The Three Levels of Analyzing Income Properties for Real Estate Investors
Purchasing income properties successfully often comes down to doing the property analysis like a rockstar. Without proper research, you’re hardly going to land on a good deal that will make the venture profitable and set you up for success in REI. With that said, here’s my little secret - the three levels of analysis.
Level 1: Paper Napkin Math
Level 1 will be the quickest analysis you will run on income properties. It should take less than 1 minute to run the math at this level. The purpose here is to save time in your analysis by using the two analysis methods being the 0.75-1.25% rule and the per unit price comparable.
Firstly, follow the 0.75-1.25% rule:
Step 1: find the Monthly Gross Operating Income for the property.
Step 2: divide the Monthly Gross Operating Income by the Purchase Price.
Step 3: if the amount is between 0.75% and 1.25% then it is good to move ahead.
Example:
Monthly Gross Operating Income: $3,000
Purchase Price: $400,000
$3,000 / $400,000 = 0.0075 or 0.75%
0.75% is between 0.75%-1.25%, so you're good to move ahead!
Then calculate the per unit price comparable:
Step 1: find the Purchase Price and the number of units in the income property.
Step 2: divide the number of units in the income property by the Purchase Price.
Step 3: find out what your market area's price per unit comparable is. Make sure that the price per unit of the income property you are analyzing is less than or equal to your market area's price per unit before moving ahead.
Example:
Purchase Price: $400,000
Number of units: 4
Price per unit: $100,000
Market areas price per unit comparable: $150,000
$100,000 is less than $150,000, so you are good to move ahead!
Level 2: Technical Numbers
At this level, we’re going to cover the 3 scenarios of analyzing. Start by creating a current scenario spreadsheet: as in the name, you are analyzing the property in this spreadsheet using the current numbers as the property sits today. Make sure not to change the numbers to project what you believe to be the future numbers of the property.
Then create the fair scenario spreadsheet. In this spreadsheet, you should project the futuristic numbers that are likely to happen for this income property after a renovation and re-rentals are completed. Lastly, craft the excellent scenario spreadsheet where you can change the numbers to fit the most ideal scenario that is still reasonable, but would be considered the best case scenario if everything went to plan and then just went even a little bit better.
Level 3: Run Comparable
There really is an art to running a proper comparable for an income property. This is a skill that is more advanced and will come with analyzing experience. Since it is very important to have an accurate comparable of an income property, it is best to have your investor friendly realtor do it. You should work with your investor friendly realtor to find the best comparable possible for your income property of interest.
The investor friendly realtor will give you what is called a CMA which stands for Comparable Market Analysis. Essentially, it is a breakdown of the properties that have sold in your market area within a specific time period, price range, amount of units, bedrooms, bathrooms and square footage. Make sure you have at least 3 comparable properties to contrast your income property of interest against.
Something to Keep in Mind
Make sure to never compare properties that are of major differences. You must keep the comparable within a 10% + or - of the income property of interest. Ask your realtor for the area’s cap rate so that you have it in the future for when you are analyzing properties.