Commercial Real Estate Appraisal

Commercial Real Estate Appraisal

Commercial real estate appraisal is a combination of art and science. Knowledgeable appraisers gather and analyze data prior to making informed decisions about real estate value. The appraisal profession has developed a series of well-established analytical techniques; the cost approach, income approach and sales comparison approach. The most appropriate approaches depend upon the characteristics of the subject property.

The cost approach is considered most applicable for commercial real estate appraisals for relatively new properties and special-use properties. Commercial real estate appraisers are less likely to use the cost approach for older properties due to the difficulty of precisely calculating the amount of depreciation.

The income approach is considered most applicable for investment or income properties. Appraisers gather data regarding the actual income and expenses for the subject property, rental comparables, expense comparables, industry expense data, market occupancy, and rental market trends. The commercial real estate appraiser then estimates gross potential income, other income, effective gross income, operating expenses, and net operating income. Net operating income is converted into an indication of market value using a conversion factor termed the capitalization rate, using the following formula:

Market value = net operating income/capitalization rate. This process is termed direct capitalization.

The income approach can also be calculated using a discounted cash flow analysis. Revenue and expenses are estimated for a period of years and the resulting annual cash flows and gross proceeds from a projected sale of the property are discounted to a present value using a discount rate.

Commercial real estate appraisers also utilize the sales comparison approach to estimate market value. The sales comparison approach is often considered most comparable for owner-occupied properties. After obtaining data regarding similar properties that recently sold, the appraiser makes adjustments to generate an indication of market value for the subject property.

After considering each of the three approaches to appraisal and preparing an analysis for the approaches which are considered relevant, the appraiser reconciles the indications of value to a final value conclusion. The quality and quantity of data for each of the approaches is considered when reconciling to a final value conclusion.

O’Connor & Associates is the largest independent appraisal firm in the southwestern United States and has over 40 full-time staff members engaged full-time in valuation and market study assignments. Their expertise includes valuing commercial real estate, single-family, business personal property, business enterprise value, purchase price allocation for businesses, valuation for property tax assignments, partial interest valuation, estate tax valuation, expert witness testimony and valuation for condemnation. They have performed over 20,000 commercial real estate appraisals since 1988.

To obtain a quote or further information for a commercial real estate appraisal, contact either George Thomas or Craig Young at 713-686-9955 or fill out our online form.The appraisal division of O’Connor & Associates is a national provider of commercial property real estate appraisal services including cost segregation studies, due diligence, insurance valuations, business personal property valuations, business purchase price allocations, single family litigation support and business valuations.

All commercial property types benefit from our appraisal services including multi-family housing, retail stores, hospitals, hotels, industrial properties, manufacturing facilities, medical offices, commercial offices, restaurants, self-storage units, shopping malls, shopping plazas and warehouse/distribution centers.

Patrick C. O’Connor has been president of O’Connor & Associates since 1983 and is a recipient of the prestigious MAI designation from the Appraisal Institute. He is also a registered senior property tax consultant in the state of Texas and has written numerous articles in state and national publications on reducing property taxes.


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Bellwether Income Property Publication Increases Cap Rate Recommendations



NetGain Increases Cap Rate Recommendations


Mountain View, CA (PRWEB) November 19, 2008

In light of recent data from key economic indicators, NetGain’s National Income Property Index™ (NIPI™), the preeminent income property guide for increasing rate of return (ROI) and minimizing investment risk, has established that today’s income property investments necessitate 7% to 7.5% capitalization rates. For the past two years the recommended range has been steady at 6.5% to 7%.

Recent changes in the U.S. economy that predicated the cap rate shift are as follows:

The unemployment rate for October increased to 6.5% from the prior 6.1% rate for September.
The Consumer Confidence Index for October is 38 (1985=100), a record low.
The Commerce Department reported that the gross domestic product (GDP) fell at an annual rate of 0.3 percent in the July-September period, a significant slowdown after growth of 2.8 percent in the prior quarter.
NetGain Co-founder, Allen Cymrot, states, “Income property owners have to pay particular attention to expiring leases in our current economy. All income from leases that expire within one year has to be re-evaluated when determining the net operating income to compute a capitalization rate. Leases with an option to renew will still benefit the lessee. If market rates go up, the lessee will execute the option. If market rates go down, which will be most common, the lessee will not execute the option but instead choose to re-negotiate the lease at a lower rate.”

