Below is a brief overview of NOI, CAP Rate, and NOI, CAP, and NOI Multiplier.

What is NOI?: Net Operating income

What does it measure?: Measures the revenue generating capacity from operations.

When is it important?: Two times: When you is sellin’…and when you aint. On a more serious note, NOI is the source of payment for debt service, and cash flow distributions to the owners.

Why it’s important:  It provides a way to measure the revenue producing capabilities of an asset excluding debt service considerations.

What’s the formula?: Current Revenue – Current Expenses (Exclude debt service, capital expenses.)

Example: Current Revenue, June 2009: $100,000.
Current Expenses, June 2009: $ 35,000.
NOI, June 2009 $65,000.

What is a Cap Rate?

The capitalization rate is what the yield as a percentage of the initial investment would be in year one if you acquired the property all cash.

Why it is important: First “sniff test” investors use to check out an available commercial property.

What is the formula? NOI/Sale Price = Cap Rate
Example: $65,000/$812,500= 8%.

What is NOI Multiplier?

How much each dollar of NOI would contribute to value if property was for sale.

Why we care: Knowing how much each dollar on NOI is worth helps us evaluate the impact of incremental increases in revenue and expense. (Great for rehab/repositioning!)

What’s the formula? Sale Price/NOI = NOI Multiplier
Example: $812,500/$65,000= 12.50 (Each dollar of NOI creates $12.50 of value.)

NOI, CAP, and NOI Multiplier Problems

A Portland Multifamily investment Property X had the following revenues in 2008:
• Rent $122,500.
• Extraordinary gain: harvest lumber on property $25,000.
• Pet rent $300.

Property X had the paid the following in 2008:
• Utilities, taxes, management fees, etc. $48,000.
• Cap Ex: Completely rebuild lower parking lot $19,000.
• Re-stripe upper parking lot $125.

QUESTIONS 1 & 2 are based on the information above.

1. What was NOI?    ANSWER:  $74,675  Note: The lumber revenue and parking lot expense were not operating related and were thus excluded from NOI.

2. What is the asset worth if we assume a 6.9 Cap% ?   ANSWER: $74,675 / .069 =  $1,082,246

QUESTIONS 3 – 4 are based on repositioning an 18 unit property we are buying for $1,200,000 at an 8 cap with a 5.9 % loan. Current Annual NOI is $96,000:

3. How much is each dollar of NOI worth? ANSWER: $1,200,000/$96,000 = $12.50.

4. How much more would the property be worth if we could raise the rents in 10 of the units $10/month? (Assume that a year has 12 months, all the units are increased at the same time for the full year…and that we could do this without increasing expenses…without any change in turnover.)  Answer: 10 units X $10 X 12 months equals a $1,200 increase in Annual NOI. Multiply by $12.50 = $15,000 increase in value!

Whether you’re a seasoned pro or a newbie…feel free to contact us:  503.577.1034 or rick@rosecitycre.com.

These equations apply whether your looking at Portland OR investments…or anywhere else too!

Profits from multiple sources

When investors buy  commercial real estate they are acquiring a revenue stream. Admittedly there are a few signature buildings that are so iconic that they are a “pride of ownership” acquisition, but most properties are valued solely for their future economic potential. There are four primary ways in which investors benefit from their acquisitions:  

1. Cash Flow

is the sum of: Cash In – Cash Out. The primary source of inflow cash is rent. Pet rent, late fees, laundry and owner contributions are also part of the cash in stream. Cash Outflows include taxes, expenses and distributions to owners.  

Owner types vary widely on the importance they place on distributions:  

• Residential Multifamily properties (2 to 4 units) and smaller Commercial Multifamily properties cast off little cash. Their owners tend to focus more on equity gained at the time of disposition.
• Investors of larger properties often use cash flows (distributions) as a primary source of spendable income. They certainly expect gains at sale, but they often will use that gain to step up in basis to acquire a larger asset in the hope of increasing the monthly cash-flow.
• The bane of all investors is the much dreaded Cash Call. When cash out ‹ cash in to the extent that operations are impacted, the property owner(s) are forced to add new equity to keep expenses current. Be aware that cash call inputs wreak havoc on IRR Calcs.
  Because of their focus on maintaining regular, dependable distributions, the owners of larger properties tend to have lower LTV loans. This doesn’t eliminate cash calls, but it does make operations inherently more stable, reducing the likelihood of requiring additional cash.

