The Hartman Risk Evaluator (HRE) is an indispensable tool for the income property investor. Why indispensable? Because it allows you to almost completely eliminate the downside risk in a real estate investment, while maximizing the upside potential.
A bold claim, to be sure. We’re going into a new way of thinking, so focus like a laser here for a few moments. Don’t fear the acronyms.
The HRE is based upon calculating the Land-to-Improvement Ratio (LTI) for your chosen piece of property. To find the LTI, we need to bi-furcate the value of the property into two pieces. The first is the improvement value, which is a fancy way of saying the house or structure sitting on the land. The second piece of the value puzzle is the land itself.
Let’s look at a real world example from Jason’s portfolio. A few years ago, he was considering purchasing a particular property in Georgia. The cost was $159,000. He received a phone call from an insurance company offering to insure the house for $135,000. It doesn’t take too much brain power to see the breakdown goes like this:
Value of improvement $135,000
Value of land $24,000
Total Value $159,000
The vast majority of the value of this property lay in the improvement which, for reasons we’ll get into next time, is not likely to drop. When bubble markets happen and overall real estate values decline, the majority of the loss is in the actual land value. The HRE realizes this and allows you to focus only on properties that have a much higher improvement value than land value. In the example we just looked at, the land value could drop by half and you still lose only $12,000.
