Don’t Jump Before You Look: Successful Real Estate Investing Through Financial Analysis

You’ve been building up the courage to start investing in real estate for some time. You’ve had every conversation with your rich uncle and your obscenely successful friends. You’ve read the how-to books. And now you have finally found the right property. It looks good, and the deal ‘smells’ good to you. The location seems like a safe bet.

But before you jump right in, take a step back and crunch the numbers. Forget the back-of-the-napkin analyzes your heroes may tell you about. If you’re spending that much of your hard-earned money, you owe it to yourself to do some thorough due diligence. There is a good reason for it:

• The financial analysis process forces you to look carefully at the big picture, not just the parts that appeal to you. You are forced to think things through, which in itself reduces the risk of you missing something critical.

Analysis can be an objective exercise, very different from the subjective and emotionally charged process of negotiating and getting caught up in the frenzy of deals. Especially when it’s your first time, you don’t want to rush into one of those projects that turns out to be one where you’d later say (regretfully) ‘it seemed like a good idea at the time’.

There are some other very solid reasons to perform a thorough financial analysis of your business:

• Techniques such as discount cash flow analysis will project the ultimate potential profit or loss on your investment. This will help you go from ‘sounds like a great deal’ to ‘has the potential to make me $200,000 in 5 years’.
• Preparing detailed financial projections is the hallmark of the professional. Doing your homework in this way will improve your attractiveness to bankers, which could help you attract financing for your business.
• Financial analysis cannot see the future; you should not expect to be able to accurately predict the final results. However, through financial analysis, you can generate best and worst case scenarios to create a range of projected results. This will help you approximate the maximum and minimum amounts you can win or lose, as well as what you think is the most likely win or loss.

Investing is all about risk mitigation. Through this process, you can avoid trades that exceed your risk threshold, as well as trades that do not offer adequate upside to balance the potential downside. Never pursue an investment in which you are not comfortable with the risks. That’s what we call ‘betting’. You also shouldn’t look for investments where, at best, you won’t achieve your minimum return.

Don’t jump before you look. Run the numbers and get ready.