Being a good investor is all about having a vision for where you want to be, taking a view on the market, and running the numbers. When these three elements don’t line up then smart investors stay on the sidelines.  But when they do line up then it’s time to act.

Having a vision, taking a view, and running the numbers: the three pillars upon which you’ll build your ability to make sustainable decisions which will, over the long run, help you to achieve your financial goals. Well forming the vision is the fun part; we all enjoy thinking about where we want to end up in life. And you’ll have lots of help in taking a view; everyone and there dog is out there making predictions about what’s next for the real estate market – your task is separating the wheat from the chaff.

But what about running the numbers? How many of us get really excited about running economic models? Well in my view looking before you leap is the best way to keep your momentum as an investor, and that means having an idea about what to expect from an investment in terms of rate of return, cashflow and net present value.

But analysis is like aspirin, or fine wine, or just about anything, for that matter. A bit of it can make a big difference – but that doesn’t mean that a massive dose is a good idea. More isn’t necessarily better.

So how do you strike the right balance? Well watch out for two traps – 1) becoming infatuated with the analysis and forgetting about the underlying uncertainties (no analysis is perfect) and 2) becoming infatuated with perfecting the analysis to the extent that you never get a deal done. In other words: don't get paralyzed.

Both of these problems happen, probably more than you’d think.

So - how to avoid these issues? Again, it depends on your goals as an investor and your personality type, but I’d suggest a few rules of thumb:

• Remember: your analysis is based on your assumptions. Unless you have a working crystal ball you’re never going to get it all right. Your analysis will give you your base case. When you get your results ask yourself “is this target a good result? Does the potential reward justify the risks?” if the answer is “yes” then drive on and figure out how to make the deal work – don’t spend too much time fine tuning. 
• Analysis is a process: I worked for a while in strategic planning with a major corporation. We spit out huge, detailed plans. And we never followed them. Is this a bad result? Well, not necessarily, because the planning process in itself is hugely valuable. It forces executives to examine their assumptions, communicate their goals, and crystallize their thinking. The planning process helps organizations to articulate their vision and set their course, even if they don’t follow the resulting plans to the letter. Real estate analysis is similar: running the numbers will force you to consider the big questions around vacancies, rental rates, repairs, and other risks that you might not consider before jumping into the investment. 
• Evaluate the sensitivities: Don’t just look at the final “answer” – look at the sensitivities to understand how much risk you’re taking. Ok, you’re forecasting a 5% appreciation rate...but what if it’s -5%? Or 10%? Most investors who bought in 2006 didn't predict today's market - but there are a handfull who at least evaluated the risk of a downturn.  Investors who consider future risks are investors who are prepared to take action when things don't go right. 
• Be honest with yourself: There are two camps that you want to stay out of – the overly conservative camp that kills every deal that comes along by handicapping them with excess costs, and the rose-colored-glasses camp that tweaks all the variables up until they get the result they want. Nervous Nellies do no deals, and Pollyannas do bad ones. 
• Remember that once you’ve made your bed you’re going to have to lie in it: A single fortuitous event (a new rail line) or misfortune (a mold infestation or a disastrous tenant) will radically impact the performance of your investment. You’re still going to have a lot of uncertainty to manage once you make your investment; the purpose of the analysis is simply to ensure you’re pointed in the right direction before you pull the trigger.

Real estate investing software is what EquityScout is all about. Ironically, it's not something that I talk about a lot in this blog. There's a reason for that. In my view real estate investment software is a tool - one of many - that can help investors to reach their goals. Much more important that the tool is the thought process that it supports. That's what I write about - the though process - and readers who identify with the thought process and the philosophy end up check out the tool.

So that said, what are real estate evaluation tools useful for?  Here's a few thoughts:

• Real estate investment software adds discipline to the investment process. Buying real estate, by its very nature, can be an emotional process. And that's ok; gut feel and intuition are qualities that are crucial to successful investing. But discipline is equally important. Software can bring some structure to your decision making process.
• Real estate investment software forces investors to explicitly state their assumptions. GIGO :: garbage-in-garbage-out. You can punch in assumptions to make any investment look like a barn burner - but if you're buying a starter duplex in Los Angeles for $500k that rents for $2,500 per month then you're actually going to have to assume a 20% appreciation rate for the investment to break even. And you're actually going to have to type those numbers - "20%" -  into the model. Being forced to explicitly articulate your assumptions in this way can be a good gut check - and sometimes can be just the wake-up call you need to get you to take off those rose colored glasses.
• Software helps investors to compare dissimilar investment opportunities. Should I buy a fourplex, that duplex around the corner, or a couple of single family homes? I have a different view on each, how do they stack up?
• Real estate investment software helps geeks to pull the trigger. This, for me, is the big enchilada. I'm an engineer by training, which means that sometimes I can't spell too good (as some of you will have noticed from the occasional typo on this blog) and that I need to see some numbers before I can get off of the fence and take action.

Read here to see more pros and cons of the real estate software approach.

• Look before you Leap
• Five Things to Remember when Running Economic Analysis
• Is a Real Estate Investment Software package right for you?

Real estate investing software offers a number of advantages to real estate investors, many of which we emphasize here at EquityScout.com.

Software, however, is not a panacea; it’s a tool to help you make good decisions but it won’t turn bad investors into good ones. In the past I’ve written about the information hierarchy:

_{DATA => INFORMATION => KNOWLEDGE}

We hear lots about the “information age” and the value of information, but not everything that we term as “information” is equal. There’s lots of data out there: listings, rental rates, interest rate forecasts, data on fees and taxes. This stuff is only useful when we can process it into something that gives us insight – turn it into information. Mastering that process will generate the knowledge that investors need to make good decisions.

Real estate investment software is a tool to turn data into information. What you do with it after that is up to you. The following is a summary of what you can expect real estate investment software to do for you…and (more importantly) what you shouldn’t expect it to do for you:

In summary, Real estate investment software can be useful for:

 Ivestors who want to quantify their decisions

• Investors who need a convenient way to save and compare opportunities
• Investors who want to add some rigor to their thought process
• Investors who want a checklist of variable to consider in the analysis
• Real estate professionals who want to present ideas to investors
• Investors who want to present ideas to sources of funding (hard money lenders, banks, etc.)

Real estate investment software is probably not suitable for

• Investors using advanced creative financing techniques or executing complicated deals
• Investors who are comfortable building their own cashflow/analysis models in spreadsheets.

...well not exactly tax free, but tax deferred at least.  Earlier in the year I mentioned a resolution that I'd declared for myself - to sell a high-end property that had built some equity via appreciation and re-invest in a multi-family via a 1031 tax deferred exchange. 

Here's a quick overview of how a 1031 works. 

A 1031 is an IRS code that allows investors to build wealth by exchanging properties while deferring taxes.  Any property may be exchanged for a "like kind" property.  Most real estate transactions fit this definition.  A rental property, for example, could be exchanged for a commercial or farm property. 

You'll need a "qualified intermediary" in order to execute a 1031 exchange.  In lay terms:  when you sell the property you're not allowed to touch the cash, otherwise the tax man is going to come knocking. 

When you sell the property, title is transferred to the buyer via the intermediary, and the proceeds of the sale are delivered to the intermediary.  At this point you have 45 days to identify replacement properties.  Within 180 days of the original closing you'll have to close on the purchase that you're making to complete the exchange.  

Here's the key: 45 days will go by like a flash.  If you haven't started the process of identifying the replacement property or properties before you close the sale of the property that you're relinquishing then you might find yourself in a squeeze. 

I'll talk a bit more about this in the near future....and discuss a project that I now find myself in the middle of.