2. Appreciation

is Future Disposition Price – Original Acquisition Price. A 53 unit complex that is purchased for $3.2 million is 2007 appreciates $700,000 if it is sold for $3.9 million several years down the road.  

• Appreciation gains can occur from (external) market forces such as a downward trend in Cap rates, or from increases in rent relative to expenses due to high demand.
• Gains can also be “forced” by internal forces. This occurs when we reposition a property. Renters will pay more for upscale amenities and newer looking accommodations. Success requires having the amortized costs of improvements be exceeded by the increased rents. In some cases we merely seek to raise the rents on the existing renters; other times we are using the upgrades to attract a new tenant profile.

3. Loan Paydown

is determined by subtracting the initial loan amount from the remaining loan balance at any given time. Suppose a $3,200,000 property is acquired with a roughly 65% LTV loan at 6% with a 30-year amortization. Day one the beginning loan balance would be $2,000,000. 42 months later (3-1/2 years) the loan balance would be $1,909,649. The loan paydown amounts to $90,351 for that period.  Using interest only loans eliminates loan paydown…but does increase cashflow.  

4. Tax Shelters and Tax Avoidance Benefits

The final benefit to investors is the tax sheltering of income. Cost Recovery (Depreciation) is the primary example. Industrial and retail properties are depreciated on a 40-year basis; housing is depreciated using 27.5-years. Note: Land is not depreciable. Using our previous example of a $3,200,000 community, let’s assume that land was 25% of the value, leaving a depreciable amount of $2,400,000 to be depreciated over 27.5 years, or $87,27.73 per year. That will act as a tax deduction to reduce profits by that amount for tax basis purposes.  

A more rapid depreciation methodology is provided by Cost Segmentation, or familiarly, Cost Seg. This is performed based on findings of a cost engineer during their on-site inspection and review of the property. There is great acceptance of this approach by the IRS, but it is not fully understood by investors and many Tax Accountants. Cost Seg. on Assets under $1 Million is not always cost effective due to the fixed costs of the on-site inspection. Savings on multimillion dollar properties are substantial, and can change a 1.1 DSCR property into a 1.25. That means that Cost Seg utilization can impact approval outcomes.  

Duties of Professional Investment Brokers

It is incumbent on the Real Estate Professional assisting a client with a multifamilty acquisition to have an understanding of that client’s risk profile, investment horizon plus target cash flow and appreciation rates. It is also beneficial to have an awareness of how important their client deems tax shelter options.  Given that 1 in 5 1031 Exchanges fail for one reason or another…it makes sense for a broker to offer information regarding Structured Sales before closing on the inital leg of the exchange.  This preserves reinvestment options.  

Whether you’re looking at Beaverton multifamily investments, Salem apartments…or assets anywnere in Oregon, contact Rose City Commercial Real Estate today at 503.577.1034, or rick@rosecitycre.com.

Optimizing your investment

 
Cost segregation, though known by many real estate owners, is sometimes overlooked.

It is a methodology used to reallocate certain building costs into separate identifiable components that can be depreciated over shorter lives. The primary purpose of a cost-segregation study is to reallocate as much building costs between land improvements and tangible property. The more costs allocated to tangible property, the greater the desired tax benefit. Tangible property creates tax benefits because it is depreciated over five or seven years while normal building costs are depreciated over 27.5 or 39 years.

A cost-segregation study may be performed for real estate already in service, for new construction and acquisitions. Generally, it is easier to analyze a building’s cost structure during initial construction or expansion since building plans are readily available and can be utilized to identify various components that may qualify as tangible property.

Costs that may be reallocated to land improvements consist of, but are not limited to, certain landscaping, sidewalks and fencing which are depreciated over a 15 year recovery period.