Along with cap rate recommendations, NetGain simultaneously released a prescription for the U.S. economy that would provide commerce to bolster income property along with other industry sectors.

States Co-founder Robert Mann, “The disease and the cure for the U.S. economy both revolve around energy and energy independence. Only robust energy-production industries have the potential to jump-start the employment base and lift income property values. In the meantime, cap rates at or close to 7.5% are recommended.”

NetGainRealEstate.com is a wholly owned subsidiary of NetGainR.E.Inc. In addition to capitalization rate recommendations, investors may also find bi-monthly essays, a comprehensive due diligence checklist, an extensive question and answer section, and a composite index of REIT data at www.netgainrealestate.com .

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How to Buy Bargain Real Estate Income Property in Atlanta

How to Buy Discount Income Property in Atlanta

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Miami Investment Property 4 Plex or 4 unit apartment building each 1 bed and 1 bath units. Income producing and cash-flow positive single-story multi-family rental investment property in North Miami on block north of stores and restaurants on NE 125th Street. Financials provided upon request showing 9% cash on cash return in-place as operated. All units legal one 1/1′s with vaulted ceilings in living and bedrooms. Cabintes and most windows updated. Pasted 40 yr recertification. Ample parking for eight cars. Call agent for me details: Brian Carter, PA Douglas Elliman Florida, LLC 305.582.2424
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Give Me Ten Minutes and I’ll Make You Better at Real Estate Investing

Okay, ten minutes is a guess. You might absorb what I have to say and thereby become better at real estate investing in less time if you’re a fast reader.

Shall we get stared?

Acknowledge the Basics

Real estate investing involves acquisition, holding, and sale of rights in real property with the expectation of using cash inflows for potential future cash outflows and thereby generating a favorable rate of return on that investment.

More advantageous then stock investments (which usually require more investor equity) real estate investments offer the advantage to leverage a real estate property heavily. In other words, with an investment in real estate, you can use other people’s money to magnify your rate of return and control a much larger investment than would be possible otherwise. Moreover, with rental property, you can virtually use other people’s money to pay off your loan.

But aside from leverage, real estate investing provides other benefits to investors such as yields from annual after-tax cash flows, equity buildup through appreciation of the asset, and cash flow after tax upon sale. Plus, non-monetary returns such as pride of ownership, the security that you control ownership, and portfolio diversification.

You’ll need capital, investing in real estate does have risks, and investment real estate can be management-intensive. Nonetheless, real estate investing is a source of wealth, and that should be enough motivation for us to want to get better at it.

Understand the Elements of Return

Real estate is not purchased, held, or sold on emotion. Real estate is not about love; it’s about a return on investment. As such, prudent real estate investors always consider these four basic elements of return to determine the potential benefits of purchasing, holding on to, or selling an income property investment.

1. Cash Flow – This is determined by the amount of money collected from rents and other income less operating expenses and loan payment. Furthermore, real estate investing is all about the investment property’s cash flow. You’re buying income stream, therefore be certain that the numbers you use to calculate cash flow are truthful.

2. Appreciation – This is the growth in value of a property over time, or future selling price minus original purchase price. The fundamental truth to understand about appreciation, however, is that real estate investors buy the income stream of investment property. It stands to reason, therefore, that the more income you can sell, the more you can expect your property to be worth. In other words, make a determination about the likelihood of an increase in income and throw it into your decision-making.

3. Loan Amortization – This means a periodic reduction of the loan over time leading to increased equity. Because lenders evaluate rental property based on income stream, when buying multifamily property, present lenders with clear and concise cash flow reports. Properties with income and expenses represented accurately to the lender increase the chances the investor will obtain a favorable financing.

4. Tax Shelter – This signifies a legal way to use real estate investment property to reduce annual or ultimate income taxes. No one-size-fits-all, though, and the prudent real estate investor should check with a tax expert to be sure what the current tax laws are for the investor in any particular year.

