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. Read more

Before a lynch mob is dispatched…let me clarify: I’m still a huge proponent of real estate investing!  It’s just that residential investments rarely cash flow…you have to wait to make your money at sale from appreciation.  And you can’t afford to have someone else manage the units for you in most cases.  Banks limit you on how many residential investment loans you can have…but they don’t care how many commercial loans you have active.

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

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.

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.

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.

There are over three dozen metrics for commercial properties that we use to evaluate assets as potential acquisitions, and to gauge their operational performance. Some are relatively intuitive: Rent/Sq. Ft., Cost per Door, Expense Ratio, Gross Income, etc. Commercial investors eschew using GRM (Gross Rent Multiplier) as that measures the income side only.

The first measurement investors look at to see if a potential investment warrants further investigation, is the Capitalization Rate Derivative, or Cap. The Cap is simply the percentage of Net Operating Income to the Purchase Price.

Cap %= Net Operating Income/Price.

As an example, an asset selling for $1,500,000 with $75,000 NOI is at a 5-Cap. ($75,000/$1,500,000 = 5%.) Understanding this ratio and its implications are key to informed investing, as well as managing operations. If you know that assets in a particular area are trading at 7-Caps you have a pretty good idea of what a property is worth if you know its NOI. Before we proceed further it’s important to clarify what NOI is.

Net Operating Income is: Ordinary Revenue – Ordinary Expenses.

The intent with NOI is to evaluate the efficiency of operations exclusive of other factors. On the income side we want to include actual rent, pet rent, late fees and other day to day items. On the expense side we want to include water, sewer, etc…the day to day operation expenses.

Exclude extraordinaryitems from NOI calcs. Examples include revenue (+) from selling timber rights, or the expense (-) of replacing a roof. These are still material when we look at a property in total…but they are not relevant in computing NOI. Also excluded from NOI are finance charges. Why? Because we use NOI to measure the effectiveness of operations. Example: A 3.87% loan with a 35-year amortization would make a poorly managed property look pretty good. Conversely, a well run property with a high interest loan might appear to be poorly operated.

I’ll discuss Net Operating Income Multipliers, the reciprocal of Cap in my next post.

Investors are risk adverse…and “unknown” is synonomous with “high risk.”  Being aware of this, The Client Centric Solution is to reduce the unknowns, reducing the risk…which delivers an increase in value to the client.  (If there are too many unknowns, the potential buyer will make a very low offer…or not bid at all.)

The Problem…

A colleague had a client that was looking to invest in quads and smaller commercial multifamily properties. One opportunity that caught the investors’s eye was a fully occupied plex that had upgraded units and an assumable loan with stated payments and interest rate.  The owner of the property was loathe to have multiple agents and investors traipse through the units on short notice and upset the tenants.  He was so concerned about losing tenants, that he instructed his agent that potential buyers could only view the inside of a unit after the owner had accepted their offer.  While this is somewhat common, without being able to view the property the investor could not verify the condition of the units, if they had a desirable layout, if they were upgraded, or if they were “repositionable” for increased income.  The potential buyer didn’t know how much time was remaining on the loan.  If it was a 30-year amortization loan with only 1-year left of the 10 year term he wasn’t interested.

The Solution…

I suggested to my friend that he contact the Listing Agent to find out how much time was left on the loan. He did, and found out that there was over 7-years left on the term and the bank was amenable to extending it on a qualifying assumption.  That eliminated one form of risk for the buyer.

Second, I suggested giving the tenants a weeks notice that each unit would be filmed for insurance reduction reasons.  About 1 minute is sufficient per unit. (I would also used that video to see if the insurance company would reduce premiums, so it is not a lie.)  Being able to view the video permitted the potential client to make an informed offer with far fewer unknowns, and less risk.  Should his offer not be sufficient, the owner had something to show future offerers.  

I think my buddy owes me a lunch!  What do you think?

The concept of eliminating unknowns to improve results applies to many aspects of business and life.  I learned this years ago when I watched a co-worker answer the President’s question with:  “I don’t know, and I don’t know when I will know.”  That co-worker was permitted to seek opportunities elsewhere.

If you would prefer Client Centric Service, you can contact me at rick@rosecitycre.com

When investors buy any 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 cash to keep expenses current.  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. Read more