Buy Properties Below Market Value

With current economic conditions, real estate investing is a precarious venture. Between skyrocketing unemployment rates, foreclosure and bankruptcy filings, few people can afford to take the risk of investing in real estate.

Previously, real estate investing was considered one of the most secure and profitable investment practices. Today, there is a gigantic question mark above real estate and financial investing opportunities. In order to profit, investors need to thoroughly understand market conditions and become savvy with financing options.

As real estate prices continue to decline there are numerous opportunities for profit. The best way to uncover hidden gems is by taking time to conduct research and attend real estate investing seminars.

Educational seminars are offered in most cities and towns across the country. The Internet provides a wealth of learning opportunities where classes can be attended in the comfort of your home via webcasts or by purchasing seminars presented on DVDs, CDs or audio files.

Investing seminars can help participants determine which type of real estate is best suited for their financial situation and management ability. Investment properties can range from single family dwellings to commercial endeavors such as retail outlets or office buildings.

Many real estate investors engage in joint ventures to purchase commercial real estate. Newbie investors would do best to engage in small joint venture projects until they obtain sufficient experience. Investing in commercial real estate is an entirely different ballgame and involves a wide range of legal procedures not typically associated with residential properties.

One popular investment technique is purchasing real estate for the purpose of house flipping. Flipping houses involves buying distressed properties below market value, rehabbing the home, and selling it quickly for profit.

Distressed properties can include foreclosure or bank owned homes, short sale real estate, and probate properties. Rehabbing distressed real estate oftentimes creates numerous unexpected expenses. It is imperative to conduct due diligence and obtain a professional property inspection prior to presenting a purchase offer.

Short sales are rapidly becoming a popular investment choice. Mortgage lenders engage in short sale transactions when borrowers are facing foreclosure and owe more than the appraised property value. Banks will accept less than is owed on the loan if the borrower is able to sell the property quickly.

Short sale properties are sold through the loss mitigation department of the originating mortgage lender. Buying short sale real estate can be complicated and time-consuming. It is best to work with a realtor or investor experienced with the short sale process.

Wholesale real estate is one of easiest and most profitable forms of real estate investing. Investors purchase properties at wholesale cost and resell in “as-is” condition. Investors who engage in wholesaling typically purchase bank portfolios consisting of multiple properties. Oftentimes, these properties can be bought for as little as sixty cents on the dollar.

Real estate investing offers an abundance of opportunities to profit. However, investors must develop a solid plan which includes short and long term goals. Investors can improve their chance of success by networking with real estate professionals including attorneys, lenders, brokers, real estate agents and other investors.

Using the cap rate approach to arrive at a property’s market value can be used for any rental income property. Including, multi-family units, office buildings, warehouses, retail strip malls, or similar properties that generate rental income.

This is particularly helpful when you want to arrive at a rough listing or resale price quickly and easily. When you might want to suggest a price for a particular rental property based on the market cap rate or a customer’s desired capitalization rate, for example.

In this article, we’ll use a mock situation and walk you through the process. Let’s assume that you were asked by a customer to suggest a selling price for his 8-unit apartment complex.

A) Determine net operating income

So you understand. Net operating income (or NOI) is one of the most important calculations made in regard to any real estate investment because it represents the property’s potential income after all vacancy and operating expenses have been subtracted; consider it as the investment property’s productivity, or measure of cash flow.

When the property is financed, for example, NOI represents the cash flow available to pay the mortgage; if the investor pays all cash for the property, and thus eliminates a mortgage payment, then it becomes the annual cash flow (i.e., cash flow before taxes).

As your first order of business, then, you would want to determine the net operating income for the property.

Here’s the calculation.

Gross Scheduled Income (GSI) less Estimated vacancy and collection losses = Effective Gross Income (EGI) + Income from other sources such as late fees, vending machines, and so forth = Gross Operating Income (GOI) less Annual operating expenses such as real estate taxes, utilities, insurance, maintenance and repairs, landscaping, management fees, legal and accounting, and so forth = Net operating income (NOI)

For our example, we’ll assume that the income property has a $54,000 GSI, $2,700 vacancy loss, $600 income from sources other than rent (i.e., coin-operated washers and dryers), and $20,760 annual operating expenses.

