Download normal regular expenses

Commercial and Investment
Real Estate Opportunities
Types of Properties
Diversity of Clients
® Dearborn Real Estate Education, 2002
Primary Classifications of
Commercial Properties

Office
 Retail
 Industrial
 Apartments
 Other Commercial Properties
® Dearborn Real Estate Education, 2002
Commercial Property
As an
Investment
Almost every type of commercial property
can be an investment!
® Dearborn Real Estate Education, 2002
Investment Customers
Users
Space Driven
Developers
Build-to-Suit
Pure Investors
Profit Driven
® Dearborn Real Estate Education, 2002
Commercial and Investment
Real Estate Opportunities

Residential Real
Estate
– One Client
– One House
– One Time

Commercial and Investment
Real Estate
– Many Types of
Properties
– Several Kinds of
Customers
– Unlimited
Opportunities
– Redundant Business Too!
® Dearborn Real Estate Education, 2002
“Taxpayer”
Small Multiuse Buildings
Typically, a store or office on the ground
floor with two to six apartments above.
® Dearborn Real Estate Education, 2002
Advantages of Purchasing
a Small Multiuse Building
Which type of customer would buy a
small multiuse building?
® Dearborn Real Estate Education, 2002
Net Operating Income (NOI)
Gross Operating Income
Less Owner’s Operating Expenses
Equals Net Operating Income
® Dearborn Real Estate Education, 2002
Case Study:
Main Street Multiuse Building
® Dearborn Real Estate Education, 2002
The 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 Equal
to or Less Than the Cost to
Rent.

Store rent (from problem)
 $15 PSF X 1,000 SF = $15,000 annual rent

Rental income (apartments)
$12,000
 Owner’s Operating Expenses
10,000
 “Profit”
$ 2,000
 Effective new rent
$13,000
® Dearborn Real Estate Education, 2002
Affordable Purchase Price
Financing the Main Street Building
Building Price
Down Payment
Mortgage
$160,000
– 32,000
$128,000
15-Year Term, 7.5% Interest Rate
Annual Debt Service $ 14,239
® Dearborn Real Estate Education, 2002
Cost to “Carry” the
Main Street Building
Debt Service (per year)
Operating Expenses
Total Expenses
$14,239
10,000
$24,239
® Dearborn Real Estate Education, 2002
New Store Rent
Cost to “carry” the building
Less income from apartments
Effective New Store Rent
$24,239
–12,000
$12,239
A savings of $2,761 over the original rent
($15,000) due as a tenant.
® Dearborn Real Estate Education, 2002
Tax Advantages of Ownership
Depreciation or
Cost Recovery
Depreciation Time
Required by IRS Code
Commercial Buildings
over 39 years
Buildings depreciate, but
land does not
Apartment Buildings
over 27.5 years
® Dearborn Real Estate Education, 2002
Tax Advantage of Ownership
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
® Dearborn Real Estate Education, 2002
Buy vs. Rent

User-investor saves $2,761 in rent
 Gains tax advantage of $3,590
Real estate agents should discuss the
advantages of purchasing with their clients.
® Dearborn Real Estate Education, 2002
The Concept of Vacancy
Vacancy is defined as a portion of, or entire
space without, tenancy, measured for a period
of time.
® Dearborn Real Estate Education, 2002
Neighborhood
Strip Center
® Dearborn Real Estate Education, 2002
Considerations of a
User 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.
® Dearborn Real Estate Education, 2002
Considerations of an
Investor Client

Quality of Tenants
 Turnover Concerns
 Rate of Return on the Investment
® Dearborn Real Estate Education, 2002
Case Study:
Neighborhood Strip Center
® Dearborn Real Estate Education, 2002
Step 2:
Adjusting for Vacancy

Adjusting for vacancy requires a reality
examination.

