Buying Investment Property
Below is a MRR and PLR article in category Finance -> subcategory Real Estate.
Buying Investment Property: A Guide
Buying investment property at the right price can be challenging. Be aware of these common tricks sellers use to inflate the appraised value.
Understanding the Tricks
To begin, let me share a story. My wife and I once stayed at a motel in Tucson for a week. Our bill was twice what it should have been, but since I had paid the correct amount in cash, I thought nothing of it. We noticed that the lobby and pool were unheated, assuming it was just frugality. A year later, I read about a new owner struggling with the motel, and it all became clear.
The previous owner likely inflated the property’s value by cutting expenses and boosting reported income. By skipping repairs, reducing heating costs, and falsely adding $100 in income daily, the annual net income could appear $45,000 higher. With a capitalization rate of 0.08, this could increase the property’s appraisal by $562,000. Imagine the poor buyer who overpaid!
Protect Yourself
To avoid such pitfalls, you need to recognize these tricks and understand how to appraise income properties.
Valuation starts with the capitalization rate, or "cap rate." If investors expect an 8% return on assets, the cap rate is 0.08. The net income before debt is divided by this rate to determine the property's value. Remember, every extra dollar of income shown can increase the appraised value by $12.50 at a cap rate of 0.08 (or by $10 if the cap rate is 0.10).
Watch Out for These Tricks
Sometimes, sellers use dishonest methods to inflate net income. Unlike deceptive tactics with houses, tricks with income properties focus on income and expenses.
Income Manipulation: Sellers might show you "pro forma," or projected income, instead of actual rents. Insist on real figures and ensure that listed occupied units aren’t actually vacant. Also, watch for income from one-time events, like sales.
Vending Machines: Income from vending machines is tricky. Some investors subtract this income before applying the cap rate and add back the machines' value instead. For instance, if laundry machines generate $6,000, it could add $75,000 to appraised value at a 0.08 cap rate. However, since machines are easily replaced, adding their $10,000 replacement cost is more sensible.
Hiding Expenses: Sellers might hide expenses by paying off the books or skipping repairs, falsely increasing net income. This could lead you to overpay, leaving you with unexpected maintenance.
Conduct Your Due Diligence
Request a full accounting of all expenditures. If any of the expense figures seem suspicious, make your own estimates and recalculate net income.
Examine and verify the following, replacing doubtful figures with your best estimates: vacancy rates, advertising, cleaning, maintenance, repairs, management fees, supplies, taxes, insurance, utilities, commissions, legal fees, and other expenses.
By doing your homework and staying vigilant, you can avoid these tricks and make a wise investment in property.
You can find the original non-AI version of this article here: Buying Investment Property.
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