Three Factors in Real Estate Investments

Here is a quick and dirty of some important things you should consider if you're looking to invest in a piece of real estate. Although, there are many considerations and a lot of elements outside your control (the market!), there are three important components of return to consider if you want to make an investment:

1. Cash flow -- how much money can the property generate on an annual basis, look at all revenues minus all expenses in a given year

2. Taxes -- what are the tax implications of such an investment

3. Future Sale or refinance -- what are the possibilities to increase the capital position of the investment when you decide to sell or refinance.

Cash flow, first and foremost, is very important and often times dictates the valuation of the property. Cash flow is determined by (roughly) Gross Revenues minus Vacancies, Bad Debts, Operating Expenses. This is also known as free-and-clear cash flows or cash flows from operations. Consequently, its important to consider what can be done to maximize revenues and minimize expenses (welcome property managers).

Taxes are then determined from the Cash Flows from Operations. Normally, Replacement reserves would be added back while Mortage interest and Depreciation are subtracted (these are tax deductible) to yield the Net Taxable Income. To find out how much is owed for taxes, The Net Taxable Income is multiplied by the Tax rate.

Finally, what are the benefits you can reap from selling or refinancing the property in the future? This depends on a number of elements, some of which you can control, some that you can't: physical characteristics of the property, changes in the neighborhood, structure of leases, market conditions (interest rates, tax policies, etc.)

Of course, this is a gross generalization and there are other important factors that come into play when making real estate investment decisions. However, if nothing else, remember these three components and you will be well underway to becoming a well-informed real estate investor.

posted by B. Samii @ 2:05 PM