Do Your Homework

1. Form the correct attitude. Dispel the thought that investing in rental properties is like buying a home and develop the attitude that real estate investing is business. Look beyond curb appeal, exciting amenities, and desirable floor plans unless they contribute to the income. Focus on the numbers. “Only women are beautiful,” an investor once told me. “What are the numbers?”

2. Develop a real estate investment goal with meaningful objectives. Have a plan with stated goals that best frames your investment strategy; it’s one of the most important elements of successful investing. What do you want to achieve? By when do you want to achieve it? How much cash are you willing to invest comfortably, and what rate of return are you hoping to generate?

3. Research your market. Understanding as much as possible about the conditions of the real estate market surrounding the rental property you want to purchase is a necessary and prudent approach to real estate investing. Learn about property values, rents, and occupancy rates in your local area. You can turn to a qualified real estate professional or speak with the county tax assessor.

4. Learn the terms and returns and how to compute them. Get familiar with the nuances of real estate investing and learn the terms, formulas, and calculations. There are sites online that provide free information.

5. Consider investing in real estate investment software. Having the ability to create your own rental property analysis gives you more control about how the cash flow numbers are presented and a better understanding about a property’s profitability. There are numerous software solutions to choose from online.

6. Create a relationship with a real estate professional that knows the local real estate market and understands rental property. It won’t advance your investment objectives to spend time with an agent unless that person knows about investment property and is adequately prepared to help you correctly procure it. Work with a real estate investment specialist.

There you have it. As concise an insight into real estate investing as I could provide without boring you to death. Just take them to heart and you should be fine. Here’s to your investing success.

James Kobzeff is the developer of a software solution for real Estate investment. Want to create cash flow, rate of return, and profitability analysis presentations in minutes? See ProAPOD at => http://www.proapod.com


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The Income Approach to Property Valuation,Andrew Baum,

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How Lenders Appraise Commercial Properties

When considering whether to finance income-producing properties, lenders are especially concerned with the property’s stability. They use three primary analytical techniques to determine the property’s strength – appraising, underwriting and structuring the loan. To increase your chances of funding income properties, you should be familiar with these three elements of the transaction.


Appraising


There are many kinds of appraisals and appraisal methods. For the purposes of commercial mortgages, lenders are generally concerned with getting a reasonable estimate of value upon which they can base their loan amount. This estimate not only must be acceptable to the lender, but it also must be acceptable to the many auditors and examiners involved in the transaction.


The information in the appraisal report should be accurate. There should not be unexplained inconsistencies within the paperwork regarding sizes, room counts or any other facets. The appraisal should be logical and based on fact.


The appraisal is always an integral part of an income-property financing submission. Still, mortgage bankers and brokers must exercise good judgment to determine exactly how much importance to give to it.


Indeed, some lending institutions are appraisal-oriented, while others place priority or equal emphasis on other factors such as sponsorship and credit. This does not mean that some lenders accept inadequate appraisals; it merely means that they place less emphasis on the appraisal and more emphasis on other basic fundamentals.


Underwriting


The next analytical technique lenders use with income properties is underwriting. Of all the elements, this is perhaps the most misunderstood and least appreciated in our industry as a whole. It is, however, of paramount importance. We are involved in the business of risk analysis. It is in this area where we find the widest divergence of opinion, appetites and attitudes.


Underwriting involves the melding of specific information on a particular project (physical characteristics, location, appraisal, etc.) with general information on similar projects with which institutions have been associated in the past. This melding of data will help the lender make a decision on whether to make a loan commitment.


Further, the underwriting is the basis for determining the loan’s ultimate terms. One lender, for instance, seems perfectly at home with full-documentation loans on shopping centers. Another is willing to consider shopping centers but only so-called prime centers and only on a conservative basis. Some lenders will accept luxury apartments, while others find these types of investment totally unacceptable.


Brokers must intimately know the underwriting patterns of the various lenders. They will vary among properties and among geographic locations, but there are a few factors that will be assessed in almost every type of income property.