Costs that may be reallocated to tangible property include movable partitions, furniture, removable carpeting and wallpaper, certain fixtures and window treatments. Support systems that are needed to run certain equipment or machinery could be considered tangible property under certain circumstances.

There are several internal levels of cost-segregation studies ranging from a detailed engineering approach through a less formal rule-of-thumb appraisal. The Internal Revenue Service prefers the engineering approach since it will produce the most accurate results.

All businesses that acquire, construct or renovate real property would benefit from a cost-segregation study.

The real benefit of a properly documented cost-segregation study is the enhanced depreciation deductions it yields. A major advantage of the study is not necessarily that it produces more depreciation deductions, but that expenses accelerate more rapidly, producing a greater benefit due to the time value of money.

The ability to write off specific components identified as they are replaced is yet another advantage. For example, when a study is performed, the cost of the roof would be specifically identified. As the roof will eventually be replaced, the remaining cost could be written off.

One disadvantage of a cost-segregation study is the potential triggering of depreciation recapture and possible understatement penalties a taxpayer could incur for studies that are too aggressive in classifying costs. To avoid penalties and pass IRS scrutiny, the study must be objective and supported by contemporaneous records. Studies supported by an engineering study add credibility and produce the most accurate cost allocations.

Overall, cost-segregation studies can produce tremendous tax savings for those who build, acquire any business that builds, acquires or renovates property. The increased tax savings increase cash flow, which in turn, businesses can reinvest.

Gary Anderson, a certified public accountant and senior manager at Reznick Group P.C. in Baltimore, can be reached at gary.anderson@reznickgroup.com.

After the shock of reading his 401-K statement subsided…this investor switched to an Equity Advantage self directed IRA!

It’s great to see the market trending upward again…well, at least for now.  Though I am not prescient, I am lucky…so I pulled all of my 401-k funds out days before the plunge.  A few months later and I would have seen over a third…and possibly half of my savings gone.  Many of my dear friends were not so lucky.  One is un-retiring.  I know that many people rely on the stock market in general (and mutual funds specifically) to make long term gains.  For my sensibilities…I’d rather own real estate than stock in a company that owns real estate.

It used to be that the stock market was the only game in town for 401-k’s, IRA’s, and Roth Plans.

Now, with the Direct Checkbook Controlled IRA you can move in and out of investments with ease, including my favorite: real estate.   This is huge.  It permits investors to play a far more direct and active role in their financial destiny.  You need to use specialists to set up the account and to recieve some background on the requirements, rights and risks.   When you’re playing pennies and nickles poker and the jackpot hits $5, it’s OK to play fast and loose.  When its your retirement at stake, lower your risks and always go with the pros. 

Enter IRA Advantage

IRA Advantage, is the new sister company of the highly regarded 1031 Exchange Accomodator, Equity Advantage.  IRA-A  sets up accounts that help investors reach their goals through direct checkbook control investment IRA’s.  Investments are made through an LLC.  I’ll describe the process in greater depth in a post next week.  If you can’t wait…call IRA Advantage now:  503.619.0223, and say the folks at Rose City Commercial Real Estate sent you!

Let Rick Bean and Rose City Commercial Real Estate be your advantage.  Contact us at 503.577.1034 or rick@rosecitycre.com.

Note:  This site is primarily dedicated to commercial real estate, with a focus on the multifamily component.  We believe that good service should be standard, but great services and products need to be acknowledged.  We reserve the right to promote unaffiliated individuals and companies that in our opinion, demonstrate excellence on an ongoing basis.  We neither solicit nor accept compensation for doing this.

DATE/TIME: Friday, May15, 2009 – 1pm PT

SESSION DESCRIPTION: Can you remember the last time you had to deal with difficult people or an event where someone was negative?  Never fear!  Our positive panelists will chat about what you can do in the future to get through these tough situations with harmony and grace.

RSVP: Visit Gracehill Taining at: www.gracehill.com and look for the details of this event on their home page. Click the RSVP link to sign up and receive Chat Event Instructions.  Then, log into Grace Hill about 10 minutes prior to the event and click on the Chat Room link, under the chat description, to be delivered to their Chat Room. 

