Analyzing a commercial real estate investment

Analyzing a Commercial Real Estate Investment

Westfield North Building, 2730 University Blvd, Ste. 200, Wheaton, Maryland 20902

301-949-1771 (Phone)301-949-5441 (Fax) www.pditraining.net

Presents:

ByD. Scott Smith, CCIM

443.691.8153

www.expertcre.com

[email protected]

http://www.expertcre.com/

Class Room, DLLR, and MREC Rules!!!

•You must sign in and out to get CE (show ID)

•No eating, sleeping, or using electronics

•You must be on time

•Raise your hand to ask questions

•Be polite


Review 4 basic steps to find a pulse on an investment.

Part 1. Determine Net Operating Income (NOI)Part 2. Loan SelectionPart 3. Determine Cash Flow Before Tax (CFBT)Part 4. Calculate Returns

NOTE: There are many additional steps needed to fine-tune each analysis.

Today We Will:


A few things first:•Analysis Paralysis is over analyzing a deal to attempt to remove risk.•The only way to completely avoid risk is to not invest.•Different methods often provide different results. •“Garbage in, garbage out”


Some Industry Standards for Analysis

•Internal Rate of Return (IRR)

•Cash-on-Cash Return (COC)

•Financial Management Rate of Return

•And Cap Rate, to name a few


The Key to a successful investment is to be able to answer :

•What is your risk tolerance?

•Does the investment make sense to you?

•Does it meet your goals?


Step 1. Net Operating Income (NOI)



Potential Rental Income- Vacancy and Credit Loss = Effective Income + Other Income = Gross Operating Income - Operating Expenses = NOI



Operating expenses consist of:• Real estate taxes• Property insurance• Property management and maintenance• Utilities• Legal fees• Advertising• And accounting, to name a few



A few more things …

•BOMA Expense Ratios for each asset class in each market•Income statements – may include many additional income streams for the current owner


Step 1. Net Operating Income (NOI) A few more things …

•A Cap Rate as a Way of Measuring an Investment and is not THE RETURN of the investment. •Cap Rate is a measurement rate of the first year NOI as it relates to the current value of the investment.

•Is a Cap Rate complete?



IRV Formula Note: A Cap Rate does not account for debt service and income tax for the investment.

INCOME

RATE VALUEX

÷ ÷


Step 2. Loan Selection



What you need to know:

•Types of loans available•Types of loan structures (Hard Money, Swap, Equity)•Which lenders offer the loans you need/want•Always have your own trusted lender for custom packages.


Step 2. Loan Selection•Consider the Debt Service Coverage Ratio (DSCR) when evaluating loan options.

•DSCR will be provided by your lender.

•DSCR is the net operating income divided by the annual debt service.

•You will need to reflect and negotiate what loan structure will be available and achievable for the asset.



It’s important to do the following:

•Build relationships with lenders.

•Find a mentor.

•Ask questions.



We will use the following loan structure for theremainder of the steps and analysis today.

•25-year mortgage, fully amortized•8% interest•Monthly payments•Debt Service Coverage Ratio (DSCR) of 1.25


Step 3. Cash Flow Before Tax (CFBT)



•CFBT is the heart of the analysis.

•This will give you the amount of income before tax your property is providing.

•This is the benchmark to calculate your return.



•NOI of $50,000 / DSCR or 1.25 = $40,000

•This means that $40,000 is the max annual debt a NOI of $50,000 can cover.

•If the NOI drops below $50,000, DSCR will change and increase the lender’s risk of losing on the investment.



NOI of $50,000 / DSCR of 1.25 = $40,000The above analysis will have a result of:

•$10,000 a year CFBT (NOI of $50,000 – ADS of $40,000 = $10,000 CFBT) or

•NOI of $4166.67 a month•Mortgage payment of $3,333 a month•CFBT of $833.33 a month


•Based on an NOI of $50,000, with a DSCR of 1.25, the max loan amount would be $431,838.