Vacancy is usually calculated as a
percentage of the Potential Rental Income
(PRI).
® Dearborn Real Estate Education, 2002
Determine
Gross Operating Income
® Dearborn Real Estate Education, 2002
Step 3:
Calculating the Total
Operating Expenses
® Dearborn Real Estate Education, 2002
Step 4: Calculating NOI
Net Operating Income
Gross Operating Income
minus Operating Expenses
equals Net Operating Income
® Dearborn Real Estate Education, 2002
Repair and Maintenance
Contingency 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.
® Dearborn Real Estate Education, 2002
Repair and Maintenance
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
® Dearborn Real Estate Education, 2002
Repair and Maintenance
Problem
® Dearborn Real Estate Education, 2002
Effect of
Repair and Maintenance
on Expenses





Operating Expenses
Taxes
$20,000
Insurance
2,500
Repair &
3,750
Maintenance
Total
$26,250


Revised NOI
Income
 Expenses
 NOI
$67,500
–26,250
$41,250
® Dearborn Real Estate Education, 2002
Market Value
© Dearborn Real Estate Education, 2002
Market Conditions
Affecting Price

Supply and Demand
 Location, location, location!
 Available Financing
 Insurance Value
© Dearborn Real Estate Education, 2002
Commercial Values

Retail
– Location
– Traffic

Industrial
– Cost of Labor
– Transportation

Investment
– Upside Potential
© Dearborn Real Estate Education, 2002
Highest and Best Use
The best use of a property will create
the highest financial return on the
investment.
© Dearborn Real Estate Education, 2002
Triple Net Lease (NNN)
Tenant pays all
© Dearborn Real Estate Education, 2002
Floor Area Ratio (FAR)
a.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 Use
Problem A
© Dearborn Real Estate Education, 2002
Conversion Costs

Variance–Legal Costs

Construction Costs

Down Time
© Dearborn Real Estate Education, 2002
Highest and Best Use
Problem B
© Dearborn Real Estate Education, 2002
Comparing NOI


Current Tenant
GOI
 TOE
 NOI
$75,000
15,000
$60,000

Proposed Tenant

GOI
$60,000
 TOE (NNN)
0
 NOI
$60,000
© Dearborn Real Estate Education, 2002
Good Deal for Owner?

Rent Increases
 No Conversion Expenses
 No Down Time
 Bigger Building
 Sale versus Land Lease
© Dearborn Real Estate Education, 2002
Capitalization Rate
(CAP Rate)
The CAP rate can be looked at as a desired
“profit percentage” for an investor.
© Dearborn Real Estate Education, 2002
CAP Rate Formulas
Solve for Market Value
Solve for CAP Rate
NOI
CAP Rate
NOI
Offer
$50,000
10%
Market Value
?
CAP Rate
$60,000
$500,000
?
© Dearborn Real Estate Education, 2002
CAP 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 Terms
© Dearborn Real Estate Education, 2002
Anchor Tenants

Do not sell anchors!
 Large department stores or supermarkets
 Do their own advertising
© Dearborn Real Estate Education, 2002
CAM Charges
Common Area Maintenance
© Dearborn Real Estate Education, 2002
GLA
Gross Leasable Area
© Dearborn Real Estate Education, 2002
Tax Escalation Clause

a.k.a Real Estate Taxes over Base

a.k.a Tax Stops
© Dearborn Real Estate Education, 2002
Annual Property
Operating Data
(APOD)
© Dearborn Real Estate Education, 2002
Case Study:
Mountain View Mini Mall
© Dearborn Real Estate Education, 2002
Base Rent Roll Calculation
Store
Square Feet Base Rent
Annual Rent
Restaurant
1,500
$15
$22,500
Dry cleaner
1,500
$15
$22,500
Video store
3,000
$18
$54,000
Stationery
2,000
$18
$36,000
Real estate
2,000
$16
$32,000
Total
$167,000
© Dearborn Real Estate Education, 2002
Step 2
Analyze all other income and
adjustments to income.
Solve for Gross Operating Income.
© Dearborn Real Estate Education, 2002
Vacancy and Credit Losses
In this problem, 5% is used for vacancy
contingency.
Potential Rental Income
Multiplied by 5%
Vacancy & Credit Losses
$177,000
X
.05
$8,850
© Dearborn Real Estate Education, 2002
Step 3
Expenses

Only the Owner’s Operating Expenses

Reminder: All figures are annual.
© Dearborn Real Estate Education, 2002
Step 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?
Step 5: Calculating Market Value
NOI ÷ CAP Rate = Value
$87,150 ÷ .12 (12%) = $726,250
© Dearborn Real Estate Education, 2002
The Value of Investments
© Dearborn Real Estate Education, 2002
Key Investment Terms

