05 Mar Data Driven Real Estate Investment
In real estate investing, it can be very easy to get tied up emotionally into a property or even an area. It is very easy to look at a particular area, fall in love and focus your investment based on a misguided sense of a particular property or even an area in general. Emotional or ‘gut feel’ investing also often leads to over paying for a property because you feel you ‘have to have it’ and that it is in some way special. A very common form of emotional investing is ‘Fear of Missing Out’ investing. For example when an investors perceives everyone around them buying real estate and feel it is an investment they have to make. Rather than working with an expert they buy a property in a neighborhood near them and use it as a rental without a clear end game in mind or a clear picture of what they are getting involved in. They have utilized almost no data to make this decision and instead rely on hard work and hope.
These traps are common and are often times fatal to investors.
If there are so many pitfalls when investing in real estate using emotions or even gut feeling, then why do so many people do it? The answer is actually quite simple: Data takes time to gather and requires effort to analyze. Most investors simply do not have the resources available to them to gather and review the data and then make the data driven decision.
What are some of the key metrics that are critical to review when you are looking for great real estate to invest in?
- What markets are you considering investing in?
- Are there any emerging areas within a particular market? Do they have growth and are beginning to experience economic rehabilitation?
- Where are you at in the current real estate cycle?
- Has the market you are looking in seen significant expansion and if so is it possibly near a cyclical high point?
- Are there other markets that are not as far into an expansion cycle that present economic strength?
- Asset Classes:
- Which asset classes have seen significant growth or expansion?
- Which asset classes have additional growth or expansion?
- Are any particular asset classes more susceptible to a correction in the next cycle?
- How many properties have you reviewed in detail?
- How many properties can you underwrite before buying?
- How do you utilize data to help weed out the lower quality properties?
- Income & Expenses
- Are income and expenses of a property in line with market?
- Are vacancy rates in line with a market?
- Purchase Price
- Is the CAP Rate you are buying at correct?
- Is there a spread on the purchase cap and a sale cap?
- Is there a spread in valuation based on adding value?
There are literally hundreds if not thousands of data points that are important to be looked at when making a real estate investment if your goal is to maximize returns. Many investors find they buy real estate only to sell it later for a loss or even slight profit, but with a sense of relief to longer manage the property.
How do we do it?
So how does a full time real estate investment company utilize data in order to make the right decisions? This is an excellent question and one that even internally we are always looking to refine and improve. We utilize a funnel approach to real estate investing. We start by researching markets, asset classes and cycles. By utilizing data we can determine what state an individual market is in and what state a particular asset class is within a market. For example, Multi-Family in Seattle in 2015 has seen significant expansion and is on the verge of being over built. This will force a correction in the coming years where vacancy rates will increase, rental rates will lower and valuations will go down short term.
Once we have completed a data driven market analysis and have selected asset classes in which we want to invest within a market, we begin to look at properties in that market of the asset classes we are planning to buy. We will utilize relationships within the community we have established to get basic financials on hundreds of properties and utilize a sophisticated analysis model to give us a high level view of these properties. By utilizing an analysis model that efficiently provides us a 3, 5, 7, 10 & 15 year discounted cash flow model, we can quickly get a high level financial view of the investment. This provides us the ability to reduce the number of properties we write offers on and perform diligence to a select few properties that appear financially viable.
Within the diligence review we will utilize a more detailed view of market trends, rental rates comparable’s, sales comparables and other statistic in order to finalize our assumptions about a property.
Finally, after significant data analysis to isolate a small number of high quality properties, we will visit the properties in person. This will help us validate our assumptions as well as allow us to review the quality of a property & location to strengthen or weaken our convictions. This strategy allows is to review large areas, hundreds of properties and eventually buy only the best properties for sale based on our goals.