Valuing Potential Real Estate Investments

Real Estate investors use net operating income (NOI) to value almost every commercial and residential income producing property. Along with a capitalization rate, or cap rate, you can place a value on any potential investment. Net operating income is calculated by subtracting the operating expenses from the gross revenues of an income producing property. NOI is calculated before accounting for the debt service obligations of the property. In order to do so, take the NOI of a potential real estate investment and then divide the NOI by the market cap rate.

Cap rates will vary from market to market and also differ based on what type of asset you are valuing. Until recently, cap rates were at historic lows, which tends to favor sellers (as a lower cap rate translates into increased value), but cap rates are slowly on the rise as the real estate and credit markets have turned. Cap rates are also directly related to the perceived risk of the potential investment. As risk increases so does the required cap rate on a given investment. The investment must generate more income (NOI) as the investor assumes more risk. You can "back into" the NOI by multiplying a cap rate by the value (or asking price) of a given property.

An example of placing a value on a potential real estate investment:

Let's assume you are interested in purchasing a ten unit apartment building. Each apartment unit rents for $500 dollars per month, and annually you collect another $5,000 dollars in other fees (such as cleaning deposits, pet fees, late fees, ect.). On an annual basis the gross revenues generated by the apartments will be about $65,000. Let's also assume you that the total operating expenses total $20,000 dollars annually. This includes your property taxes, management fees, insurance, lawn care, general and administrative, and any other general expense items. This does not include capital expenditures or debt service. The net operating income based on the preceding assumptions would be $45,000 annually. Now, let's assume you live in a secondary market and cap rates on apartment buildings have averaged about 8.0% over the past 6 months.

With this information we are ready to put a value on this potential real estate investment. Let's take the $45,000 Net Operating Income and divide it into 8.0%. This gives us a value of about $562,500 for your 10 unit apartment building, or about $56,250 per unit. Viola! We have officially placed a value on this potential real estate investment. This is very powerful information. Let's assume the current owner is asking $600,000 for the property, which equates to a 7.5% cap rate. You are now informed enough to know that the current owner may be a little aggressive with his asking price. As a wise man once said: "Knowledge isn't power...the application of knowledge is power!"

California, Technology, and potential Real Estate Opportunities.

As we head into 2009, foreclosures are reaching their highest levels in decades. According to a recent Fortune Magazine article I read, the Los Angeles housing market is expected to decline another 25% in 2009. And only a couple of markets in California are expected to show positive gains in 2010. What does all of this mean? I believe it means we are on the front end of seeing some great opportunities for real estate investments. As prices continue to fall we will see a continued increase in foreclosures, with California leading the way. The California housing market tends to lead the rest of the country anywhere from 12 to 18 months in advance. And with the California market at least expected to stabilize if not show some positive signs in 2010, the rest of the country could hopefully see the same in 2011 and 2012.

If you're looking for a way to find great deals in residential real estate, you're in luck. With the amount of information published online and almost in real time, the real estate game has changed. Anyone with an internet connection has access to thousands of distressed property listings at any given time. For example, Williams & Williams auctioneers allow you to invest not only on site, but they offer a number of "online only" auctions. This means you could be bidding against people from all over the world. This may not sound to exciting considering today's technological achievements, but when you put in context of the real estate markets, think of the last significant downturn, say 1992. Al Gore was only in the beginning stages of inventing the Internet. Good job Al.

Back in those days you not only had to be present at the auction, but think about how you would have examined the market place. Sure, a call to a local real estate agent would help, but think about how difficult it would be to find past sale information, estimated values (such as Zillow.com), liens against the property, property taxes, even a map. In today's real estate market, using only the internet, you can probably find 95% of this information in a matter of minutes. The real estate landscape has changed significantly, and unless you are armed with the tools to not only access information quickly, but make decisions quickly, there are hundreds of others out there that you will be competing against. And they don't even need to be located in your real estate market.

1031 Exchanges

Internal Revenue code 1031 allows investors to sell one property and re-invest in another "like kind" property to defer their capital gains taxes. This gives the investor more capital to work with and essentially creates more "buying power". To fully qualify for a 1031 exchange you must meet the following timelines and criteria:

The Replacment property must be identified within 45 days of the closing of the original property.
You must close on the replacement property within 180 days of the sale of the original property.
A qualified itermediary must complete your 1031 exchange. This means the intermediary will hold the proceeds of the original property until those funds are reinvested.
The property must be of "like kind", which means the investor must roll into a similar type of property, such as a business or investment property.

For more information on 1031 Tax Deferred Exchanges, please go to 1031 Exchange Info.

Investing in Tax Lien Certificates

Property Taxes, also known as Real Estate Taxes, are taxes paid to local and state governments based on the value of the property owned. When these taxes are not paid by the owner, they may become delinquent. Once delinquent, the Government agency responsible for collecting property taxes has the authority to force collection on those taxes. This is most commonly referred to as a "tax sale" or "tax auction". Each of the 50 states have their own laws governing the procedure to collect on delinquent taxes. In many cases the local county government is responsible for this process, as property taxes are generally collected for the use or improvement of local communities. TLCinvesting.com provides information on how each state handles delinquent taxes, and how individual investors can benefit from them. There are 2 types of government tax sales used in the United States, which includes most US Territories. Each is discussed in turn below.

Tax Deed Sales

The Tax Deed Sale is an auction held by local governments for tax delinquent property. Usually the minimum bid is the sum of taxes owed, plus any administrative charges and interest on the amount owed. The winning bidder at the Tax Deed Sale is awarded the deed to the property. For more information go to Tax Deeds.

Tax Lien Certificates

Tax Lien Certificates are usually auctioned in the same fashion as a Tax Deed Sale. Each Tax Lien Certificate has a face value of taxes owed, plus administrative charges and interest. Depending on the laws in that area, the Tax Lien Certificate will either be sold at that amount, or can be bided up. Tax Lien Certificates may also be bid on by interest rate. For more information go to Tax Lien Certificates.