Rate of Return
 Leverage
 Initial Investment
 Cash Flow Before Taxes (CFBT)
 Equity
 Cash on Cash Return
 Internal Rate of Return (IRR)
© Dearborn Real Estate Education, 2002
Leveraged Purchase
Cash on Cash Return
CFBT = NOI – Annual Debt Service
Cash on Cash = CFBT ÷ Initial Investment
© Dearborn Real Estate Education, 2002
Investment Strategies

Stability
 Potential
 Flipping
 Upside Potential
 Holder
© Dearborn Real Estate Education, 2002
What Is the
Property Worth?
© Dearborn Real Estate Education, 2002
Components of Value

Current year analysis
 Five-year forecast
 Owner’s perspective
 Buyer’s perspective
© Dearborn Real Estate Education, 2002
Case Study
Office
Building
© Dearborn Real Estate Education, 2002
© Dearborn Real Estate Education, 2002
Determine
Current Rent Roll
and
Potential Rental Income
© Dearborn Real Estate Education, 2002
Complete the Income
portion of the APOD.
© Dearborn Real Estate Education, 2002
© Dearborn Real Estate Education, 2002
Operating
Expenses
© Dearborn Real Estate Education, 2002
© Dearborn Real Estate Education, 2002
Net Operating Income
© Dearborn Real Estate Education, 2002
Cash Flow Before Taxes
(CFBT)
© Dearborn Real Estate Education, 2002
Cash 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 Purchase
Capitalization Rate Formula:
NOI ÷ Value (Purchase Price) = CAP Rate
$60,936 ÷ $500,000 = .1219
12.19% CAP Rate
© Dearborn Real Estate Education, 2002
Spreadsheets
Cash Flow Forecasts
© Dearborn Real Estate Education, 2002
The Upside
Current Year 2
Year
Year 3
Year 4
Year 5
NOI
60,936 73,644 79,166 87,284 90,486
CFBT
15,294 28,022 33,524 41,642 44,844
© Dearborn Real Estate Education, 2002
Cash on Cash Returns
Year
CFBT
1
2
Initial
Investment
$15,294
$125,000
$28,022
$125,000
Cash on Cash
Return
.1224 (12%)
.2242 (22%)
3
$33,524
$125,000
.2682 (27%)
4
$41,642
$125,000
.3331 (33%)
5
$44,844
$125,000
.3588 (36%)
© Dearborn Real Estate Education, 2002
Market Value
Does the potential buyer care about the
present owner’s return on his/her
investment?
© Dearborn Real Estate Education, 2002
Potential Market Value
Current Year 2
Year
NOI
Year 3
Year 4
Year 5
60,936 73,664 79,166 87,284 90,486
10%
CAP
12%
CAP
© Dearborn Real Estate Education, 2002
Potential Market Value
Current Year 2
Year
Year 3
Year 4
Year 5
NOI
60,936
73,664
79,166
87,284
90,486
10%
CAP
12%
CAP
609,360
736,640
791,660
872,840
904,860
507,800
613,867
659,717
727,367
754,050
© Dearborn Real Estate Education, 2002
What Is My Property Worth?
© Dearborn Real Estate Education, 2002
Considerations
Regarding Value

What the current owner paid is irrelevant.

Test the assumptions used in the forecast.

How much upside potential will a buyer pay
for?
© Dearborn Real Estate Education, 2002
Methods of Valuation

Income Approach

Comparable Sales Method

Cost Approach
© Dearborn Real Estate Education, 2002
The Buyer’s Perspective
Challenges

Incorrectly Stated Facts
 Questionable Assumptions
 Business Style
© Dearborn Real Estate Education, 2002
Applied to the last problem

Basement Rent?
 Vacancy Rate 7%?
 Repairs and Maintenance 5%?
 Off Site Management 5%
© Dearborn Real Estate Education, 2002
Compare the Market Values
None of the “facts” changed.
What did change were the assumptions.
© Dearborn Real Estate Education, 2002
Commercial Agents
Validate the facts and evaluate the
assumptions.
© Dearborn Real Estate Education, 2002
To make a deal

Negotiate the assumptions first
 Then the price
© Dearborn Real Estate Education, 2002
Future Business
Develop relationships with commercial and
investment customers for life.
© Dearborn Real Estate Education, 2002