Doing a real estate analysis on rental properties prior to making investment decisions is crucial to real estate investors seeking to earn maximum profit and rates of return.
A real estate analysis is essentially a study of a rent property’s financial and other data to determine whether or not it is a suitable investment for a given investor.
Of course, this would involve a full range of considerations such as location, condition, unit configuration, comparative market value, financing, and so on.
But at the end of the day, the investor is really most interested in how all of those issues effect cash flow. For unlike residential home buyers, real estate investors are running an investment business that succeeds or fails by the amount of profit he or she can achieve by owning the property.
So it’s safe to say that the true bottom line of any real estate analysis concerns the property’s present and future cash flow performance; namely, rents. Rental income, of course, is what drives cash flows; so the investor will always consider rents in a real estate analysis.
In this article I want to show you a helpful way investors can study rents during the real estate analysis process using a rent scenarios report based upon the scenario analysis model.
Scenario analysis involves evaluating a range of variables likely to impact investment performance and then assigning a discrete (point) estimate to create a most likely, best-case, and worst-case scenario for each in order to see how each estimate for the variable might likely influence investment performance.
In our case, the investor would be conducting a rent scenario analysis as part of his or her real estate analysis. Therefore he or she would assign an estimate to each of the current rent variables that best reflects a most likely, best-case, and worst case scenario to thereby evaluate the impact each would have on cash flows and rates of return.
Let’s say the investor is considering purchasing a 100-unit apartment building consisting of three different unit configurations (or unit mix).
- Twenty five one-bedroom one-bath units renting monthly at an average of $515
- Sixty two-bedroom one-bath units at an average of $560
- Fifteen three-bedroom one bath units at of average $615
The investor in turn assigns three average monthly rent estimates (shown below) to each of the three unit configurations ranging from what he or she deems that the rental income can be “in a heart beat” (Scenario1) to “yes, I won the lottery” (Scenario3).
As a result, the investor can now see that the property could at the very least generate an annual cash flow of $157,213 (low risk), perhaps $168,613 (moderate risk), and $180,013 (high risk).
You get the idea.
The objective of the investor is to decide whether his or her real estate investing objective is met by the “upside potential” reflected in the rent scenario analysis. The report is printed and included as part of the overall real estate analysis for the eventual investment decision.
The Rent Scenarios Report provides investors with the property’s “upside potential”. In some cases it may prove dismal enough for the investor to pass on the rental property. In other cases it could indicate a very solid investment opportunity and keep an investor who otherwise might have walked away to instead make a purchase on a rental property with enormous income potential.
The Rent Scenarios Report can also help educate sellers about his or her rental property’s “realistic” income potential and thereby prevent over pricing it based upon “pie-in-the-sky” rental income projections that neither support or justify the price.
So You Know
ProAPOD Real Estate Investment Software solutions Agent 6 and Executive 10 both include the Rent Scenarios Report.