk Realty Santa Monica. For your real estate needs, , or call (310) 309-4219. Visit her Web site at www.santamonicalandmarks.com.)
Originally published in the Santa Monica Daily Press print edition on August 2, 2006. Read the original PDF.