If you’re considering buying investment property you should always “kick the tires” first. First, walk through the building to assess its physical condition. Then, talk with the existing tenants. See how stable they appear to be and make a judgment about whether they’ll stay there, paying the rent regularly.
Different types of properties have different types of leases, which will affect the price you’ll offer to pay. Today, you can earn 7 percent-8 percent on a high-quality corporate bond; that is, you’ll pay 12 to 14 times the interest income you’ll receive. If you buy a property and assume responsibility for tenants, you should pay less.
For a warehouse, where those responsibilities may be slight, you might want to bid 10 times the operating income you expect to receive from the property.
A professional office building is likely to require somewhat more management while posing more risks of tenant turnover so you might pay only seven or eight times anticipated operating income.
If you’re buying a strip mall, with a lot of transient tenants, you might want to bid even less, perhaps five times projected operating income.
After you have determined on a purchase price you need to decide how much debt to carry on the property, if any. An all-cash purchase will reduce your risk and maximize your income because you won’t have to make debt service payments. On the other hand, taking out a large mortgage will maximize your gains if the property appreciates in value: if you buy a $1 million building with a $100,000 down payment you’ll have a 100 percent profit if the property appreciates just 10 percent, to $1.1 million.
Start by calculating the cash flow (income over expenses) you’re likely to receive with an all-cash purchase. Assuming you don’t need the extra cash flow, which may be largely taxable, you should figure out how large a mortgage you’ll need to fully offset rental income with interest deductions. This will spare you a current tax obligation while giving you some leverage if the property gains value.