These universal considerations include the loan-to-value ratio, the debt-service-coverage ratio, the break-even point, the loan and the income per unit typical of the property type in question. You may also wish to chart, as a routine matter, appropriate area sizes, parking requirements and typical amenities.


Keep alert to the elements of prudent underwriting. It will make it easier to determine what lenders find acceptable with the majority of projects.


Structuring the loan


When it comes to structuring the loan, you have to make a significant judgment concerning the proper amount of financing that a particular property can sustain. The judgment must be based on a thorough analysis of the project’s characteristics.


The recommended financing must be attuned to the particular lender with whom you are dealing. If, for instance, the property is a nursing home, and your one nursing home lender has never made a loan in excess of 70 percent of value or has never made a nursing home loan with less than a 1.5 debt-service-coverage ratio, keep those facts firmly in mind when negotiating an application and recommending a particular dollar amount to the lender.


For some borrowers, the aim of financing is not necessarily to arrange for a proper level of financing as much as it is to obtain the highest dollar amount at the lowest rate for the longest term.


On the other side of the fence, however, some lenders believe they should strive for the lowest number of dollars at the highest interest rate for a term that keeps the loan classified as a long-term, permanent loan.


For many of these lenders, the actual amount of the loan is immaterial. Fortunately, there are many members of our industry who aspire to place a proper level of financing upon any income-producing property.


Lenders’ levels of interest will vary between types of properties and industries. There are some life-insurance lenders that have had phenomenal success with financing industrial properties or shopping centers or motels and are willing to lend more aggressively in those categories.


Many experienced players in our industry will agree that more projects have failed from overfinancing than from underfinancing, and a lot of people have been driven from our industry because they never acquired the self-discipline to allow projects to stand on their own merits. Older and wiser heads in our industry can recount tale after tale of competent borrowers who began counting on the funds from their next project to bail out a previous one.


Ultimately, the structure of the loan must be reasonable for the property type, borrower and lender. It is this combination of project, sponsor and lender whose interests must all be evaluated and equalized if one is to be associated with successful income-producing properties.

For more information see East Coast Commercial Finance, affiliated with the National Association of Industrial and Office Properties, Urban Land Institute and Mortgage Bankers Association. East Coast Commercial Finance is located in Charlotte, N.C., and is involved in commercial real estate finance and investments.


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Managing For Value – A Guide For The First-Time Landlord

It is easy to get wrapped up in the metrics of analysis, development and acquisition of income property and to forget that eventually you’ll have to engage in the human and sometimes demanding business of actually managing the property you buy.

How you fulfill that task can go a long way toward determining the financial success of your investment. Property management is a complex subject, but if you observe some basic principles you can maximize your long-term profit and minimize some of the burden.

It’s business, nothing personal

Existing tenants will naturally harbor some suspicion about a new owner. Ignore it. Eventually you won’t be the New Guy or they won’t be the tenants, so it doesn’t really matter. Conduct yourself in a businesslike manner starting on day one. Treat your lease agreements like the business contracts they really are. Don’t simply ask a new tenant to sign the lease. Explain the terms and translate the legalese. Doing so establishes the fact that the lease terms matter and you expect both sides to observe them.

The Aretha Franklin Principle

In more than 30 years of owning rental property (and watching others do the same), I have found one principle that has proved consistently valid: Don’t expect your tenants to treat your property with respect unless you treat it with respect. If something is broken, fix it. If something is dirty, clean it up. If something is dangerous, make it safe. You can be certain that very few tenants will put forward any special effort to take care of the property if your attitude is one of neglect. The converse of this principle is also true. If you behave like a slumlord, you’ll get what you deserve.

Not only does this principle occupy the ethical high ground, it also makes very good business sense. Deferred maintenance is ultimately more expensive than aggressive maintenance and it will eat away at your investment return from several sides. The postponed repair will typically ring up a larger bill later. Consider the small plumbing leak you ignore today versus the additional damage you must repair when you finally fix the leak a few months hence.