* Please note that space is limited to 350 attendees in our chat room.  Be sure to log-in to the chat room 10 – 15 minutes prior to the event.  
 

What else is free?  Call contact me at 503.577.1034 or rick@rosecitycre.com for an equity redeployment assessment.

Beautiful, Affordable Portland

One of the metrics to look at when picking an area for a long term investment is the affordability index.  And by that I don’t mean looking soley at how much the median income is in an area…I mean:

Average Rent/Median Household Income = Affordability Index.  (What portion of your pay goes to rent?)

It’s great that some investment counselors track Median Household Income (MHI), but without the context of average rent for that area we really don’t have a way to evaluate areas that have long-term rent expansion capability.  An obvious example is New York City.  Clearly the MHI is higher there, but so are average rents.  New York has an affordabilty Index of 57.2%.  That means that between half and two thirds of the household income goes for rent.  I suggest that while NYC has posted impressive rent gains for all property types, that the pace of those increase is likely to wane…how much more than 57% of your income could you afford to pay for rent?   Years ago I had an employee that considered himself to be a real tout, a master horse race handicapper.  Mark would always tell me:  “Rick, there are horses that run fast, and horses that run long…but aint no horse that runs fast and long.”

Highly Ranked Portland

With Average Rents at $825 and Median Household Incomes at $57,757, Portland’s Affordability Index is 16.8%.  That’s fifth in the nation.  Portland-Beaverton-Vancouver “Asking Rents” jumped an average of of 3.1% in the fourth quarter of last year compared to a year earlier.   Full disclosure:  Oklahoma City had the nations best ratio at 12.3%…but the catch is that if you move there …every morning you wake up in Oklahoma.

With room for long term rents to expand and a great area to live in, isn’t this a great time to invest in Portland area multifamily properties?

Details: The large unit is 1,208 Sq. Ft. 2 bedroom/1.1 bath home with a fireplace.  It rents for $795 per month.  the smaller 1 bedroom/1 bath unit has 650 Sq. Ft. and rents for $625/month.  Contact me at 503.577.1034 if this sounds attractive.  Or e-mail me at rick@rosecitycre.com.

I will be describing cash flowing commercial deals soon!

Portland, OR

Look at current and future job growth as key factors when evaluating a market for multifamily purchases.  To research opportunities I have traveled to  Reno, Albuquerque, Phoenix, Seattle,  and Los Vegas.  Without exception job creation/population growth seemed to be the common fundamentals that told the tale.  It seems that folks would move to hell if they could get a job.

That’s why I’m so strong on Portland.  We’ve seen good job growth on a consistent basis here for years and the promise of the future is for the pattern to continue or accelerate. 

For those that are dour about the current multifamily market…remember that while Cap Rates are decompressing currently, there are many properties that were purchased at the average 8.3 Cap in 2002. They would now  trade at a 6.50 Cap.  Do the math: 8.3 divided by 6.5 equals a 28% increase in value even if NOI only stayed constant.  The truth is that this market enjoyed significant increases over that period and many Portland multifamily investors have huge sums of redeployable equity, and this is the time to act.

Contact me for equity redeployment information now at: rick@rosecitycre.com

Figuring LTV's

Simply expressed, LTV is the loan amount divided by the property’s value, expressed as a percentage.  The value used will be the lower of the sale amount and the appraisal.  Banking theory goes that the lower the LTV the more the investor goes from involved to committed.  Yogi Berra might explain that discrepancy thus:  “In a ham and eggs breakfast the hen that laid the egg was involved, but the pig the ham came from was committed.”

Example: What would a bank with a 60% LTV maximum, loan on a 42 unit multifamily asset under contract at $117,000 per door that was appraised at $4,850,000?  The lesser of:

60% of Purchase =  .6 X ($117,000 per unit  X 42 units) = $2,948,400

60% of Appraisal :  .6 X $4,850,000 = $2,910,000.

