REAL ESTATE ANALYSIS MADE SIMPLE
Investing in real estate is almost always a smart decision, but based on calculated facts rather than wishful thinking. To quote Sgt. Joe Friday (Dragnet), “Just the facts, please.” Exactly our job as real estate professionals – to uncover, and then present the facts in writing.
The Annual Property Operating Data (APOD) is arguably the most popular real estate analysis report used by investors, appraisers, lenders, and real estate brokers. Big-time (sophisticated) investment evaluators like REITS and CCIM’S start with it. Most would-be clients stop there.
With an APOD, prospective buyers get a quick, immediate glimpse at a property’s income, expenses, mortgage costs, and cash flow – in order to make preliminary decisions about the property (eliminate or check out further). Considered equivalent to a property’s P&L statement, the APOD presents initial profitability and possible terms of sale in one concise, easy-to-read report.
Like its name suggests, APOD concerns itself with the property’s yearly financial performance (actual or potential). Unlike an “Income Pro-forma” that speculates how an investment might perform over future, multiple years of ownership, APOD simply provides a one-year snapshot, usually the first twelve months after purchase. It is NOT intended to supply enough financial data to make a final (go/no go) investment decision, as it overlooks not only future cash flows, but other, just-as-important elements of taxation, possible tax shelter, property appreciation, and the “time value of money” – much longer term, albeit complex, implications (good and bad) that should not be minimized or ignored.
Five important areas of financial data (and calculation) comprise a properly constructed APOD:
Effective Rental income – the actual or potential rent roll, including other income possibilities like laundry equipment or vending machines, LESS reasonable allowances for vacancies and bad debt. 100% occupancy and every tenant paying on time are unlikely, otherwise tenants are immortal, or rents too low!
Operating expenses – taxes, insurances, maintenance, repairs, including outside costs like advertising, management, HOA, accounting and legal. All such expenses are “out of pocket,” and do NOT include tax write-offs like depreciation. Don’t leave anything out.
Net Operating Income (NOI) – the effective rental income less all operating expenses (but not any mortgage payments). NOI is a “key” number used to evaluate all income properties from a lender’s perspective.
Mortgage payment – annual principal and interest only, since any required escrows or impounds have already been accounted for under “operating expenses.” APOD uses the fancy term “debt service” instead to describe these loan payments (probably to confuse or impress us).
Cash flow – what’s left over after all bills (including mortgage) have been paid. Hopefully this is still a positive result, though it needn’t be, as there’s more to real estate investing than immediate cash flow.
If accurate and complete, the APOD report provides enough information to satisfy two major participants in most every proposed real estate transaction:
- The investor (purchaser) – looking at the projected cash flow in relation to the amount of cash the investor is expected to put up. He (or she) expects a rate of return that’s better, safer, more liquid than a bank C.D., Treasury note, or mutual fund.
- The appraiser who’s usually evaluating the property on behalf of a proposed lender. In this instance, appraisers stop at the Net Operating Income, and apply a comparative capitalization rate to determine Fair Market Value by the Income Approach.
SIMPLE ENOUGH? Actually it is, even though some property owners and real estate “professionals” try to dismiss this need for full financial facts before marketing non-residential properties. APOD is a simple but vital beginning point in showcasing non-residential listings; hopefully inviting further interest, requests for more detailed information and discussion. It’s the very least every real estate professional should provide.