When looking at both commercial and residential properties for the sake of an investment, one must ensure that they are getting the best deal possible. In order to do that, there needs to be a systematic way to look at a property and make sure that all aspects are accounted for. The Strategic Analysis method is the best way to make this happen. This method ensures that the potential buyer looks at four main areas of concern in the due diligence process: Financial, market and competitive, location and site, and political and legal. We will go into more depth on each one of these subcategories.
The purpose of an investment is to make money. In real estate, this is done in many ways, including cash flow, appreciation, tax incentives and more. If a property does not make money it is typically not a good investment. This is why the financial analysis is so important. In order to review the financial status of a property, we need to treat it as a business and look at all the books. We need to start with looking at the current year, the past three years of income, and the last year of expenses. Also, I highly recommend also getting a copy of the rent rolls and the last Schedule E (Form 1040) that they filed with the IRS. This will show exactly how the property is performing.
Do not make your purchasing decision on the listing agent's word or the cash flow analysis. You can trust their work and hope that it is accurate, but always verify the numbers with your own research and calculations - as mentioned before in “Five Beginner Investor Mistakes to Avoid”. Lastly, you need to factor in the debt service for the property, if you are financing it.
Once you have all of the records, you need to analyze and compile all of the information. You are looking to make sure that everything is accurate and consistent. If the rent roll shows more units occupied than the income statement shows, then you know there could be some discrepancies. Also, look to see if the annual cash flow is decreasing, stagnant or increasing. We want the property to be increasing in cash flow and the rents being raised.
A quick breakdown of cash flow before taxes is:
Potential Rental Income
-Vacancy and credit losses
= Effective Rental Income
= Gross Operating income
= Net Operating Income
-Annual Debt Service
= Cash Flow Before Taxes
If the financial statements make sense and the property is making money, then we are going to start looking at other areas of the property.
Market and Competitive Analysis
In the market and competitive analysis, the goal is to start broad with the entire market you are located within. Then get narrow to your direct competition and the specific buildings that draw the same customers or tenants you are seeking.
Always know what your market is doing. And if you don't know, then find someone who does! There are four main elements to the market cycle: recovery, expansion, hypersupply and recession. This affects all types of real estate. Know which market trend you are in currently and invest accordingly.
In assessing the market, pay special attention to vacancy rates and trends. Also look at how long vacancies take to get occupied and the supply and demand of all similar properties. This is true in all commercial properties whether that’s retail, office, warehouses or multi-family. The goal is to understand what your market is doing and find out if the investment you are considering can weather the worst case scenario. If you can make money in the worst case then you will be truly successful.
Once you've analyzed the market as a whole, proceed to research your direct competition. Look for similar properties in close proximity to yours and see what amenities they offer, what condition they are in, the prices of products they offer and how your investment will be better or worse.
Location and Site
Just as the market and competitive analysis started broad and got more specific, so does the location and site analysis. This analysis looks at the physical attributes of the investment from the location, which is the specific area of a market that you are looking in, and the site which is the exact address of the property. For example, the location could be a neighborhood while the site is the street address for the exact building.
Identifying great locations can be difficult but not impossible. You must analyze the supply and demand, growth potential and specific operating data of similar properties. For example, if you are looking for a location of a new multi-family you could start with the market vacancy rate trends and demand and supply analytics. This will give you great information on the location. Then, we would get more narrow and look at the neighborhood and street. Looking at surrounding buildings, use of those building and their current state. Additionally, look for ease of getting to the property. Is it at the end of a one-way road, or is it in a great location near main thoroughfares?
Political and Legal
This is often overlooked by most, especially in smaller properties. This section includes analysis of the proper zoning regulations, impact analysis, planning department research, property use permits, development incentives, and many other items. Legal also covers the contract terms, negotiations and feasibility of future use.
These four steps are created in order to inform you about each investment you consider. If you don't fully understand any of these or would like someone to consult on the project that you are looking at, reach out to me today at firstname.lastname@example.org.