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Should I Buy This Home as an Investment Property?

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Real Estate Broker/Owner with Veritas Prime, LLC dba Veritas Prime Real Estate CT, NY, FL

Should I Buy This Home as an Investment Property? Out of the box seller lead follow-up or a segue into a different category or real estate?

 

How to convert a CMA inquiry into an investment analysis discussion.

 

Property Value

 

Real Estate agents often offer free home price analysis to potential sellers, hoping to convert them to listing clients. This study, commonly known as Comparative Market Analysis (CMA) typically consists of an evaluation of comparable homes in the immediate area that were recently sold, are in contract to be sold plus those that are still on the market. Most agents are reasonably adept at doing this, but not all are comfortable with investment analyses.

 

I once received a request for a CMA for a single family home that was already on the market, which was a bit puzzling. As it turned out, the enquirer was not a seller at all, but a buyer, who was interested in this house as an investment property and wanted to know if the asking price was “right”.

 

ROIHaving crunched the CMA numbers before calling this gentleman, I was able to assure him that the price of the home in question was in line with the current market for a RESIDENTIAL property. However, to view it as an investment property, I offered the capitalization rate approach to provide a better measure of Return On Investment, or ROI.

 

Capitalization Rates (Cap Rates) are used to establish value for investment properties. What to a residential buyer is PRICE, to an investor is VALUE. A higher Cap Rate indicates more efficient use of  your money.

 

You could consult a friendly local commercial lender to get a sense for what the current Cap Rates are in your area. Generally, a Cap Rate of about 8% is considered respectable, but sometimes lower ones may be acceptable.

 

The Cap Rate (CR) formula is:

 

NI/Value = CR, where NI is Net Income and Value is the Price

 

To get a TRUE Cap Rate, one would need a thorough understanding of the detailed operating expenses of the property so as to arrive at the proper number for NET Income. In the absence of that, for a rough comparison of potential returns from different properties, one can use gross rental income.

 

FINDING THE CAP RATE

My potential investor client would need to determine what the going rental rates are for homes similar to the one he is considering (BTW, we love investors because they normally represent repeat business).  Let’s say this 4 Bedroom Single Family home could be rented for $2,500/month, yielding an annual income of $30,000. The asking price for the home is $500,000.

 

Using the formula:  NI/Value = CR: $30,000/$500,000 = .06 or 6% Cap Rate  TOO LOW

 

FINDING THE RIGHT RENT NUMBER

Going at the matter a different way, you could ask HOW MUCH DOES THE RENT NEED TO BE to make this price worth my while, i.e. for me to get my 8% Cap Rate?

 

Using the formula: RENT =  CP x Value: .08x$500,000 = $40,000/year or about $3,333/month. My investor would have to charge $3,333/month in rent to get his desired return.

 

FINDING THE RIGHT PRICE OR VALUE

Since it’s not likely that tenants would be willing to pay an above-market price for a rental, investors can focus on the VALUE of the property. To arrive at a worthwhile value, or the amount an investor is willing to pay to get his ROI:

 

Using the formula: VALUE = NI/CP: $30,000/.08 = $375,000

 

To achieve his target ROI on this property in the current rental market, the investor should not pay more than $375,000 for the home.

 

This methodology for analyzing the value of potential investment properties is clearly very basic, but it’s a good starting point to determine how far the price might need to be negotiated down to get to the value of the property to you, or phrased differently, what the maximum price should be based on what profit you want to get out of the investment.

 

It was certainly an out-of-the box conversation for what was presumably a typical seller lead from a homeowner that might be thinking of selling his house. For any investment considerations, professional advice is always recommended, particularly in establishing detailed operating expenses, debt service costs and tax liabilities.

 

NOTE: Images courtesy of Stuart Miles of freedigitalphotos.net

 

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For Quality Solutions and Intellegent Answers to Your

Real Estate Needs or for Referrals, Consult With Olga

 

   

OLGA SIMONCELLI

Consultant

Real Estate Risk Management

203-482-2009 Cell

consultwitholga@gmail.com 

Visit My Website: www.thegoodrealestateagent.com

Your Local or Global Real Estate Consultant and “green broker. 

Candlewood Lake Real Estate

 

 

 

 

Endre Barath, Jr.
Berkshire Hathaway HomeServices California Properties - Beverly Hills, CA
Realtor - Los Angeles Home Sales 310.486.1002

Olga great idea one has to understand the language and wants and needs of an investor... and if the numbers make sense than it is a wise investment. Endre

Aug 12, 2016 03:00 PM
Olga Simoncelli
Veritas Prime, LLC dba Veritas Prime Real Estate - New Fairfield, CT
CONSULTANT, Real Estate Services & Risk Management

Endre Barath, Jr. - Thanks, it's really a different way of looking at a property.

Aug 12, 2016 11:52 PM
Sheri Sperry - MCNE®
Coldwell Banker Realty - Sedona, AZ
(928) 274-7355 ~ YOUR Solutions REALTOR®

Hi Olga Simoncelli - You are spot on when dealing with investors.  A very savvy investor should already know the formulas but it takes an expert like you to point out the small differences and how it might affect the local market. I just had an investor ask what the cap rate was all about, so I did a blog about it.  I was surprised that no other Realtor had explained this to her.  

Aug 23, 2016 02:34 AM
Olga Simoncelli
Veritas Prime, LLC dba Veritas Prime Real Estate - New Fairfield, CT
CONSULTANT, Real Estate Services & Risk Management

Sheri Sperry - MCNE - good for you Sheri for explaining the concept to your investor. Most realtors are not comfortable with that.

Aug 23, 2016 02:39 AM
Michael J. Perry
KW Elite - Lancaster, PA
Lancaster, PA Relo Specialist

I've been thinking about guaranteeing a listing I have and keeping it as a rental property !

Oct 23, 2016 07:56 AM
Olga Simoncelli
Veritas Prime, LLC dba Veritas Prime Real Estate - New Fairfield, CT
CONSULTANT, Real Estate Services & Risk Management

Michael J. Perry 

Some realtors use rental properties to secure retirement income.

Oct 23, 2016 09:56 PM
Bob Crane
Woodland Management Service / Woodland Real Estate, KW Diversified - Stevens Point, WI
Forestland Experts! 715-204-9671

Great post Olga, I work these numbers with each investment, unfortunately most agents who try to tell me about their great investment really do not know how to evaluate one.

Oct 29, 2016 02:01 PM
Olga Simoncelli
Veritas Prime, LLC dba Veritas Prime Real Estate - New Fairfield, CT
CONSULTANT, Real Estate Services & Risk Management

Bob Crane - thank you Bob. It's good to have some familiarity with these basic numbers.

Oct 30, 2016 04:00 AM