Understanding Investments
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Transcript of Understanding Investments
Commercial and InvestmentCommercial and InvestmentReal Estate OpportunitiesReal Estate Opportunities
Types of Properties
Diversity of Clients
® Dearborn Real Estate Education, 2002
Primary Classifications ofPrimary Classifications ofCommercial PropertiesCommercial Properties
OfficeRetailIndustrialApartmentsOther Commercial Properties
® Dearborn Real Estate Education, 2002
Commercial PropertyCommercial PropertyAs anAs an
InvestmentInvestment
Almost every type of commercial property can be an investment!
® Dearborn Real Estate Education, 2002
Investment CustomersInvestment Customers
UsersSpace Driven
DevelopersBuild-to-Suit
Pure InvestorsProfit Driven
® Dearborn Real Estate Education, 2002
Commercial and InvestmentCommercial and InvestmentReal Estate OpportunitiesReal Estate Opportunities
Residential Real Estate– One Client
– One House
– One Time
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Commercial and Investment Real Estate
– Many Types of Properties
– Several Kinds ofCustomers
– UnlimitedOpportunities
– Redundant BusinessToo!
““Taxpayer”Taxpayer”Small Multiuse BuildingsSmall Multiuse Buildings
Typically, a store or office on the ground floor with two to six apartments above.
® Dearborn Real Estate Education, 2002
Advantages of PurchasingAdvantages of Purchasinga Small Multiuse Buildinga Small Multiuse Building
Which type of customer would buy a small multiuse building?
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Net Operating Income (NOI)Net Operating Income (NOI)
Gross Operating Income
Less Owner’s Operating Expenses
Equals Net Operating Income
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Case Study:Case Study:Main Street Multiuse BuildingMain Street Multiuse Building
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The Advantages of PurchaseThe Advantages of Purchase
Often the cost to buy is equal to or less than the cost to rent.
Purchase price is affordable.Tax benefits of ownership, i.e., depreciation
® Dearborn Real Estate Education, 2002
Often the Cost to Buy Is EqualOften the Cost to Buy Is Equalto or Less Than the Cost to to or Less Than the Cost to
Rent.Rent.Store rent (from problem)$15 PSF X 1,000 SF = $15,000 annual rent
Rental income (apartments) $12,000Owner’s Operating Expenses 10,000“Profit” $ 2,000Effective new rent $13,000
® Dearborn Real Estate Education, 2002
Affordable Purchase PriceAffordable Purchase Price
Financing the Main Street Building
Building Price $160,000
Down Payment – 32,000
Mortgage $128,000
15-Year Term, 7.5% Interest Rate
Annual Debt Service $ 14,239
® Dearborn Real Estate Education, 2002
Cost to “Carry” theCost to “Carry” theMain Street BuildingMain Street Building
Debt Service (per year) $14,239
Operating Expenses 10,000
Total Expenses $24,239
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New Store RentNew Store Rent
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Cost to “carry” the building $24,239
Less income from apartments –12,000
Effective New Store Rent $12,239
A savings of $2,761 over the original rent ($15,000) due as a tenant.
Tax Advantages of OwnershipTax Advantages of Ownership
® Dearborn Real Estate Education, 2002
Depreciation or
Cost Recovery
Required by IRS Code
Buildings depreciate, but
land does not
Depreciation Time
Commercial Buildings
over 39 years
Apartment Buildings
over 27.5 years
Tax Advantage of OwnershipTax Advantage of Ownership
® Dearborn Real Estate Education, 2002
Purchase Price $160,000
Less Land Value – 20,000
Depreciable Building Value $140,000
Building value divided by 39 years equals the annual tax depreciation.
$140,000 divided by 39 = 3,590 Tax Benefit
Buy vs. RentBuy vs. Rent
User-investor saves $2,761 in rentGains tax advantage of $3,590
® Dearborn Real Estate Education, 2002
Real estate agents should discuss the advantages of purchasing with their clients.
The Concept of VacancyThe Concept of Vacancy
Vacancy is defined as a portion of, or entire space without, tenancy, measured for a period of time.
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NeighborhoodNeighborhoodStrip CenterStrip Center
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Considerations of aConsiderations of aUser CustomerUser Customer
The cost to buy may be equal to or less than the cost to rent.
Tax advantages of ownership.However, “Purchase price is affordable”
may no longer be true.
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Considerations of anConsiderations of anInvestor ClientInvestor Client
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Quality of TenantsTurnover ConcernsRate of Return on the Investment
Case Study:Case Study:Neighborhood Strip CenterNeighborhood Strip Center
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Step 2:Step 2:Adjusting for VacancyAdjusting for Vacancy
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Adjusting for vacancy requires a reality examination.