A property with deferred maintenance also diminishes the amount of rent you can expect to collect. First, because few tenants will pay top dollar to occupy a poorly maintained property. And second because those who do, but feel they are not getting what they bargained for, are more likely to default in their payments.

Finally, on what should be your big payday – the day you sell the property for a handsome profit – you’ll find yourself making price concessions because of the property’s poor condition and its below-market revenue stream. By operating on the cheap you’ve bought your way into a lose-lose-lose trifecta.

Managing for Maximum Return

Buy Right

Your goal should be to manage the property for the greatest long-term gain. You need to understand that an income-property’s value is directly related to its income stream. Hence, your best chance to maximize that gain is to grow the property’s Net Operating Income. Doing so translates into at least two benefits: It’s likely to help your year-to-year cash flow, but even more important, NOI is fundamental to the valuation of the property. Hence, by increasing the NOI you create equity.

One way to optimize the growth of the property’s NOI is to buy it right. That’s not code for “look for properties you can steal.” It is not at all uncommon to find properties that earn below-market rents. This may happen because they have the kind of deferred maintenance discussed above, but it can also occur because the owner has simply not kept pace with the current market. Some landlords, especially those for whom real estate is a sideline, find it easier to renew the leases of good tenants at a nominal increase rather than demand market rents and take on the work and risk of finding new tenants.

When you locate such a property, you must not lose sight of the fact that you should purchase only if you can do so at a price that is very close to what its current income justifies. The seller will tell you that it should rent for more and therefore it is worth more. You could rephrase the seller’s position as, “Do my job and assume my risk, but pay me as if I had done it myself.” If you purchase a property with below-market rents at a price consistent with those rents and then proceed to bring them up to market, you will almost always create additional equity.

Implement Management Improvements

Unless the property you buy is a textbook case of managerial perfection, you can almost enhance it revenue stream (and therefore its value) by making management improvements. Not to beat a fallen horse further, start by cleaning up the previous owner’s deferred maintenance. After that, begin looking for ways to make the property more appealing to your pool of potential tenants. For example…

Common Areas – For apartment and office properties, make sure the hallways and stairways are clean and well lighted. Some artwork on the walls and furniture or other decorative items in the halls creates a more welcoming and less institutional atmosphere. They convey that the owner cares about creating a quality environment.

Security – For better or worse, we’ve become a very security-conscious society. Don’t take that concern for granted, but rather deal with it in a way that distinguishes your property from other with which it competes. The appropriate level of security varies a great deal from one type property of to another, but look for ways to improve whatever you have now. Exterior lighting, higher quality doors and door locks, controlled access to parking, and monitored fire and smoke detectors are just a few of the steps you can take.

Amenities – What do tenants really want? Can you wire the building for high-speed Internet access? Provide pooled secretarial and reception services for small office tenants? Pay for a series of newspaper ads promoting the businesses in your strip shopping center? Your goal is to maximum your income stream and to do so you need to distinguish yourself and your property from your competition. The numbers will add up quickly. Do the math:

Value = Net Operating Income / Capitalization Rate

Let’s say that, in your market, the prevailing cap rate is 10% (that is, if investors are buying properties for 10 times the NOI). You purchase such a property, make some of the management improvements suggested here and increase the Net Operating Income by ,000 per month, or ,000 per year.

Increase in Value = 12,000 / 0.10 = 0,000

By making management improvements, you created 0,000 in additional equity. Did you spend some time accomplishing this? Yes. Did you spend some money to make those improvements? Certainly. Did you spend 0,000? Not likely, probably not even close.

People who buy single-family homes with intention of “flipping” them quickly for a profit in a hot market are relying on economic forces beyond their control to create that profit. Those who invest in equities are also relying on outside economic forces as well as the competence and integrity of company management.

The bottom line with income-producing real estate is this: If you manage your property intelligently, ethically and responsibly with an eye toward providing the kind of quality environment that can command optimal rent, you can do something that you could never accomplish with a stock or bond investment or even with a flip. You can use your own initiative and skill to create value. In the most literal of terms, you can make money.

