How to evaluate a real estate opportunity?

The evaluation of a real estate property is simple:

1. Verify property income -> actual income
2. Verify property expenses -> adjust saler numbers + include vacancy
3. Determine net operating income (NOI) = income - expenses
4. Calculate the loan payment and your profit

1) Verify the property income

There is 3 types of income:

1. Actual income: what the property has generated in the last 3 months
2. Actual potential income: total income that could have been generated if 100% occupied
3. Future potential income: total income at today market rents. 

Don't forget to consider vacancy (missing income due to vacancy). 

2) Verify the property expenses

Concerning the expenses:

• Repairs and maintenance: it always increase (old = start higher)
• Insurance is a fast moving business and rates can vary widely 
• Replacement reserve: suspicious if 0 (usually under-estimated)

3) Determine the NOI

• The larger is better but don't forget to include your loan payment ;)
• profit = NOI-loan payments

4) Find the capitalization rate and valuation

Capitalisation Rate = NOI / Purchase price

OR

Offer price = NOI / capitalization rate 

capitalization rate = [7-12]

5) Calculate the loan payment and your profit cash on cash

profit = NOI - loan payments

cash on cash = profits / down payment

example:

http://www.remax-quebec.com/fr/multiplex-a-vendre-2255-226-rue-sheppard-ville-marie-central/12922399.rmx?fromsearch=formSearch_plex

saler price = 989K 

income estimate = 3K*4 -> 12K

expenses estimate = 7.2K (just taxes)

NOI = 5K

Offer price = 5K/.08 = 62.5K

saler capitalisation rate = 62.5K/989K=0.06 -> not 0.08

What should be the income to justify this valuation = 0.8*989k=79K

This property is definitely not a good investment.