Buying Rental Property - Avoid Seller s Tricks
Below is a MRR and PLR article in category Finance -> subcategory Real Estate.
Buying Rental Property: Avoid Seller's Tricks
Summary
Investing in rental property can secure your financial future, but be wary of sellers' tricks to artificially inflate appraised values.Key Points
- Cap Rate Insight: Understand the cap rate, as it crucially influences property valuation.- Identify Tricks: Recognize common tactics used by sellers to misrepresent income and expenses.
- Conduct Thorough Research: Verify all financial data to ensure you make a sound investment.
Article
Be Cautious When Purchasing Rental Property
When buying rental property, vigilance is key. Consider this example: We once stayed at a motel where the bill was twice what it should have been. Although I had already paid the correct amount in cash, I dismissed the discrepancy. The lobby and pool were unheated, which at first seemed like a cost-saving measure. Only later did I learn that the owner was preparing to sell by manipulating expenses and income.
She increased the appraised value by reducing costs and inflating reported income?"adding $100 each day without actually earning it. This seemingly small adjustment could show $45,000 more net income annually. With a cap rate of .08, this would inflate the property's appraisal by $562,000. The new owner, unaware of these tactics, overpaid significantly.
Avoiding Mistakes
To avoid such pitfalls, it's crucial to understand both the tricks sellers use and the basics of appraising income property.
Understanding the Cap Rate
The capitalization rate, or "cap rate," is essential. If investors in the area expect an 8% return, the cap rate is .08. This rate helps determine property value by dividing the net income before debt service by the cap rate. Remember, every additional dollar shown as income can increase the appraisal by $12.50 with a cap rate of .08.
Common Seller Tricks
While increasing net income honestly is legitimate, many sellers use deceptive methods. Unlike home sellers who might mask physical flaws, sellers of income properties manipulate financial figures. They might present "pro forma" projected income instead of actual rents. Always request real figures and verify that listed occupied units aren't actually vacant. Be cautious of income shown from one-time events, like sales.
Laundry and vending machine income can be misleading. Prudent investors often exclude these from net income when applying the cap rate, opting instead to add the machines' replacement cost. For example, if laundry income is $6,000, it might incorrectly raise the appraisal by $75,000 with an .08 cap rate. Instead, consider adding only the $10,000 replacement cost.
Scrutinizing Expenses
Hiding expenses is a common tactic. Sellers might not record repairs or defer them, inflating net income. Demand detailed financial records. If you notice discrepancies in expense categories, make your own estimates. Analyze factors such as vacancy rates, advertising, cleaning, maintenance, repairs, management fees, supplies, taxes, insurance, utilities, commissions, and legal fees.
By carefully reviewing these elements, you can make a well-informed purchase and safeguard your investment.
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