If you are a real estate investor, here’s a question: when did you last review your real estate portfolio? Just like your stock portfolio or insurance policies, your real estate investments should receive an annual review.
Markets change, properties age, interest rates move up and down — all these factors make it a good idea to sit down with a professional and review your real estate investments regularly. In this issue of Borelli Investment Company’s Commercial Real Estate Insider, we provide four tips for your next review.
“It just makes good sense to do a comprehensive review of your real estate investments, from time to time,” explained Ralph N. Borelli, chief executive officer of Borelli Investment Company. “This will better enable you to decide whether to stand pat, or reposition or redeploy any of your invested capital.”
Tips for a Successful Real Estate Investment Review
- Learn the ABCs about ROE
- Estimate projected income going forward
- Evaluate capitalization rates
- Go beyond the numbers
The ABCs of ROE
The first thing you should do is analyze your return on equity (ROE) on an annual basis. This is really the return on imputed equity—based on the expected sales price of a property, less debt and closing costs. By dividing your current cash flow by the imputed equity you have in a property, you can calculate your current ROE.
“Many people will hold a property for years, never realizing that the annual ROE is two or three percent,” Borelli explained. “Holding a property for another year is a little like buying it again; there are other investment opportunities for that money. So, if you’re aware of what your return is, you can make better decisions.”
Crystal Ball Gazing – With Help
The next step involves evaluating a property’s rent prospects going forward, over perhaps one to five years. This type of crystal ball gazing is best done with the help of a real estate investment professional you trust.
“If you anticipate that rents will rise or fall—driving your ROE higher or lower—this could impact your decision of whether to hold or sell a property,” commented Borelli. “Looking ahead is critical, because it helps to stay ahead of the herd when buying or selling.”
Other important considerations include whether major capital expenditures will be required for roofs, mechanical systems, structural improvements, parking lots, or similar upgrades. In addition, lease roll-over exposure can significantly impact your operating cash flow.
Calculating the Cap Rate
Step three in a detailed analysis involves computing the capitalization (cap) rate, another measure of value in real estate investments. The cap rate is calculated by dividing a property’s annual net operating income over its projected sales price.
While it was common a few years ago for cap rates to be 8.5 to 9.0 percent, those rates have declined recently as investors appear willing to pay more to buy properties producing less net operating income. The cap rate can be very helpful in gauging the appetite of buyers before deciding whether to sell or hold a property.
Going Beyond the Numbers
The final step in analyzing your real estate investments has nothing to do with numbers. Instead, it has everything to do with you and your life objectives and circumstances. Sometimes, a decision to sell may be driven by estate planning needs, or gifting desires. You may simply be at a point where you want to slow down a bit, and reduce your risk, or the opposite—where you are willing to assume more risk in hopes of earning a higher return. Or, you may simply decide it’s time to do something else with your money. Any of these reasons could be valid considerations in reviewing your real estate portfolio.
“At Borelli Investment Company, we work with many clients to help them review their holdings as needed,” Borelli said. “A regular review of your investments will help ensure that your portfolio keeps working hard for you, through up and down cycles year after year.”