The following article is emblematic of the reasons I feel that real estate should be a key component of any long term net worth building program.  Don’t get me wrong…it’s OK to put part of your money on Mr. Hare…I just think you should put most of it on Mr. Tortoise. -Rick M. Bean

From: Pittsburgh Business Times – by Patty Tascarella

 The Securities and Exchange Commission announced Tuesday that stock-by-stock circuit breaker proposals are being filed in response to the market disruption of May 6.

Stocks lost $1 Trillion in a half an hour?  That’s why I’m in real estate investing!  They’re proposing to limit losses to 10% in a 5-minute period.  Ouch!  To employ your wealth building strategy on a local level, contact us at Rose City Commercial Real Estate.  503.577.1034 or rick@rosecitycre.com

The national securities exchanges and the Financial Industry Regulatory Authority are filing proposed rules under which they would pause trading in certain individual stocks if the price moves 10 percent or more in a five-minute period.

The SEC is currently seeking comment on the proposal, which would take effect as a pilot program running through Dec. 10, 2010.

The fastest, abruptest market slide in Wall Street history plunged the Dow Jones Industrial Average a fraction short of a 1,000-point drop on May 6. The exchange regrouped just as quickly to a 347.80 point loss by the end of trading.

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It came down to an error stemming from a lack of communication between the six exchanges operating in the United States — The New YorkStock Exchange, Nasdaq, BATS, Direct Edge, ISE and CBOE. Each operates with different rules. So when the New York Stock Exchange put a hold on trading on a number of stocks, chaos ensued with traders and computer systems. The SEC has been meeting with the various exchanges to develop a structural framework for strengthening circuit breakers and handling erroneous trade.

“I don’t know if that’s the ultimate solution, but it’s a step in the right direction to avoid large issues like we just had,” said Dale Dominick, managing director of BenchMark Financial Network’s Pittsburgh office.

Circuit breakers could be “a good safeguard,” he said, “Until they figure out a better solution —if there is a better solution.  Anyone can make an error and it can cause a rippling effect through the whole industry.”

Senior reporter Patty Tascarella covers banking, finance, legal, marketing and advertising and foundations at the Pittsburgh Business Times.
Contact her at ptascarella@bizjournals.com or (412) 208-3832.

Read more: SEC proposes rules to curb market mayhem – Pittsburgh Business Times

Yet another sign the economy is recovering

Even though this investment news doesn’t directly impact Portland multifamily real estate I’ve included it because it speaks to the general improvement beginning in the overall economy.  I’ve personally seen a huge surge in interest in Vancouver apartments in the last month.  

 From: Retail Traffic Apr 13, 2010 10:59 AM  

Bed, Bath & Beyond’s announcement last weekthat it plans to open 60 new stores in fiscal 2010 highlighted a change in attitude that’s slowly taking place among national retail chains. While most national retailers spent 2009 trying not to drown, a brighter outlook for U.S. economy and better pricing on available space has led to an increase in expansion announcements in 2010.   

Meanwhile, children’s apparel seller Gymboree has doubled the number of stores planned for its new off-shoot Crazy 8 up to 100 from previously announced 50. And Urban Outfitters Inc. decided to launch a new concept next year that will focus on the always popular bridal market.  This year, leasing activity might rise 5 percent year-over-year, according to some experts. But the growth will be concentrated among a few key sectors, including discount stores, furniture sellers and fast-food operators.  

“If you are a landlord, you’ve got to really focus like a laser beam on the strategies these companies have and the potential of these businesses,” says Howard Davidowitz, chairman of Davidowitz & Associates Inc., a New York City-based retail consulting and investment banking firm. “At the end of the day, this economy is not going to be good, so they really have to understand who’s going to be a viable [long-term] tenant.”  

For example, Bed, Bath & Beyond, which reported a 4.4 percent increase in same-store sales for 2009 while the industry as a whole experienced a 0.5 percent decrease, seems like a strong bet, according to Davidowitz. During its earnings conference call on Apr. 7, the Union, N.J.-based retailer announced it plans to open 60 new stores in North America in fiscal 2010, including 30 namesake stores, 20 buybuy BABY stores and 10 Christmas Tree stores. Overall, the company believes it can support 1,300 Bed, Bath & Beyond stores in U.S. and Canada, according to Warren Eisenberg, co-chairman. As of 2009, it operated 958 namesake stores in the United States.  

“We continue to apply our stringent standards of growth as we evaluate new store price, as well as continue to review our existing locations and lease terms for opportunities to relocate and/or right size our stores in response to changing market conditions,” Eisenberg told analysts.  