$54,000 (GSI) less 2,700 (Vacancy) = $51,300 (EGI) + 600 (Other Income) = $51,900 (GOI) less 20,760 (Operating Expenses) = $31,140 (NOI)

B) Determine the desired rate of return Next, we have to determine the capitalization rate we want to use for our calculation using one of two approaches. Either we research the market for similar income properties to arrive at a market cap rate or we use the customer’s desired rate.

For our example, let’s say that other similar apartment complexes in the area reveal an average cap rate of 6.23% and in turn make the decision along with the seller to use that rate. Bear in mind, however, if the seller is adamant about using his own desired rate, and it’s different from the market rate, we would side with the customer.

In other words, if our seller preferred to use a capitalization rate of, say, 5.5%, then we would calculate his rental property value based upon that rate of return.

C) Calculate the real estate value Lastly, now that we have the property’s net operating income of $31,140), and plan to use the market rate of 6.23%, we can calculate our customer’s income property value with this formula: Net operating income / Cap rate = Real estate value, or $31,140 / 6.23% = $500,000

Okay, now you’re ready to call your customer. Based upon a net operating income of $31,140 and a market cap rate of 6.23%, you estimate that the customer’s apartment complex has a market value of $500,000.

Of course, for our purposes, we kept it simple. In a real life situation you, naturally, would want to use credible and accurate (not pie-in-the-sky) numbers to arrive at the property’s NOI. Moreover, you would want to consider other factors that could influence the property’s value.

Upside rent potential, for instance, or the ability to add more units to the property would surely increase its market value. Whereas, perhaps an impending zoning regulation that would make it a less desirable rental, and maybe negatively impact the rents or decrease occupancy levels, would drop its market value. But you get the idea.

It should go without saying that the overall cost of buying fixer-uppers has a direct effect on one’s bottom profit line when it comes time to reselling. Of course, the main goal behind the entire process is to buy low and then resell high to make the most profit possible, which is why it’s extremely important to never pay market value when buying fixer-uppers for the purpose of reselling them.Understanding Property ValuesWithout being able to easily determine property values, no investor will be able to turn an attractive profit, not when purchasing fixer-uppers, nor when listing and reselling them. Learning how to make property comparisons by utilizing the many tools available in the real estate market today will indeed take a bit of time and plenty of research, however, the end result is more than worth the effort spent.Researching the MarketToo many investors make the mistake of relying on the internet, word of mouth, or on simple photographs in listings when it comes to researching the market and finding fixer-uppers that would be worth their investment dollars. To determine whether or not a property is truly worth it, you must personally look at it yourself with your own eyes, which also applies to looking at potential contractor’s current work that’s done at varying levels and stages of renovations. While a picture may be worth a thousand words, in this case, seeing something for yourself just can’t be beat.Many real estate agents rely upon what’s known as a CMA, or Comparative Market Analysis, when it comes time to determine the value of a property, which essentially, is a spreadsheet of information that outlines any recent sales within a certain geographical proximity to the property in question.To create your very own CMA, use data only from sales that have already been completed for the truest results rather than those that are still pending or under negotiation, and turn to resources such as real estate appraisers, the local tax assessor and county clerk’s offices, as well as the area’s local real estate brokers.Estimating All CostsEstimating all costs of your fixer-upper projects includes first the acquisition costs, which are the property’s purchase price, any taxes that haven’t been paid, and the origination fees, as well as the amount to renovate the home, such as the cost of a new roof, new carpeting, paint, or plumbing and electrical repairs.Also, never make the mistake of forgetting about any hidden costs, and you can rest assured that there are at least one or two you hadn’t counted on at the beginning of your real estate ventures. The property will need to have the proper inspections, as well as ensuring that all necessary documents are in order, like the certificate of occupancy or building surveys.Having an accurate and realistic picture of the total costs involved is really the only way to guarantee you’ll be protecting your money and enjoying a healthy return on your investments when buying and reselling fixer-uppers for profit.