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French Property Law Aims To Protect – Part 2

In properties shared between several co-owners, the building’s manager insure the common parts of the building (staircases, elevator and the like) and some privative parts of the apartments and their inside fittings. This is referred to as group insurance and provides cover for fire damage, lightning, explosions, water/flooding, natural disasters, acts of terrorism, storms, hail, snow and more. In these contracts, a clause must specify that co-owners are regarded as being third parties between themselves.


Bear in mind that France has relatively high taxes including income, property, and residential taxes, wealth and capital gains tax. Although the French Government has pledged to reduce income tax by 30 per cent in the coming years, tax is still rather high in France and there are hefty penalties for late payers, so check your French tax return for the deadline.


Property owners will have to pay a local tax which covers services such as road maintenance and rubbish collection. The cost varies from area to area. Wealth tax applies if your French assets exceed 720,000 euros. Properties with a rental value of over 4,600 euros attract a residential tax (taxe d’habitation). The tax is due by whoever lives in the property. Income tax applies to rental income. Regardless of their nationality, individuals who do not reside in France are taxed on their income from French sources only.


In accordance with the provisions of Article 164 B of the French tax code, income from immovable property situated in France is subject to French tax. Non-residents should file their tax forms by 30 April in the following year. If a property is rented out furnished and provides a gross renrtal income of more than 23,000 euro, a specific return has to be submitted to the local tax office. Net rental income from French property is taxed at a minimum of 25 per cent, but no assessment raised if liability less than 305 euros.


French capital gains tax may apply when you sell the property. Income earned from French property is considered to be income arising in France and, as such, must be declared to the French Inland Revenue. For non-EU residents, the rate is 33.3 per cent of the net gain. You may have to appoint a guarantor which may be a bank or other approved financial institution operating in France.


Your beneficiaries may be liable to French inheritance tax when you die. Parents, spouses and children benefit from higher tax free allowances, but successors who are neither blood-related nor married to the deceased are liable to pay tax at the rate of 60 per cent.


Your French property will be governed by French succession law. The consequences are that children automatically inherit part of their parents’ estate. There is a limit to how much may be left by Will to non-blood relatives.


An individual’s assets on death consist of the retained portion (reserve legale) and a disposable portion. The former goes to the protected heirs, regardless of the wishes of the deceased. If there are no children or grandchildren but there are surviving ascendants (living parents or grandparents), the retained portion is 25 per cent of the deceased person’s estate.


That difficulty can be avoided by opting for a purchase en tontine for jointly owned property: the whole French estate then devolves to the surviving partner, as if the property were owned in the survivor’s sole name from the time of purchase. For married couples, changing your marriage regime to “Communaute Universelle” is also an excellent method of ensuring that when either spouse dies the other inherits the property in full and avoids inheritance tax liability.


Communaute universelle involves all of the couple’ assets falling into in joint ownership. A special clause (clause d’attribution integrale au conjoint survivant) allows all the assets to devolve on the surviving spouse without the payment of French inheritance taxes. The French civil code has been recently amended in consideration to the 1978 Hague Convention on marital regimes. As a result, it is a lot easier for couples married abroad to change their matrimonial regime than it is for French couples to do it.


Changing your matrimonial regime affects your French assets alone and therefore any provisions made in your home country remain unaffected.


The Acte Authentique can also be amended to include a Tontine clause. With such a clause, the survivor has complete autonomy to dispose of the property as he or she wishes. The surviving partner or spouse is deemed to have owned all the property from the beginning. The downside of a tontine resides in the fact that:


* in the event of a dispute between joint owners a judge may have difficulty making an order in relation to the property because there will be uncertainty as to who is the owner. A court could therefore only order a sale by both parties.


* the sale of a property when both parties to the Tontine are alive is only achievable if both agree. If one refuses to sell, the other cannot force the sale.


A general rule is that you must be sure you know what it is you are buying: inspect the property thoroughly and enquire whether there are any covenante(servitudes) such as rights of ways for example.


Caveat emptor applies to French property purchases: remember that buyers take responsibility for the condition of the items they purchase and should inspect them before purchase.


Where a property is purchased off-plan, the purchase process is strictly regulated. It is nevertheless advisable to check what completion guarantee is offered by the developer. Is the latter financially sound? Will the works realistically be completed by the contractual date?