“We are going to have tremendous growth in the extreme value sector, big growth in food retailers and it looks like home [furnishings] is coming back after a five-year slump,” Davidowitz says. “In extreme value alone you’ll see thousands of stores.”  

Overall, U.S. retailers plan to open 65,257 stores in the next two years, according to a March 16 report from RBC Capital Markets and Retail Lease Trac. (The report includes data on 2,000 retailers, but does not follow expansion plans for some of the bigger U.S. chains, including Walmart, Target and Macy’s.) The March figure represents a 1.2 percent increase from the number of stores planned in December 2009. The sectors with the greatest number of planned openings include variety, with 2,839 stores; salons and spas, with 2,509 stores; and pet care, with 493 stores.  

For example, Dollar General plans to open 600 new stores in 2010, while Family Dollar will open net 120 to 140 stores.  

As a result of this revival in interest, there has been a 20 percent to 30 percent increase in leasing activity from this cycle’s low point in 2009, according to Alvin Williams, principal with Excess Space Retail Services Inc., a Huntington Beach, Calif.-based real estate disposition and lease restructuring firm. Williams, who works with retailers to dispose of surplus store space, attributes the increase partly to his clients’ greater willingness to compromise on deals.  

“We are seeing more flexibility for what kinds of tenants they’ll expect, what kinds of deals they’ll do, they are much more open to splitting their spaces,” Williams says. “We have found what I would call a temporary new normal. There hasn’t been a month-to-month increase [in leasing activity], but we are off the low point.”  

Most national players, however, are still not launching new concepts and those outside the extreme value sector are approaching expansion very cautiously, notes John Bemis, executive vice president and director of leasing with Jones Lang LaSalle Retail, an Atlanta-based third party property manager. He estimates that under the best circumstances, leasing activity this year might increase 5 percent compared to 2009. But if same-store sales remain in the high single digits for the rest of the year, this might position the nationals for growth in 2011 and 2012.  

—Elaine Misonzhnik  

 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.

Preparing To Sell!

While we focus on NOI and Cap Rates when buying apartment investment properties…we still pay close attention to curb appeal…that’s part of what attracts potential tenants. With that in mind, when preparing to sell a multifamily property we want the grounds to look the best they can without breaking the maintenance budget.  If you can’t afford to do everything, do everything you can.

PHASE ONE:  Before listing a multifamily property take a walk around it with a different focus. Try to looking at it as you would a plane when you board. The psychology of safety is that when things look messy, ill planned or in disrepair, we perceive that higher risks are present.   To ease traveler’s fears airlines strive to have passengers enter a clean and neat plane.  The multifamily analog is we stripe the parking lot so it looks sharp, prune tall bushes….particularly those near buildings.  Mowing the lawn is a must. Adding colorful flowers to the landscaping is a good idea. 

Create scenes, viewpoints that best displays the pluses of the property.  The marketing photos and videos will use those to attract attention to the property.  The financials will be what ultimately sell an investor…but the marketing images increase the odds of a buyer taking the time to look close enough to view the financials.

PHASE TWO:   The first items that any investor or buyer’s broker will ask for is a Rent Roll and Profit and Loss Statement.  Those need to be  current and readily available upon request in electronic format.  In this climate actual results must be delivered.  Proformas…”the art of the possible” are acceptable…but only if real numbers are shown as well.  That may be enough information for a potential buyer to submit a Letter of Intent (LOI), but that is only the tip of the research iceberg.  In order to be ready to go to market, Sellers need to have the entire Due Diligence Package complete and ready for submission to the Buyer.   Imagine that you are an interested investor that requests a complete package…only to be told that will be sent in a few days or weeks. 

The best time to forward information requested in the initial interest phase is immediately.  Delays create the impression of increased risk…higher perceived risk inherently reduces perceived value.  Contrastingly, Sellers and Seller’s agents that anticipate questions and answer them in advance of their being asked create trust and value.

In my next article I’ll discuss everything that belongs in competent Due Diligence Packages…and how that package will vary based on the size of property.

Free Offer:  I will give you up to two hours of my time without cost or obligation.  That includes reviewing wealth building strategies, tax deferral opportunities, disposition/acquisition tactics, equity analysis, etc. 

The fine print:  You pay for the coffee.  Contact me at: 503.577.1034 or rick@rosecitycre.com.

