Today we're going to talk about the analysis of the acquisition process when one is looking to acquire a piece of investment real estate. It's important to understand the different phases of acquisitions, so that you can analyze them and create accurate projections. You also need to anticipate where variables might come into play and where costs might change and cash flow might change.
We'll cover how to perform financial analysis on a real estate acquisition, and show how each of the three phases correspond to the inputs in a financial calculator or a spreadsheet model.
Acquisition Phase. This is the phase of looking at the market, making an offer on a property, and closing on that property. We have a variety of costs that must be accounted
for in the acquisition phase:
Market research costs, if applicable
Legal fees for setting up the ownership entity
Inspection costs for physical and environmental inspections
Due diligence costs -- examining the books, records and title
Loan fees or other ancillary costs
All must be accounted for in addition to the purchase price.
Holding Period. This is the time that we own the property in between the acquisition of the property and sale of the property. During this time we have costs associated with:
Any major renovations or other capital expenditures
Periodic cash flow (that can be positive or negative)
Operating expenses -- taxes, insurance, repairs and maintenance, utilities, etc.
All of these things together add up to the cash flow during the holding period.
Disposition Phase. This is the process of selling the property at the end of our investment term. It's important to examine various exit strategies here, to be sure that your analysis includes a variety of potential scenarios.
Net sales price
Selling expenses (such as brokerage fees or legal fees)
In order to analyze your internal rate of return on an acquisition, you want to look at it as if you're analyzing any other financial investment over time. Your acquisition costs would be your present value; your time would be the number of periods; your cash flow during your holding period would equal your payment; and then your disposition proceeds would equal your future value. You can then put these into your analysis. Typically, you would want to use a spreadsheet because your cash flows are going to be variable throughout the life of the investment. Put this into a spreadsheet and you can calculate your internal rate of return.
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