Vacancy is usually calculated as a percentage of the Potential Rental Income (PRI).
DetermineDetermineGross Operating IncomeGross Operating Income
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Step 3:Step 3:Calculating the Total Calculating the Total Operating ExpensesOperating Expenses
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Step 4: Calculating NOIStep 4: Calculating NOINet Operating IncomeNet Operating Income
Gross Operating Income
minus Operating Expenses
equals Net Operating Income
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Repair and MaintenanceRepair and MaintenanceContingency ExpensesContingency Expenses
Contingency expenses are best thought of as irregular, unexpected or emergency events. There is an important distinction between normal regular expenses and contingency repair and maintenance expenses.
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Repair and MaintenanceRepair and Maintenance
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Guidelines Age of the building Condition of the
property Under the lease terms,
what are the landlord’s responsibilities?
Calculation Percentage of PRI
or Percentage of GOI
or Fixed Dollar Figure
Repair and MaintenanceRepair and MaintenanceProblemProblem
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Effect ofEffect ofRepair and MaintenanceRepair and Maintenance
on Expenseson Expenses
® Dearborn Real Estate Education, 2002
Operating Expenses Taxes $20,000 Insurance
2,500 Repair &
3,750Maintenance
Total $26,250
Revised NOI
Income$67,500
Expenses –26,250
NOI $41,250
Market ValueMarket Value
© Dearborn Real Estate Education, 2002
Market Conditions Market Conditions Affecting PriceAffecting Price
Supply and DemandLocation, location, location!Available FinancingInsurance Value
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Commercial ValuesCommercial Values
Retail– Location– Traffic
Industrial– Cost of Labor– Transportation
Investment– Upside Potential
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Highest and Best UseHighest and Best Use
The best use of a property will create the highest financial return on the investment.
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Triple Net Lease (NNN)Triple Net Lease (NNN)
Tenant pays all
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Floor Area Ratio (FAR)Floor Area Ratio (FAR)a.k.a Land Coverage Ratioa.k.a Land Coverage Ratio
The ratio of the bulk area of a building to the land on which it is situated.
© Dearborn Real Estate Education, 2002
Highest and Best UseHighest and Best Use
Problem A
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Conversion CostsConversion Costs
Variance–Legal Costs
Construction Costs
Down Time
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Highest and Best UseHighest and Best Use
Problem B
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Comparing NOIComparing NOI
Current Tenant
GOI $75,000 TOE 15,000 NOI $60,000
Proposed Tenant
GOI $60,000 TOE (NNN) 0 NOI $60,000
© Dearborn Real Estate Education, 2002
Good Deal for Owner?Good Deal for Owner?
Rent IncreasesNo Conversion ExpensesNo Down TimeBigger BuildingSale versus Land Lease
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Capitalization RateCapitalization Rate(CAP Rate)(CAP Rate)
The CAP rate can be looked at as a desired
“profit percentage” for an investor.
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CAP Rate FormulasCAP Rate Formulas
Solve for Market Value
NOI $50,000
CAP Rate 10%
Market Value ?
Solve for CAP Rate
NOI $60,000
Offer $500,000
CAP Rate ?
© Dearborn Real Estate Education, 2002
CAP Rate ProblemsCAP Rate Problems
A property is priced at $750,000 and has a NOI of $67,000. What is the CAP rate being offered?
An investor wants to sell her building. She advises you that she has an NOI of $48,000 and will offer the property at an 11% CAP. At what price do you market the building?
© Dearborn Real Estate Education, 2002
Retail TermsRetail Terms
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Anchor TenantsAnchor Tenants
Do not sell anchors!Large department stores or supermarketsDo their own advertising
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CAM ChargesCAM Charges
Common Area Maintenance
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GLAGLA
Gross Leasable Area
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Tax Escalation ClauseTax Escalation Clause
a.k.a Real Estate Taxes over Base
a.k.a Tax Stops
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Annual Property Annual Property Operating DataOperating Data
(APOD)(APOD)
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Case Study:Case Study:Mountain View Mini MallMountain View Mini Mall
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Base Rent Roll CalculationBase Rent Roll Calculation
$167,000Total
$32,000$162,000Real estate
$36,000$182,000Stationery
$54,000$183,000Video store
$22,500$151,500Dry cleaner
$22,500$151,500Restaurant
Annual RentBase RentSquare FeetStore
© Dearborn Real Estate Education, 2002
Step 2Step 2
Analyze all other income and adjustments to income.
Solve for Gross Operating Income.
© Dearborn Real Estate Education, 2002
Vacancy and Credit LossesVacancy and Credit Losses
In this problem, 5% is used for vacancy contingency.
