How to Evaluate Real Estate Investments
Evaluating a property takes skill and experience. There is a lot to look at to determine if the property is a good investment or not.
The more properties you look at each day and analyze, the better you will become at determining if a property is a good deal or not.
It’s commonly known that your profits come from the purchase. You have to evaluate a property thoroughly in order to know the exact price you are willing to pay for the deal to work.
You can start by downloading this real estate analysis spreadsheet.
Negotiate the Deal
Tip #1…If the seller doesn’t agree to your price then you walk and find a new property. Become a master negotiator.
You must negotiate and fight for every detail so that you can secure terms that are favorable to you and maximize your profits. Things you need to negotiate include:
- Purchase price
- Costs of financing
- Closing costs
- Date you get possession of the property
- Ability to rent prior to the closing date
- Ability to make repairs to the property before the closing date
In order to calculate your max purchase price you are willing to pay that would still make the deal profitable you must review a number of factors and expenses to budget for. In simple terms:
- Determine your down payment amount
- Determine the amount of financing you would need
- Calculate the cost of financing
- Estimated repair costs
- Closing costs
You will also have a list of other expenses when managing the property but they will vary based on the property type.
If you have a single family home then expect:
- Estimated Repairs
- Unexpected Repairs
- Trash Removal Fees
- Lawn Care Fees
- Maintenance Fees
- Vacancy Costs
- Uncollected Rent
Multi-family homes will have additional expenses but to save time here is a general list of many possible expenses that may apply to any property type you are evaluating:
- Appliances – New
- Appliances – Used
- Bank Charges
- Cleaning Vacant Unit
- Carpet Cleaning
- Carpet New
- Cleaning Supplies
- Drain Cleaning
- Eviction Costs
- Fire Protection
- Insurance for fire and extended coverage
- Leasing Fees
- Licenses, Fees, Permits
- Lock Service
- Maintenance Supplies
- Make Ready Maintenance
- Management Fees
- Miscellaneous expenses
- Painting Labor
- Pest Control
- Parking Lot
- Resident Manager
- Payroll Tax Escrow
- Repair – Appliance
- Repair – Drywall
- Repair – Electrical
- Repair – General
- Repair – Heating
- Repair – Plumbing
- Sewer Fees
- Snow Removal
- Tax – Personal Property
- Property Taxes
- Trash Removal
- Window Replacement
- Window Coverings
Expenses are only part of the cash flow equation. Once you understand the costs associated with the potential property you can then begin calculating the rent/income needed for this property to become profitable.
If you are evaluating a property as a fixer-upper to buy, rehab, and re-list for sale, then make sure you are buying the property at a big enough discount from market value that you have room to add in your rehab expenses and profit still.
You can find what similar houses fixed up are selling for by running a comparable market analysis.
Ask your Realtor to run a comparable market analysis for you to determine the local sales comps. Sales comps or “comps,” as you’ll commonly hear in real estate language, are the prices at which other properties nearby with similar to identical characteristics sold for.
An example Fix and Flip Deal:
You discover a property in a decent neighborhood that is selling for $55,000. The overgrown lawn and shrubbery tells you it has sat empty for some time.
Your realtor gets you inside for a showing and upon looking at the house it is clear it needs some fixing up.
You calculate the obvious fixes it needs and come up with a rough figure of $25,000. This will put your total costs at $80,000 after adding the $25,000 in rehab to the $55,000 purchase price.
Your realtor ran sales comps and found that houses with very similar characteristics and features sold recently for $110,000 and $115,000.
Your realtor thinks you could get $115,000 for this property after fixing it up which would be a $35,000 profit before subtracting holding and closing costs so you decide to purchase it as you have room in case some unexpected expenses occur.
The quicker you fix up and re-list the house the less you’ll pay in holding costs which include taxes, insurance, and utilities. Closing costs and realtor fees will also cut into your profits and need to be budgeted for.
Generally you want to purchase properties that are 30% below market value or properties that have estimated profits of $30,000 to give you enough of a cushion.
If you decide to rent the property you’ll need to make sure the rent you charge is greater than the expenses to maintain the property so that you achieve positive monthly cash flow.
Analyze your local market’s rental rates to get a feel for what you can charge your tenants.
If the rent you would need to charge to cover expenses is above your local market rent then the property is probably not going to work out and not a good investment.
You also want to analyze future rental rates for your local market. Are rent prices going to appreciate in the upcoming years keeping up with or outpacing rising expenses.
Overall, it’s all in the numbers.
Jumping randomly into a property expecting it to appreciate in value and earn you money from renting it is the wrong way to approach real estate investing.
You must do your homework and crunch the numbers making sure there is profit to be made in the deal.
Again, the more properties you analyze the easier it will become to determine good deals from bad deals. Once you have found a property and it passed evaluation, it is time to figure out how you will finance the purchase.
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