The life and times of an Arizona Investor

This will be my personal journal to document my failures and successes during my real estate experiences in Arizona. All stories, thoughts, and successes will be documented..

Monday, December 19, 2005

A quick way to analyze income property..

I had a few hours to re-think on how to analyze income property on the MLS quickly. I want an approach that I could complete in a few seconds to assess the potential "bargain" of the listing.

The best approach is using gross rent multiples. I have been using capitalization rates, but there's too many varying parameters that skew the data. The capitalization rate is simply:

CAP Rate = NOI (annual) / value of property

NOI (annual) = The operating income on yearly basis (Gross rents - expenses).
value of property = The true worth of the property

So, If you know the going cap rate in your area, you take the NOI and complete the math to calculate the "value". Pretty simple. I've gone through scenarios taking certain type of financing and interest rates to back out a pseudo cap rate. I than take the NOI thats listed in MLS and calculate value. For example, MLS rates in my neighborhoods are 5-7 percent. My goals are 10 percent for positive cashflow. You can do some cals to quickly determine how far Tucson's rental market is from the highly appreciated properties.

The problems: The NOI calculation is not consistent w/ how I personally calculate NOI. On the MLS, they almost never use manager salaries and maintenance in their NOI numbers. So, thats an issue. You also have to assume that all the numbers are pretty accurate or else your value is not correct. Guess what side (seller of buyer) the numbers fall to?

Gross rent multiples is a great way.

Gross rent multiples: The number of years that the gross rents (yearly) to get to the purchase price.

Example: Yearly rent 12,000 Price of house 100000 Gross rent Multiple =8.33 So , it would take 8.33 years to get to your money back (get to the purchase price).

There's only two parameters in this equation! If you know know the rents in your area ( and you should) than you can calculate good numbers all day!

I used some of my properties to back out what the gross multiples are. Its roughly about 10-10.5. Let's compare to the average gross multiples in different areas.

Gross rent multiples on MLS

Houses, duplexes, tri-plexes, four-plex, -> 13 - 17
Income property by the university -> 16-19
mulit-unit one bed rooms -> 11.75-13
Properties in much less desirable areas -> 11-15

Ok, this is why I don't buy properties every mnoth. You cannot buy a property and get break even cash flow with mulipliers this high! The cool thing about using this equation is that the "bargain" should not be a function of location. Because some areas have lower or higher rent, this equation normalizes the value to the selling price. You want to pay off your properties as soon as possible, so if you buy a university house, sure you'll get a higher rent, but it'll take longer to pay off the house than in a different area!

So, by scanning the MLS entries, you can cherry pick the lower muliples and ask for a lower price and you may get one at break even cash flow.

I still hate the MLS, but its the best way to find a property that can be split for new construction.

Good investing!
|| Bginvestor, 6:10 AM


Very interesting stuff!

I must say, after studying the way cap rates vary across the country, I'm leaning towards the following conclusion.... Cap rates on commercial properties are oppositely proprotionate to the desirability of the area. What I mean is, the more desirable the area, the lower the cap rates seem to be! Hawaii has cap rates of 2-4% or so, while some are even negative! In the middle section of the US, the cap rates are higher--I've seen them anywhere from 6% to 16%!
Blogger Trisha#1, at 1:54 PM  

Tucson is from 5-6 on average. If the property is in a bad neigborhood it will go to 8.

Talk soon!
Blogger Bginvestor, at 6:35 PM  
What REI books would you recoomend to a beginner?
Blogger Dynamite, at 11:50 PM  
I've been looking for a book on this exact subject - how to analyze income properties. One thing that you don't touch on here, but would seem important to understand, is IRR and discounted cash flows as they relate to the opportunity cost of an investor's investment dollars. Can you recommend a book that comprehensively looks at income property evaluation?

Blogger Seattle Eric, at 1:02 PM  
I just came across your blog and wanted to drop you a note telling you how impressed I was with the information you have posted here.
I also have a web site & blog about dummy investing
so I know what I'm talking about when I say your site is top-notch! Keep up the great work!
Blogger Investment Center, at 10:32 PM  

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