Average Asking Price
Why it’s important
The average asking price for a comparable property type should provide a loose guideline for the feasibility of a proposed project. If you are able to achieve your target revenue with projected prices that are in line with average asking prices, your project has passed an important test and may be viable.
Strengths/Weaknesses
This does not take costs into consideration, so has only limited utility on its own. Ideally, one is able to achieve their target return by combining this figure with a conservative expense budget. There is also the risk of comparing asking prices with properties that have underlying difference. For instance, a condominium may be a near perfect match physically, but one association may be in a much worse financial situation than the other and can expect substantially higher HOA fees. An additional risk worth stating is that there may be a lack of substitutable inventory. This lack of data may lead to unrealistic projections.
Resources
The multiple listing service and an experienced broker will generally understand the local market dynamics. If feasible, a boots on the ground approach allow you to identify competing product and interact with tenants in the area. Ideally you are in a position to cherry pick the most desirable aspects for your own projects.
Historical Sale Price Trends
Why it’s important
In order to forecast appreciation rates, it is helpful to understand historical trends. While momentum is not a guarantee of future performance, it can help you identify markets which may be overheated and which markets may be undervalued.
Strengths/Weaknesses
Black swan events are not captured with historic data. Over-reliance on historic trends can lead to undue risk for a project.
Resources
While the multiple listing service is a solid resource for residential properties, commercial transactions tend to be more opaque. The county recorder or local property tax office generally keeps a copy of the deed, as well as any mortgage notes on file. This information is often available online direct to the public or through third party data aggregation services.
Cap Rates
Why it’s important
Cap rates can indicate a number important characteristics about a project. A cap rate is calculated dividing the net operating income by the purchase price of the asset. One key use of cap rates is price setting. Knowledge of cap rates on comparable projects can help you to project the value of your project, given a projected net income. In general, a lower the cap rate should indicate a less risky cash flow projection. Projects with inherent challenges, should produce a higher cap rate. These challenges can include high vacancy rates, high crime and lack of investor demand.
Strengths/Weaknesses
Cap rates can be analyzed with and without leverage. Because each loan has unique terms and characteristics, a levered cap rate can distort the underlying nature of the project. However, unlevered cap rates do not reflect the unique impact debt service can have on a particular project. Since cap rate data can often be difficult or impossible to come by, one can alternatively look to the gross rent multiplier (GRM). This figure is derived by dividing the purchase price by the gross rents. This obviously has less value in one’s analysis due to the lack of expense figures. Other issues with cap rates include lack of knowledge of non-property inclusions in the sale and the use of projected vs. historic income.
Resources
The authoritative source for cap rates has been the Korpacz Real Estate Investor Survey. Knowledgeable local brokers are usually your best alternative to costly data subscriptions like Korpacz.
Competing Supply
Why it’s important
Knowledge of alternatives or substitutes for your product are key to understanding the local market dynamics of supply and demand. This understanding will aide you in setting pricing, incentive offerings, and whether a market can support the project you have planned.
Strengths/Weaknesses
Real estate is known for being a heterogeneous asset type. You will never find a perfect substitute, as each plot of land is unique in its precise location. In addition, you will find differences in the age of various components, layouts, styles, construction materials and more. One must compensate for this by adjusting for differences when comparing.
Resources
The multiple listing service and an experienced broker will generally understand the local market dynamics. If feasible, a boots on the ground approach allow you to identify competing product and interact with tenants in the area. Ideally you are in a position to cherry pick the most desirable aspects for your own projects.