Are you losing potential profits due to an inadequately trained staff?  Multifamily Property Managers (PMs) and Leasing Agents (LAs) must be thoroughly trained in a number of areas before they can effectively run an asset.  More often than not we ask these folks to work pretty hard for darn little money…must we also withhold the tools and training necessary for them to be successful?

Remember that in a 7-cap market every  buck of Net Operating Income (NOI) translates into $14.29 of value at the time of sale…and all properties are always for sale…at a price.  Having a happy crew is nice…having a well trained group is a must.

Riverstone Property Management is notable for their meteoric rise in market share.  That’s largely due to shrewd acquisitions of competitors, but there’s much more to their success than that.   They are an industry leader in employee training and employee retention by design. They feel that focusing resources on these two items delivers a better value to their owner/clients, and retaining the best employees help retain clients.  Every Riverstoner (an unfortunate nickname…but that’s the one they chose) has training in non discrimination laws, company values, how they are to treat residents, how to do market research, safety, reducing liability, etc.  Hours and hours of training, with a mentor.  Each leasing agent works from day one on developing their “kit.”  The kit is a mobile office with calculator, tape measure, lists of amenities, competitive information, local attractions, great area restaurants, ATMs, dry cleaners and churches.  In short, leasing agents are prepared for every question and have resources in hand (that they have personally developed) to resolve a host of housing related challenges.  After four months a Riverstoner may have more valuable industry specific knowledge than many of their competitors gather in a decade.

I have a smaller property, so I can’t afford training…The smaller your staff the more important that each one be trained because they don’t have as many co-workers to back them up.  In the case of a single employee on site, it is imperative to have training programs.  Remember that not all training is expensive.  Grace Hill www.GraceHill.com is the industry standard for excellence, offering both affordable and free courses.  They also have apartment news updates, on line webinars and flexible plans permitting you to custom tailor your training program.  They offer a great variety of products free, hoping multifamily professionals will also subscribe to their paid products.  Riddle me this:  With all the poorly trained Leasing Agents out there…why isn’t every single property using Grace Hill or one of their imitators?

Note:  I am not affiliated with Riverstone Property Management, nor Grace Hill Training.  I am not compensated in any way for promoting them…I’m just an ardent supporter of the way they go to market, and their approach to taking care of their clients.

Are you ready for a client centric multifamily broker?  Please call me at 503.577.1034.

Investors are increasingly turning to Cost Seg.

Not every tool is appropriate for every investor, but my job is to make them aware of what is available to them so they can make  informed decisions.  One of the tools that has been around for years, (but is only now starting to see much application,) is Cost Segmentation.  Most investors use depreciation as part of their tax deferment strategy; cost seg. greatly accelerates the permissible amount of depreciation in the first years of ownership.  The effect is to offset much of the current tax liability from profits of operation.  For some investors it offsets all current profits and provides a hedge for income derived outside of the producing property.

Investors love getting depreciation on appreciating assets!

Cost Seg simply lets them get more of what they want…and earlier.  What’s not to like!  It works like this:  the concrete in a building has a much longer life than a washing machine…even if it’s a Maytag.  It makes sense to permit the apartment owner to use an accelerated depreciation schedule on the washing machine, the drapes, the pool equipment, etc., than the concrete.  For years some accountants have cherry picked a few items that were obvious and used shorter “dep scheds.”  Cost Seg is the same process…but on steroids.  The “bright line” ruling on this is that for Cost Seg studies a “Cost Engineer” (not “Cost Accountant”) must perform a site inspection to determine what components are subject for accelerated depreciation.  There are tables with thousands of components…each with their individual depreciation schedules.  The accumulated list of items sets the basis for what may be used in which years. 

What’s the best time to initiate Cost Seg.?

The most fruitful time to have the experts perform a cost seg study for a project is at acquisition.  Years later it may still make sense…but its aways best from the first year of ownership.  For this reason I believe that it is the duty of a (good) investment broker to inform his clients about cost seg.  Even more so than a tax accountant.  Some tax accountants see cost seg as a threat to their position rather than an adjunct to their valuable services.  The real litmus test should be: “What’s best for the client?”

What does it cost? Where do I sign up?

Costs vary from project to project based on complexity.  That permits it to be a viable tool on $500,000 acquistions as well as mammoth developments.  For every dollar invested in Cost Seg you will likely get a much higher return than you do on the property itself.  Much higher. I talk several times a week with a Director of the largest Cost Segmentation provider in the nation.  One of the services that I offer investors (whether they are my client or not) is a no cost cost seg feasibility study.  I ask for the opportunity to be of service.  Please contact me at: 503.577.1034, or 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.