Real Estate Investment Deal Analysis
I just read J. Scott's blog post on deal analysis and have learned an immense amount of information. If you've ever been confused about some of the terms thrown around here at biggerpockets, it should clear things up for you.
Scott outlines the 5 areas of information gathering an investor must prepare:
- Property Details
- Purchase Information
- Financing Details
Scott also stresses to verify any information provided by the seller. No matter how trustworthy someone seems, this makes a lot of sense.
Scott goes through an example scenario and calculates the following information:
Net Operating Income = Income – Expenses
NOI is important to calculate because it shows your income after expenses (excluding debt).
Cash Flow = NOI – Debt Service
Cash Flow shows how much actual cash you, as the investor, will have after taking your debt into consideration.
ROI = Cash Flow / Investment Basis
We want to compare our ROI to what we could get if we invested our money in a CD at a bank or a good mutual fund.
Capitalization Rate = NOI / Property Price
The Cap Rate is independent of the buyer and the financing, it is the most pure indication of the return a property will generate. This ratio is the equivalent return on investment if you paid all cash for the property.
Cash On Cash Return = Cash Flow / Investment Basis
This shows true cash on cash return where investment basis represents the amount of cash laid out for the investment.
Total ROI = Total Return / Investment Basis,
Where total ROI is Cash Flow +Tax Consequences + Property Appreciation + Equity Accrued. Investment Basis represents the amount of cash laid out for the deal.
The above ratio's paint a picture that allow the investor the examine. In the end your decision will be based on the amount of risk you're willing to take on a deal.
The post by Scott is a gem. I've written the above so I can get a quick overview when examining deals, but I'd highly suggest you go check his blog post out for the full details.