The Second Step Towards Real Estate Investment: Analysis

Analysing an investment proposal can be one of the most critical aspects of investing in real estate. Most people do not realise the importance of carrying out a proper analysis and are forced to bear significant losses along with a host of other problems related to the property. Investment opportunities are mostly presented in a way that makes them very appealing and reliable. However, a proper analysis can help an individual understand whether the returns from an investment are sufficient enough to compensate for the risks involved. It can also help an individual understand the key drivers of a project’s performance and pick the most valuable investment option with confidence. Analytical strategies like the back-of-the-envelope analysis and deep-dive analysis are used in different stages of the process to determine and filter out investment options. Continue reading to understand the different analytical strategies used to evaluate real estate investment proposals.

Many real estate investors fail to realise the importance of a proper analysis. Whether they lack the skills or the knowledge, market analysis is an undervalued asset in real estate investment. There are two main types of analysis that can be done for a real estate property namely, the back-of-the-envelope analysis and the deep-dive analysis. The former is a fast and reliable method to sift out those properties that fall within the criteria of the investor, whereas the latter is used to further investigate the different aspects of a property and its characteristics. Considering the entirety of the analysis process, the back-of-the-envelope method can be understood as the top of the funnel. Properties that make it through can move on to the next stage. The method is an informal mathematical calculation that uses numerical estimations to develop a “ballpark figure”. Five basic metrics are required before beginning the process namely, the purchase price or initial investment, rental income per month, down payment, loan amount, and monthly repayment amortization. Once these metrics have been collected, different calculations are performed to calculate the annual rent, cash flow before financing, annual cost of financing, and cash flow after financing. Completing the analysis seems time-consuming, but after a few attempts, it becomes easier and can be used as a powerful tool by investors (Trident, 2013).

If a property seems worth investing in after the back-of-the-envelope analysis, it can be further analyzed using a deep dive analysis. In this method, multiple factors like lease rates, vacancy rates, construction estimates, rehabilitation estimates, stabilization costs, permits, local fees, and contingencies are also evaluated to understand the investment opportunity in a better way. For example, vacancy rates are an important factor when buying rental real estate, be it residential or commercial, to establish a future forecast of rental income from the property. Moreover, if considering a fix and flip property, construction and rehab estimates have to be figured out accurately to avoid incurring any future overhead and unexpected costs along with determining an accurate time frame for the job. Similarly, those who invest in properties where market rates have fallen need to accurately calculate a stabilization rate. This rate determines when the market will reach back to its normal rate. Developmental projects in real estate require several permits and local fees to be paid. Calculating the estimated cost of these permits and local fees is also an integral part of the investment process. Lastly, contingency costs are associated with the what-ifs of a project. A developer might be interested in checking if installing a new kitchen would increase the property value. The cost of adding this new kitchen will be considered a contingency cost and can help investors in evaluating the overall potential of a property (RealWealth, 2020).

Investments in real estate can be compared to investments in the stock market. Although many people invest in different stocks based on speculation and assumptions, those who make real profits have often deeply analyzed the market along with the company they invest in. They look at past trends of company performance along with forecast models to determine whether investing in its shares would be profitable over a certain period of time. It minimizes their chances of making a loss and manages their risk to a higher extent than the general investor. Investments in real estate are similar to the stock market but can require the evaluation of a much broader set of parameters. Properties can be either residential or commercial. Each sector has a different set of metrics that determine the overall value of a property. Analysing the potential cost, expense, income, and profit from a particular investment can even allow an individual to risk greater amounts of capital. Moreover, since real estate requires large sums of capital investments over a longer period of time, and is less liquid than a stock market transaction, the need for properly analysing all parameters before making any investment is highlighted (Goodwin, 2017).

Conducting a proper analysis of real estate investment options can greatly impact a person’s risk assessment and profit management strategies. Not only will it help in putting value on the property, but it will also help the individual or company in understanding the key performance indicators impacting a project’s development. Analytical strategies like the back-of-the-envelope method can equip an investor to easily determine the feasibility of an option in a short span of time. If the option is worth considering, a deep dive analysis can be done to incorporate multiple other factors in the analysis process. Therefore, following the second step of investing in real estate, analysing is an important part of the process.

Goodwin, K. (2017). Why Is Real Estate Market Analysis So Important? Retrieved from https://propertymetrics.com/blog/why-is-real-estate-market-analysis-so-important/#:~:text=After%20addressing%20the%20physical%20factors,particular%20type%20of%20real%20estate.

RealWealth. (2020). How to Do a Real Estate Market Analysis (aka a Comparative Market Analysis). Retrieved from https://www.realwealthnetwork.com/learn/how-to-do-a-real-estate-market-analysis/

Trident. (2013). Back of the Envelope Analysis (BOE): Your Investment Master Key – Part 1. Retrieved from http://tridentrealestate.com.au/2013/09/27/back-of-the-envelope-analysis-boe-your-investment-master-key/