It is a common mistake made by real estate investing novices to exclude (or unintentionally misrepresent) three financial data items when creating a real estate analysis.
As a result, the cash flow, rate of return, and profitability numbers presented to real estate investors regarding a particular rental property get skewed and investment decisions become more or less faulty.
After working with investment real estate for more than thirty years, I’ve seen more than one real estate analysis created by a well-intending novice that made the mistake.
So in this article I want to address these items and strongly suggest that you always consider them when evaluating rental income property.
Vacancy and Credit Loss
The rule is to always include a rate for vacancy and credit loss.
Whether the current owner has been experiencing 100% occupancy or not, always show a realistic percentage for a vacancy allowance (let’s say 5%). Bank appraisers do, and it always makes you look better to your investor when you compute one into your proforma for your investor.
Why? Because no one knows for sure why the owner had such good fortune. Maybe the tenants are relatives or are just getting a good deal.
Real estate investors, on the other hand, should never run the risk of assuming that a complex will continue with the minimal vacancy experienced by the current owner and must always make an allowance for it when considering the investment.
Repairs and Maintenance
Here again, agents generally tend to report on numbers achieved by the owner. This can be a two-edged sword that should be avoided.
If the owner was a poor manager, costs for repairs and maintenance can be skewed higher than reality; if the owner is a fix-it type of person (or has a relative that is) costs for repairs and maintenance can be skewed lower than reality.
It is always best to include repairs and maintenance as some realistic percentage of income in the proforma rather than the owner’s numbers. The rate you use will vary depending upon the age and condition of the property but generally falls somewhere between 4-8% of GSI.
Real estate investors may not actually set money aside for a future replacement of things like roofs and appliances, but it should be accounted for in the real estate analysis. Again, no hard-fast rule, but replacement reserves are commonly computed at $200-300 per unit per year.
So You Know
ProAPOD Real Estate Investment Software makes it easy to include all three items and then automatically populates the appropriate reports with the results.