The answer is $2,910,000.  That applies to most banks currently lending practices…there are other options.

TRENDLINE:  a year ago the internet was rife with commercial multifamily loans with 90 -95% LTV’s…those are yet another victim of the lending crisis. For most purchases now banks want a minimum of 25% down (75% LTV) but many require 40% down (60% LTV).  I’m working with a lender on a multifamily loan right now that is requesting an additional down payment to be submitted that will bring my client’s effective down payment to 51% (49% LTV.)  Stricter LTV requirements are probably here to stay…at least for awhile.  But to those that think the forces that caused this change are permanent, please remember that $6 trillion bucks of market value was lost when the tech bubble burst…but only a few years later the DJ not only recovered…but went well past the pre-bubble highs.  The recent downturn has again wiped those gains out…but I long ago transferred my 401K and stocks into a self directed program with checkbook control so that I can focus on Real Estate.

In the interest of full disclosure…while I wish LTV’s were lower…I’m definitely not a fan of extremely high LTV loans.  Remember that as the LTV rises resources available to make it through difficulties diminish.  As banks have become more risk adverse they are requiring those taking out loans to have more “skin in the game.”  They want committed investors.  Think of it this way:  A buyer of a $1,000,000 property who puts down 5%  ($50,000) often is creating a no cash flowing deal with no funded reserves.  If the economy in that area goes soft and rents drop $50 per month he’s going to have a “Cash Call” every month.  Then he stops maintaining his property and stops making full payments.  This creates a distressed property that lowers values of competing properties.  If that same property had a 30 or 40% LTV loan the debt service would be less, making it possible to weather the storm better.

I mentioned previously that there are other options…among them are HUD Loans…which I’ll cover in a future post.

If you found this information useful, please use the orange subscribe button to sign up for periodic updates! Or, e-mail me: Rick@RoseCityCRE.com

Take Off Your Training Wheels-

Rumor on the street is that banks are again permitting a prospective borrower to have up to 10 residential loans. Legally you

Heather Joy, An 8-unit Investment

can have as many as you want of course…its just that lenders won’t underwrite loans past 10 residences. (This is a reversal from a year ago when Freddie Mac tightened up standards to permit only 4 loans.  Fannie Mae adopted the stricter rules shortly thereafter.)

Will the banks  change course again and tighten up standards anew? Rather than shout: “Hurray!” and buy more residential investment properties, I advocate a different strategy.

Convert your multiple residential property equities into a single commercial investment.

Here’s an example:  I have a friend that has 10 single family homes, nine of which are investments. He holds many of them “free and clear” while others have small balances.  He can sell off some of the homes and use a 1031 Exchange to defer taxes, converting the proceeds into equity for a commercial property downpayment.  He can also put new loans on the remaining house to add still more.  Banks are currently writing loans of up to 70 to 80% LTV on investment properties where cash is being taken out at refi.  When this is done my friend will easily be able to acquire sufficient funds ($250-350,000) to buy a commercial property like Heather Joy, currently listed at $779,000.  The advantage of Heather Joy is that he will be able to manage 8 units by going to a single address…a significant improvement in efficiency.

South Towne, An 18 Unit Investment

The next step up would be to take an even greater portion of his existing portfolio equity and purchase a larger asset like the 18-Unit South Towne. That $1,150,00 property would require approximately $350-450,000 in equity to purchase.  It has enough units that we could now afford MBO…Management By Others.  That means that my friend would transition from running all over town to manage 9 single family homes to reviewing the results created by the management company.

Los Verdes, A 53-Unit Investment

To take this further…if my friend’s holdings were enough that he could combine equities to add up to $1,200,000…he could purchase Los Verdes, available for $3,200,000.  That property is large enough to not only have management by others…but an on-site manager.  Contrast owning 53 units in one spot that are managed by someone else vs. running all over town to manage and maintain 9 single family homes.

Summary:  You will make more money, receive it earlier, and have fewer headaches…when you transition to Commercial Real Estate Investments.

Call Rick Bean at Rose City Commercial Real Estate for a no cost, no obligation assessment of your investment options.