Real estate investment decisions are made on the investor criteria. Unless the rental property serves some other purpose, perhaps to close a 1031 tax exchange in a hurry, capitalization rate, internal rate of return, cash on cash return, or some other factor or combination of all factors, tell the real estate investor whether to make the investment or walk away. Real estate investing, after all, is all about the numbers.
There is, however, the matter of any “upside rent potential” associated with the income-producing property that prudent real estate investors should consider before making investment decisions. This is not always the case, though. Remarkably, there are times real estate investors pass on good investment property opportunities because they fail to consider the potential of a property’s upside in rental income adequately.
An income property with “upside rent potential” simply implies that its rents are lower then what the market will bear and the “potential” to collect higher rents and generate more income are a real possibility. To the real estate investor analyzing the income property it means, “hold on, and don’t make any decision to pass on the property until you’ve reevaluated the cash flow based on several other rent scenarios”.
Believe it or not, sellers (or their agents) sometimes, whether by neglect or faulty research, do fail to consider the property’s true income potential when setting a price. If so, then any APOD, Proforma, Marketing Package, or other income and expense statement presented you, at the very least, distorts the income and every key rate of return guiding your investment decision. If unchallenged, and you rely on those numbers, and deem them unfavorable, you could pass up a good investment opportunity. It happens.
Always conduct your own rent survey. Know what comparable rental properties in the area are getting for rents and then make your own evaluation of what the market will bear. You might uncover something the seller overlooked, or perhaps discover that the seller set the price for the property with no consideration for upside rent potential at all.
Then run your own numbers. Using the rents you regard more in line with the market, recalculate the investment property’s cash flow, cap rate, cash on cash, internal rate of return and other financial measures. Who knows, you could discover a nugget of a deal you might otherwise have missed. It happens.