Potential Rental Income $177,000
Multiplied by 5% X .05
Vacancy & Credit Losses $8,850
© Dearborn Real Estate Education, 2002
Step 3 ExpensesStep 3 Expenses
Only the Owner’s Operating Expenses
Reminder: All figures are annual.
© Dearborn Real Estate Education, 2002
Step 4: Solve for NOIStep 4: Solve for NOI
Net Operating Income (NOI)
Gross Operating Income $168,150
Less: Operating Expenses – 81,000
Net Operating Income $87,150
© Dearborn Real Estate Education, 2002
What Is My Building Worth?What Is My Building Worth?
Step 5: Calculating Market Value
NOI ÷ CAP Rate = Value
$87,150 ÷ .12 (12%) = $726,250
© Dearborn Real Estate Education, 2002
The Value of InvestmentsThe Value of Investments
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Key Investment TermsKey Investment Terms
Rate of ReturnLeverageInitial InvestmentCash Flow Before Taxes (CFBT)EquityCash on Cash ReturnInternal Rate of Return (IRR)
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Leveraged PurchaseLeveraged PurchaseCash on Cash ReturnCash on Cash Return
CFBT = NOI – Annual Debt Service
Cash on Cash = CFBT ÷ Initial Investment
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Investment StrategiesInvestment Strategies
StabilityPotentialFlippingUpside PotentialHolder
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What Is the What Is the Property Worth?Property Worth?
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Components of ValueComponents of Value
Current year analysisFive-year forecastOwner’s perspectiveBuyer’s perspective
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Case StudyCase Study
Office
Building
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© Dearborn Real Estate Education, 2002
DetermineDetermineCurrent Rent RollCurrent Rent Roll
andandPotential Rental IncomePotential Rental Income
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Complete the IncomeComplete the Incomeportion of the APOD.portion of the APOD.
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© Dearborn Real Estate Education, 2002
Operating Operating ExpensesExpenses
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© Dearborn Real Estate Education, 2002
Net Operating IncomeNet Operating Income
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Cash Flow Before TaxesCash Flow Before Taxes(CFBT)(CFBT)
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Cash on Cash ReturnCash on Cash Return
Cash on Cash = CFBT ÷ Initial Investment
$15,294 (CFBT) ÷ $125,000 (II) = .1224
12.24% is the Cash on Cash Return
© Dearborn Real Estate Education, 2002
All Cash PurchaseAll Cash Purchase
Capitalization Rate Formula:
NOI ÷ Value (Purchase Price) = CAP Rate
$60,936 ÷ $500,000 = .1219
12.19% CAP Rate
© Dearborn Real Estate Education, 2002
SpreadsheetsSpreadsheets
Cash Flow ForecastsCash Flow Forecasts
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The UpsideThe Upside
44,84441,64233,52428,02215,294CFBT
90,48687,28479,16673,64460,936NOI
Year 5Year 4Year 3Year 2Current
Year
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Cash on Cash ReturnsCash on Cash Returns
.1224 (12%)$125,000$15,2941
.3588 (36%)$125,000$44,8445
.3331 (33%)$125,000$41,6424
.2682 (27%)$125,000$33,5243
.2242 (22%)$125,000$28,0222
Cash on Cash Return
Initial Investment
CFBTYear
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Market ValueMarket Value
Does the potential buyer care about the present owner’s return on his/her investment?
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Potential Market ValuePotential Market Value
12%
CAP
10%
CAP
90,48687,28479,16673,66460,936NOI
Year 5Year 4Year 3Year 2Current Year
© Dearborn Real Estate Education, 2002
Potential Market ValuePotential Market Value
754,050727,367659,717613,867507,80012%
CAP
904,860872,840791,660736,640609,36010%
CAP
90,48687,28479,16673,66460,936NOI
Year 5Year 4Year 3Year 2Current Year
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What Is My Property Worth?What Is My Property Worth?
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Considerations Considerations Regarding ValueRegarding Value
What the current owner paid is irrelevant.
Test the assumptions used in the forecast.
How much upside potential will a buyer pay for?
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Methods of ValuationMethods of Valuation
Income Approach
Comparable Sales Method
Cost Approach
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The Buyer’s PerspectiveThe Buyer’s Perspective
Challenges
Incorrectly Stated FactsQuestionable AssumptionsBusiness Style
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Applied to the last problemApplied to the last problem
Basement Rent?Vacancy Rate 7%?Repairs and Maintenance 5%?Off Site Management 5%
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Compare the Market ValuesCompare the Market Values
None of the “facts” changed.
What did change were the assumptions.
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Commercial AgentsCommercial Agents
Validate the facts and evaluate the assumptions.
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To make a dealTo make a deal
Negotiate the assumptions firstThen the price
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Future BusinessFuture Business
Develop relationships with commercial and investment customers for life.
© Dearborn Real Estate Education, 2002