Check that there is proper access to the property. If this is an older property, has a survey been carried out? Are you buying the contents too? Are there any rights of way? Where are the property’s boundaries and who pays to define them? Is there agricultural land and is it farmed? (If this is the case, the farmer may have a right to gazump you);


Be careful with attractive tax loopholes: never neglect the character and quality of a property in consideration to tax advantages. Seek legal advice on what happens to the property when you sell, upon your death or in the event of a dispute with co-owners.


Do not pay money directly to the seller, since you may lose it or have to pay twice: sometimes the seller is not empowered to sell, or the property is subject to mortgage. And when you sell, do not let the buyer enter the premises before signing the final deed of sale or before paying the purchase price.

For further information on buying investment property abroad and homes overseas
visit Fly2let.net.

http://www.fly-2let.co.uk


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Ratios Real Estate Investors Should Understand

Real estate investing requires operating decisions be made on a timely basis. Some for day-to-day operations and others for long-run investment strategies based upon the real estate investor’s portfolio considerations.

For that reason, real estate investors typically make use of a pro forma operating statement for management plan decisions. The proforma incorporates anticipated and forecast levels of cash flow and often includes a number of useful ratios, multipliers, and other analytical formulas developed to make better use of that cash flow information.

In this article, we will discuss several of those ratios and formulas.

1. Economic Value – This is a measure of value from the standpoint of the real estate investor. In other words, it shows what value the property is to the investor. Economic value is determined by the property’s NOI and a capitalization rate suitable enough to the real estate investor to attract that specific investor’s capital to the project.

Formula: Economic Value = Net Operating Income (specific property) / Capitalization Rate (individual investor)

For example, say the investor has established that the best cap rate for a specific area is 6.0 and wants to determine the economic value for an apartment complex that produces a net operating income of ,000. The result would be 0,000 (30,000/6.0). In other words, if the property is priced over 0,000 the investor knows that the economic value has not been met, and therefore the property might not warrant a closer look.

2. Operating Expense Ratio – This provides an indication of what percentage of the gross operating income (GOI) is being consumed by operating expenses. This is helpful for investors to understand because he or she can make some determinations about a property based on the operating expense ratios of similar properties.

In other words, if similar competing properties typically have an expense ratio of, say, 42% and the subject investment property has, say, a 36% ratio, the investor learns something about the property. It either has a good handle on the management of expenses or some or all of the expenses indicated for the property may be skewed or improperly ascertained.

Formula: Operating Expense Ratio = Operating Expenses / Gross Operating Income

3. Break-even Ratio – This ratio (also called default ratio, or BER) provides the investor with the percentage of gross operating income operating that operating expenses and debt service will consume. It is often a benchmark ratio used by lenders when underwriting commercial mortgages because it estimates how vulnerable an income property is to defaulting on its debt should rental income decline.

Formula: Break-even Ratio = [Operating Expenses + Debt Service] / Gross Operating Income

4. Debt Coverage Ratio – This ratio (also known as DCR) provides information on the extent to which the net operating income covers debt service. In other words, it indicates to investors and lenders whether the property produces enough income to cover the loan payment.

Formula: Debt Coverage Ratio = Net Operating Income / Debt Service

For example, a ratio of 1.0 means that the property just produces enough income to make the loan payment without a penny to spare. Whereas a ratio of, say, 1.20 means that the property’s net operating income is 120% higher than the debt service and therefore does produce enough income to make the mortgage payment with 20% to spare. In this case, lenders typically look for an NOI cushion and require a DCR of 1.15 or greater.

Okay, here’s some advice.

Bear in mind that these ratios (though very easy to compute) alone does not provide enough information to make a prudent investment decision. They are only useful when integrated as part of a full real estate analysis. Always be prepared to validate and crunch all the numbers before you make your real estate investment decision.

James Kobzeff is the developer of ProAPOD – leading real estate investment software since 2000. Create rental property cash flow, rate of return, and profitability analysis presentations in minutes! All ratios provided automatically! Learn more at => http://www.proapod.com


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