First, he would acquire a team of experts to help him. Trump understands the old saying: “If you act as your own attorney, you have a fool for a client.” This could also apply to the person who tries to be his or her own property manager, real estate broker, accountant, escrow officer, building inspector, loan broker (Russian?), and/or appraiser. It takes many skilled people to make a winning team.
To find “Location, Location, Location”, he would use his team to contact universities, financial institutions and real estate research department such as Cal State Companies. As part of the analysis, absolutely nothing beats the feel-and-touch approach. Trump probably would conduct a physical inspection of an area to confirm all reports. Critical words like good, bad, best, worst, bright, dull, a lot, and a little are subjective. He wants to make sure everyone is singing from the same hymnbook when praises are being sung!
Trump would ask the following questions when evaluating the area as part of the physical inspection of the location:
• Would he be willing to live in the area
• What is the graffiti index
• What are the aesthetics
• Is there debris in the streets
• Is it off the beaten path
• Is the area growing in a favorable direction
• Are transportation lines readily available
• Are recreational facilities nearby
His physical test will give him that personal viewpoint necessary to complete the analysis on location.
Once the location has been determined and he has the property under his control, his team can begin to prepare a comprehensive analysis using the following techniques:
The key figure used is the internal rate of return (IRR) after taxes. By comparing this figure with the IRRs from other investments, his team is able to determine the best investment for him. Trump knows that IRR shows the time value of money, and it reflects cash flows based on present values. Return on investments, in terms of purchasing power, might actually be less, depending on how the cost of living has changed. Knowing the IRR helps to quantify his investment opportunities.
His team’s analysis is based on two types of returns, growth rate and replacement costs. Growth rate projections are based on historical trends. An analysis performed using this rate will give a conservative IRR. An aggressive IRR is obtained by projecting a future selling price based on future replacement costs. .
What his team is looking for is a steep growth. His SOP (Standard Operational Procedure) is to buy property below the cost of replacement and sell when values are at least equal to or greater than replacement costs.
The five methods Trump and his team used to analyze property are as follows:
• Qualified appraisers
• Comparable sales data or “comps”
• Gross multiplier approach
• Capitalization rate method
• Property analysis software
Qualified Appraisers use three appraisal techniques to establish the current market value of apartments. They are the (1) cost, (2) income, and (3) market data approaches. The cost approach establishes market value based on what it would cost to replace a reasonable facsimile. The income approach is designed to calculate the market value based on the expected future income. In addition, the market data approach uses information gathered from recent comparable sales to determine value. The appraiser considers all three methods when making a final determination as to current market value.
Comparable Sales Data or “Comps “In a weak market, it is difficult to use comparable sales data to determine market value. Sales figures may not be available or may be stale because properties are not moving. Prices, under these circumstances, usually have no bearing on current market conditions. At best, comparables will give an indication of trends.
Gross Multiplier Approach is the ratio between the gross rents and the selling price. By comparing gross multiples of other properties in the same general area, a rule-of-thumb determination of market values can be made.
Capitalization Rate Method is the ratio between the net income and the
selling price. This rate can also be compared to those of other properties
Property Analysis Software will give Trump an IRR that will reflect the degree of risk he is willing to take. The more risky an investment, the higher the IRR. Conservative projections are computed using rental growth and vacancy rates, and they establish the lower limits of the IRR. IRR projections based on replacement costs determine the higher limits of the IRR. Analyzing both rates of return allows him to assess the risks versus rewards relationship of each investment.
Trump’s approach to analyze real estate is to use a combination of all the above evaluation methods. Doing the analysis, with the help of a qualified team, gives a better understanding of the investment and its profit potential.
ABOUT THE AUTHOR: Eugene E. Vollucci is the Director of The Center for Real Estate Studies, a real estate research institute. He is author of four best selling books and many articles on real estate rental income investing and taxation. To learn more about the Center for Real Estate Studies, please visit us at CALSTATECOMPANIES.COM