•With an asking price of $500,000 (or a 10% Cap Rate), you would have to put down $68,161.45.


Step 4. Calculating Returns


Step 4. Calculating Returns Determine the maximum loan amount anddown payment based on:

•Net Operating Income (NOI) of $50,000•Debt Service Coverage Ratio (DSCR) of 1.25•Annual Debt Service (ADS) of $40,000•Loan – 8% interest, fully amortized over 25 years•Current asking price of $500,000



Compare the $10,000 CFBT you receive againstthe down payment amount of $68,161.45.

Which is called…



Cash-on-Cash Return (COC) is:

•The first year’s Cash Flow Before Tax (CFBT) / Initial Capital $10,000/$68,161.45 = 15% Return on Equity

Investors usually think of this percentage as “THE” return!



Internal Rate of Return (IRR): A rate of return earned on each dollar, for as long as it stays inside the investment. More appropriately, the discount rate, if you add up all the future cash flows, reduced to present value where that total equals the initial capital investment. That percentage would be the Internal Rate of Return.


Step 4. Calculating Returns In order to achieve a desired IRR of 10%, determine:

•Amount at which you need to sell the property•When you would need to sell

(Assuming all things remained the same inside theinvestment over the holding period.)


Step 4. Calculating Returns Suggestion: You may want to use the HP10BII to complete this advanced step.

1. (-$68,161) down CFJ key2. $10,000 CFBT in CFJ 1-4

3. $10,000 + $50,000 a. $550,000 sales price in 5 years – $500,000 of initial purchase) in the CFJ 5 key.


Step 4. Calculating Returns 4. Push Gold key then IRR key

5. IRR = 10.34

You could also achieve this result byputting down $50,000 less of initial capital.


Case Study


A property is currently on the market for a salesprice of $750,000 with a Cap Rate of 9%.

What purchase price would you need to achieveto receive a 9% COC return?

Case Study


Step 1: The NOI (if real) should be ________ based on a 9% Cap Rate and market price of $750,000.

Step 2: If the NOI is $67,500 and you know that your lender has a loan program of 8% interest, fully amortized

over 25 years, no points, and a DSCR of 1.25, your max Annual Debt Service (ADS) will be:

$67,500 / 1.25 = ___________ ADS

Case Study


Step 3: $67,500 NOI - $54,000 ADS = $4,500 a month

= $13,500 CFBT = $1,125 a month

Step 4: A monthly payment of $4,500 consisting of 8% interest over a 25-year term will bring the max loan amount

to $583,040. Compare that to your purchase price of $750,000.

You will have to put down $166,960 and receive $13,500 a year. The COC is 8%.

Case Study


Step 3: $67,500 NOI - $54,000 ADS = $4,500 a month

= $13,500 CFBT = $1,125 a month

Step 4: A monthly payment of $4,500 consisting of 8% interest over a 25-year term will bring the max loan amount

to $583,040. Compare that to your purchase price of $750,000.

You will have to put down $166,960 and receive $13,500 a year. The COC is 8%.

Case Study


You could look at the following to achieve 9% COC:

1. Lower your asking price.

2. Achieve a higher NOI.

3. Get a lower interest rate.

4. Any combination of the above.All of these will get you there! Let’s look!

Case Study


By reducing the asking price to $735,000 or by 2%, a COC of 9% can be achieved.

If you increase the NOI by 2% a year ($1,350), your NOI would be $14,850, giving you a COC of 9%.

An interest rate of 7.75%, but keeping monthly payments at $4,500, would produce a COC of 9%.

Case Study


GOT QUESTIONS?

Case Study

Westfield North Building, 2730 University Blvd, Ste. 200, Wheaton, Maryland 20902

301-949-1771 (Phone)301-949-5441 (Fax) www.pditraining.net

We Thank You and hope to see you again!

ByD. Scott Smith, CCIM

443.691.8153

www.expertcre.com

[email protected]

http://www.expertcre.com/

Economy & Finance

Analyzing a commercial real estate investment