Numbers Don't Lie - Especially in Real Estate!
By George Duck
Jun 1, 2006
I continue to be amazed at the number of real estate investors who gloss over the financial projections of a prospective investment property and readily accept "cap" rates or cash flow estimates from sellers or brokers. They get so caught up in the thrill they forget why they are there: To make money!
You know what they say...Love is blind.
As CFO of Rich Dad I focus on the numbers of any deal. And while I understand and appreciate how exciting it is to hunt down a great property, it's the attention to detail in when it comes to the numbers that will pay you back many times over.
Numbers don't lie and I would much rather know the complete story early on (like before I buy!) instead of after the fact when I am forced to contemplate and calculate as to "how am I going to make this work?"
I advise investors to not only to get as much back ground information as possible - on taxes, electric, gas, ground maintenance etc. - but also to request the actual invoices for the past 12 months for these expenses. And, I suggest, taking a look at the list of all other repairs and upgrades. I've even gone so far as to call the utility companies to get the averages for the past years! Constantly challenge yourself - and the seller - to evaluate all costs.
Next, I advise they take a long hard look at any deferred maintenance. Oversights here can kill you! Will the property need a new roof? Has the HVAC been poorly maintained? What's the condition of the plumbing? A homeowners warranty provided by the seller can help - but don't count on it to address (and remedy) everything.
I also recommend a healthy allowance for repairs and vacancy since I consider the first 12 months of a new property to be the shakedown period. What has the vacancy activity been for the past two years - and why? Be prepared for the worst.
Know that I speak from experience. About a year ago I found a complex of my dreams. A prime property: 12 units, great location, long-term tenants, the seller owned for 25 years...you get the picture.... I spotted this beauty the first day it ran in the Sunday paper classifieds "before it went on MLS." I locked up the deal on Monday and then went to work on the numbers.
What was represented as a 10.7% cap rate turned out to be closer to 3% due to sizable monthly maintenance costs. The complex was on a large parcel of land with a grapefruit orchard incorporated into the courtyard and an elaborate pool area When I asked the broker "Why the big difference?" he responded that the expenses had personal costs of the seller included for tax reasons.
I was encouraged by this response and thought, " My great deal may still work!" I went back and requested actual copies of invoices and then contacted the service companies. I learned that these were the real costs of the property. The current owner was just not concerned about the costs since he had owned it for so long. But, in relation to the sale price, it made no sense.
The seller would not come off the asking price. And I killed the deal by Wednesday morning. Interesting enough, the property was listed subsequently on MLS and sold shortly thereafter for more than the deal I had locked up. I had to wonder if that buyer really analyzed the numbers. And it felt good walking away... because the numbers don't lie. Happy hunting!
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