Boots before numbers crunchin’ was how it was taught to me. The investment world is and has been consumed with ‘the numbers’. Yet real estate investors, at least in my experience, do much analysis, and produce more spreadsheets based upon garbage numbers than even they’ll ever know. Possibly the worst source for income property numbers is your local MLS. Forget the probability that most rents and expenses are even cursorily vetted. Forget that most small residential income properties are listed by honest agents who do the vast majority of their business in owner occupied homes.
How ’bout the fact that even if the rents and expenses come directly from the seller’s tax return, they’re still virtually guaranteed to be inaccurate, at least in part. In California for instance, the real estate taxes today will not be what they are after you close escrow. Then there’s maintenance and repairs, always cheap and abundant fodder for one-liners. In San Diego, a 35 year old fourplex is merely considered broken in. Yet the operating expenses shown in the listing says it cost the current owner just $563 for that line item. Spotted the developing trend here?
Captain Obvious alert: It’s called income property for a reason. It’s value is BASED on it’s income.
Grab your clipboard, put on a smile, and put your boots on the ground. Knock on doors to find out what’s really up in the neighborhoods with rent. Gain serious local intel from tenants and managers willing to talk with ya. Learn which buildings are rented below market, even in area tenants’ eyes. They often know the local neighborhood better than anyone, sometimes better than the owner. Over the years I’ve learned things about areas I ‘knew cold’ that stopped me in my tracks. Every now and then I’ve been able to spot a trend in its infancy. There are times when that knowledge can be invaluable.
Operating expenses — You’re already there, so why not?
Way back in the day, I was conducting an extensive clipboard excursion for a new client. She wanted to exchange her high equity duplex for more property in another, better neighborhood. When asked the value of her property, she gave an honest answer. In fact, my immediate response was complete agreement. The next day I commenced by boots on the ground tour, clipboard in hand. Surprise surprise surprise. Long story short, her duplex was separately metered for both gas and electricity. Furthermore, each unit had it’s own water heater. With only a couple exceptions, the other duplexes in the area sported just one gas and one electric meter, and one water heater. In other words, even though she was commanding the same rents as her immediate competition, her expenses were demonstrably lower.
Obviously, this resulted in her NOI, (Net Operating Income) being higher. You see where this is goin’, right? Turns out real estate investors value net income a bit more than gross income. Who knew? The difference in value, based on actual sales price, was around 10% of her competition.
Clipboard first — then calculator.
I realize that such a simple thing seems silly. Yet experience has shown me that first timers and short timers can easily miss this sorta thing. I know, cuz I’ve seen me do it. When I was around 26 or so, my mentor looked at my cash flow sheet one day and started laughin’ out loud. He then handed it back to me, asking between bouts of coughing, “What’d ya miss Mr. Analyst?” He’d given me homework a few days before. I was to ‘walk the neighborhood’ in which his own 22 unit building was located. I missed this very factor: An all electric building with one meter. This was no minor error, as it was clearly compounded by the number of units vs the aforementioned duplex.
He brought the lesson home though, by being serious as a heart attack. He asked me how I’d feel, if I’d sold it to a buyer as if it’d been separately metered? He made it so real, my heart sunk. It was as if I’d really done it. I never wanted to feel that way again.
From that day forward — clipboard — THEN calculator.
It’s as simple as A-B-C — until ya don’t do it.
First, get the chronology right. Then, at least at first (I still do), wield the clipboard yourself. Put your own boots on the ground. Get scary good at it. This post merely touches the tip of the iceberg of both the value this principle offers, and the potentially ruinous mistakes that can come from ignoring it. Like many tried and true practices, this one will not be mocked. Do the work, or pay the price.
Photo: Dan Dickenson