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Garbage In / Garbage Out: How The Accuracy of Data Can Impact Your Investments
Investment Real Estate
Looking at acquiring Commercial Real Estate property is a major undertaking
for any investor. Whether an apartment complex, office building, retail space,
or industrial property, you can quickly put TheAnalyst PRO to work. Let’s
review how you can ensure you are using the most accurate information possible
when calculating the Net Operating Income (NOI) for a property.
The first step in determining the accurate value of a property is to review the current cash flow. This is also known as the going-in or year one value. Using TheAnalyst PRO provides you with the advantage of being able to quickly and easily determine the future cash flow. Cash flow will come from various sources, based on the nature of a property. It could come from the operations of the property such as rental income, as well as the appreciation value when the property is sold.
You will want to review the financials you
have been provided and adjust for current market conditions. This is what Todd
refers to as “Scrubbing the Numbers”. It is important to remember that
in most cases the proforma you’re provided with will have been produced by the
broker who is trying to sell the property. You will want to review the trailing
12 months of cash flow and expenses for the property. These are going to be the
numbers we can scrub through, and make sure they accurately represent the
It can be very time-consuming and challenging to obtain all of the appropriate information, but it could be the difference between being profitable or taking a loss on your investment. A major benefit of TheAnalyst PRO is that with the advanced algorithms used by the program, you can accurately project future cash flows each year for up to 10 years. Here are some ways to review the information you have been provided.
“When I purchase investment
real estate, I am purchasing future cash flow”
Todd Kuhlmann, Founder of
Scrubbing The Income
Start by obtaining a copy of every lease for the property. It is important
to compare the leases with the rent roll. A rent roll shows the current rental
income for an investment property. It can be used for any type of
cash-producing property such as apartment buildings, office space, retail and
leased land. Information from the rent roll can be used to provide key property
financial performance and information on the rent being collected.
We often find the lease terms, or the lease amounts, do not match what is
reflected on the rent roll. We encourage investors to physically inspect each
tenant’s space, to ensure the lease details provided are accurate for the
property and that you have a copy of all leases for tenants occupying space
on the property. This is a big part of making sure we are not putting bogus
information into TheAnalyst PRO calculations. Remember, “Garbage In / Garbage
Scrubbing The Expenses
Review the historical expenses in detail, and properly scrub through each
line. One of the most common errors found in the proforma for expenses is underestimating
certain expenses such as professional management fees, current hazard insurance
premium and property taxes. If the current seller is self-managing the
property, they may not include management expenses on the historical expense
report. On the other hand, the seller may include items that are not relevant
to the operation of your property, such as including auto expenses that has no
actual impact on the operation of the property.
Property taxes are often one of the highest recurring expenses. Scrub the
property taxes by researching the current assessed value of your property. Many
times, the current assessed value is less than the purchase price. Assessment
guidelines of property values alter based on the state, so it’s always
important to be aware of your state's assessment
regulations. States have different requirements for how often reassessments
are conducted. For example, in the state of California, a property will be reassessed
when a “change of ownership occurs” or new construction finishes. In this case,
the property taxes will be based on the purchase price, not last year’s
assessed value. Adjust the property tax expense based on the anticipated reassessed
value upon purchase of the property.
All properties will require standard minor maintenance and repairs that may
recur each year. However, larger non-recurring repairs are often categorized as
Replacement Reserves. Replacing a worn-out roof or repaving a parking lot are a
couple examples of work that would be funded by a replacement reserve, and not
as a property expense. Most owners and property investors know they will
eventually have to invest in these capital items. Reserve funds can also be
used to cover any emergency costs not covered by insurance. An example of this
includes a central boiler system that stops functioning.
Those are a few situations in which we can ensure the data being inputted
into TheAnalyst PRO is as accurate as possible. Now that we have that
information, we can take a look at the data that is being output.
"Bricks and sticks are
great and I like that I can touch and feel my investments, but the investment
value is based on future cash flow."
Todd Kuhlmann, Founder of
Net Operating Income
After scrubbing each line of the cash flow and property expenses, we can
properly calculate the current NOI and project future NOI. TheAnalyst PRO was
designed to provide you with this information quickly and efficiently, saving
time from having to calculate it in a spreadsheet or other complex software. It
also uses advanced algorithms to accurately forecast future income and expenses,
providing a much more accurate NOI to work with.
Uses of Net Operating Income
There are two major uses for the NOI. The first is that appraisers will use
the NOI to calculate property values at any specific point in time using the
market CAP rate. Having the ability to predict future values is one of the
greatest benefits of investing in commercial real estate and TheAnalyst PRO
makes it easy. At any time, investors will be able to see the estimated value
of their property on a yearly basis for the next 10 years.
NOI is also used by lenders to determine the maximum loan amount you will be
able to get. TheAnalyst PRO also has a built-in loan calculator that can
provide you with the maximum loan amount, based on the Year One NOI of the
Net Operating Income Accuracy
If the calculated NOI is too high, you may be overpaying for the property.
And if it is too low, your future sales price could be much lower than you have
estimated. The rule of thumb is that for each dollar the NOI is off, it can
change the property value by $10 - $20. This is why it is so important to have
accurate information being entered.
Example of Net Operating Income Variance
Let’s imagine you have a proforma that has the Year One NOI projected at
$500,000, with a CAP rate of 7%. This would mean you have an estimated property
value of $7,143,000.
After scrubbing the numbers, you determine that the actual NOI is $400,000.
This would result in the updated property value being $5,714,000. This would be
a decrease in value of $1,429,000.
Using TheAnalyst PRO, you can quickly determine the proper value of your
investment property, as long as the numbers you have used are accurate.
TheAnalyst PRO is CRE Tech®’s #1 investment modeling (DCF)
software, including Offering Memorandums, Lease Analysis, Location Risk, Demographics, Infographics, Flyers & Brochures.