Real Estate 011: Cash Flow Analysis and Market Research

Cash Flow Analysis and Market Research

When people ask me how I can invest thousands of miles away in the midwest while living in California, I tell them that your confidence build the more research you do on your markets as well as your local team on the ground. That is why I started to build my own team after purchasing a couple turnkey houses. Mainly, a realtor (who gets paid when you close a deal) is going to see a project differently from a contractor (who gets paid by the amount of work performed) and that will be entirely different from a property manager’s perspective (who gets paid by the amount of income it produces) By looking at a property and its market through the lens of a team who all have different opinions, you will get a better view of the whole picture.

Here is the recommendation I received from a local property manager when I was starting to research my market:

1. Using an Agent/Realtor

If you are buying a property through the MLS, have your realtor go out to the property and take photos/videos. Ensure that they get pictures of the roof, mechanicals, foundation, and plumbing/electrical systems. These will make a bigger impact on your investment as a new roof and furnace doesn't necessarily demand a higher rent rate but it may lead to loss of tenants and in turn, revenue for your business. These capital expenses don't usually have much impact on the rent rate, so if they need to be updated, you want to ensure that it's figured in the rehab budget. Unless you are doing a full gut-rehab, I always recommend getting a home inspection and having a General Contractor walk through the property as well. Your realtor should be able to coordinate these activities.

2. Researching the area

How is the crime? Is the school system a factor in vacancy? What conveniences and amenities are nearby? Are there any industrial areas nearby (landfills, recycling facilities, wastewater treatment facilities, train tracks, air ports, prisons re-entry program, etc.?) Is it in a flood zone (High insurance deductibles)? Are there problematic homes in the immediate vicinity (boarded up homes, illegal dumping, abandoned cars, unkept yards, etc.?). These potential issues should be communicated by your agent and/or property manager who are your local boots on the ground.

3) Tenanted Properties

If the home you wish to purchase is tenanted, make sure to get copies of the leases and rent rolls. What are the tenants paying? When does their lease end? Are they current? How much is being held in a security deposit? Is the security deposit going to be rendered to the buyer at closing? Newbie investors may think that “cash flowing on day one” is an advantage, but note you may be paying a premium to take on someone else’s problem. Buying a vacant property allows you to have your trusted/vetted PM place a qualified tenant, even though that may mean your property sits vacant for a month or two, and will be paying a lease up fee.

4) Proforma vs Actuals

Most of the time, an agent or the seller may provide you with a proforma, or estimated cash flow the buyer may expect to see with the purchase of the property. Based on my experience, these numbers are optimistic at best. Ensure that you get market rent rates from both the realtor and property manager (This information can also be cross referenced to websites like Zillow, hotpads and Rentometer). Frequently, realtors are not as accurate with their rental information unless they work heavily in that space, where as property managers should always have the most current data based on their experience and inventory.

You will also want to understand property taxes, HOA fees, and get an idea of insurance costs. Your realtor should be able to help with this as well and a good insurance company should be able to assist with the insurance costs (Obtain an actual quote).

After verifying against the location criteria, understanding the scope of any rehab and having a budget built, and getting a good understanding of the probable rent rate, you plug these new numbers in the original underwriting you did with assumptions and see if it fits the original plan. If it doesn't, negotiate the deal to better fit the criteria that you set up in advance.

Here's a checklist to help assist your research:

  • Get opinions on specific location. Crime, School, Flood zone, Specifics to that location?

  • Get market rates to determine ARV / Fair Market Value. In some markets you will want retail prices and as-is, distressed prices if investing in areas with lots of rehabs. A realtor should be able to provide a broker’s price opinion (BPO) or Comparative Market Analysis (CMA), sometimes for a fee.

  • Understand the property taxes, HOA fees, property management fees, and insurance costs.

  • Get rent rates for the location, size, amenities, condition, time of year, etc.

  • Get a home inspection and have a General Contractor (GC) build a rehab budget.

  • Verify tenant information (if tenanted).

Plug all of that data that you obtained yourself into your calculations and see if it still performs against your criteria. Do not fudge the numbers to make it work because you want to close. The only thing worse than no deal is a bad deal that loses money. Don't take a bad deal because you are eager, ensure that it's a deal and get a third party to help you put an eye on it.

As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Advisor before making any investment decision.

Good Luck!

Market Research