Buying A Real Estate Note Is Like Buying A Boat David E Wish
Real Estate Investment Advantages ● Pride in Ownership ● Personal control ● Self-use & Occupancy ● Estate Building ● Security of Capital ● Operating Cash Flows ● Leverage ● Tax Shelter factors
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● Capital Appreciation & In lation Protection
Real Estate Disadvantages ● Illiquidity ● Required equity capital ● Management burden ● Depreciation of value ● Government controls ● Real estate cycles ● Legal complexity
● Lack of information & education
Trade-Offs: Risk/Return
• Legal: Zoning, public opinion, public services, etc.
• Market risks: Marketability study • Will it rent? Will it sell? • Market study: S&D, Competition
• Absorption rates: How fast is space being utilized
●Risks
Risks Cost risks:
●
Watch out for cushion
Interest rates ● General contractors: Reputable & bonded Estimates●poorCompletion bond (Lenders may require) ▪ Guarantees price Labor ● Cost plus contracts: Developer pays costs + Weather ▪
fee
• • • •
Possible Solutions: Guaranteed price contracts
Return Measures ● Cash Flow (Net Spendable) Pro Forma: Equity:
$
20,000.00
Loan: (DP=$10,000)
$
100,000.00
Gross Possible Income:
$
60,000.00
$
(9,000.00)
Gross Effective Income:
$
51,000.00
Less Operating Expenses:
$
(37,000.00)
Net Operating Income:
$
14,000.00
Less Debt Service (P&I):
$
(12,900.00)
Cash Flow Before Tax:
$
1,100.00
Less E(Vacancy):
Cash on Cash= Net Spendable/Down payment =1100/10000=11%
●
●
Return Measures ● Rate of return on total capital: = NOI/Total Capital • = 14/120 = 11.7%
● Return on Equity (ROE) = CF Before Tax/Equity • = 1.1/20 = 5.5%
● Favorable leverage: If ROE > ROR • If unfavorable leverage:
Don't buy Reduce Price Try to lower APR or increase term Raise NOI or lower expenses Restructure (ie., more equity)
• • • • •
Return Measures ● Equity cap rate: = CF before Tax/Equity • (ie., required ROE)
• For example: • • • • •
Your desired cap rate is 14% CF before tax is $1,100 Equity value = 1.1/.14 = $7,857 Plus loan of $100K Therefore property value = $107,857
● Risk measures: BEP & Debt Coverage Ratio
Discounted CF Analysis ● Income Cap Rate: • NOI/Market Value • Compare to other opportunities ● Do Cash Flow Spread sheet: ● Ratio Analysis ● Sensitivity Analysis:
• What if we change the value of a variable? ● Scenario Analysis: Worst versus Best? ● Monte Carlo Analysis:
• Randomly assign values & check bottom line
Investment Analysis Process ● Strategy: Determine First!! • Return/Risk Objectives • Ownership Form • Market Analysis • Screening Criteria • Location/Property Analysis
● Generate Alternatives: Those that pass screen ● Use Basic Financial Feasibility Model • Develop Finance Screens (APRs, CapRates, NOI)
• Examine Finance Alternatives (Loans, Equity, etc)
Investment Analysis Process ● Negotiate Basic Terms with Seller • Price • Financing • Covenants • Escape Clause ● Do Detailed Feasibility Research • Market:
▪ Supply & Demand, Competition, Absorption, Vacancy
• Marketability: Property Condition • Legal, Political, Environmental • Management & Operations
Investment Analysis Process ● Structure Tax Bene its • Cost Recovery • Useful Life • Passive Loss Limitations ● Discounted CF Analysis • After-Tax CF, DCF, Adjust for Risk ● Final Negotiations & Closing ● Management of Property
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● Termination • Sell, merger, IPO
Control ● Purchase Price & Terms ● Form of Ownership ● Financing amounts, rates, terms ● Tax structure & Planning ● Property management ● Property location
● Tenants & Lease rates & terms
Negotiation (Cont) ● Concentrate on items that e ect pro its • Down payment, price, contract period
● Employ conservative concession policy • • • •
Don't give in or reciprocate/ No sportsmanship/ Never concede irst Never accept a radical countero er without analysis
● Use intermediaries when to your advantage • With agent, more time to analyze • Advisor: Openly discuss concerns
● Try for better deal for both parties: ● Place proof burden & satisfaction on them
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• Prove to you that it is an attractive opportunity
Negotiation (Tactics) ● Standard Practice: Terms are "standard practice" ● Bogey: “I only can a ord $7,500 in cash" ● Good guy/Bad guy: • One makes strong demands ... • Opponent is more susceptible to good guy's weaker demands
● Deadline:
Always use them!
● Nibbling:
Get additional minor concessions
after
Get the property o the market while
you're
major agreement ● The tie-up:
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making decision
Property Types ● Land
Most Risky Low income Interest, taxes, insurance Interest deduct income only No depreciation 20 30% ROR for risk Consider • Access/Slope • Zoning • Public services & Utilities • Return=capital appreciation
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• • • • • • •
Property Types ● Residential Rental (Houses,Apts,MHs)
Management Intensive Good inancing Tax shelter High appreciation Know location & physical condition Check neighborhood & proximity to services Good irst step for real estate Some income -- mostly capital appreciation
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• • • • • • • •
Property Types ● O ice Buildings
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• More income/less appreciation • Appreciation can be improved w/ maintenance • Needs more knowledge for leasing & • Property management • Types: Downtown vs Suburban Medium vs HiRise vs Garden (Low) • Locations: Highways / Shopping Centers • Better construction • Low tenant turnover ratios • Prestigious clients
Property Types : Industrial & Special ● Industrial • • • • •
Warehouses, factories, indust parks Almost all income Not easily converted … increases risk Low risk overall if you have a client Near highways ● Special Use • Need expertise: RE + the application • Risky: Be ready to substitute • Loans are hard to get … banks ??
• Requires time commitment
Overview
●
Combine land, labor, capital &
●
Entrepreneurial ability ●
Good developers can “visualize” good uses of space
●
Creation of space for play, living & working
●
LT Motive=Income, Mgt, Community/
ST Motive=Cap Gain Redevelopment: Restoration of older structure
●
Development
Development ● Types: • Land Prep: Lots of all kinds • Sell land to other developers
• Erect improvements on land
● Who Develops? • Part-time • Proprietorship • Corporation, etc.
• Joint ventures (ie., 2 developers)
Be ready to bail out Stages may be done simultaneously
● Idea: Can develop over life of project ● Preliminary Feasibility: Rough cut analysis • Are computer programs: Go if pro it looks good ● GainControl: Ground lease(ties you up), option, seller fin ● Feasibility Analysis & Design: • Detailed analysis, Check site, market, legal, inancial
● Finance: Need cash ASAP, should have already talked ● Construction: Problems: cost overruns & contractor fails ● Marketing: Lease (don’t lease too early rates change)
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vs Sale: When … remember trade-o s
Development Process:
Redevelopment & trends Redevelopment:
●
Costs are high, structures - obsolete ITCs, grants Popular trend
● ● ●
Trends:
●
●
●
Mixed use development: One structure Planned unit development (PUD) New towns/Village concept: Integrated approach: work, shop, play, live
●
Professional Help ● Real Estate Brokers:
• Get a specialist! Has access to information
● Appraisers & consultants: Can do DCF ● Property managers:
• Has rental & vacancy rates, op. expenses, etc
● Morgage bankers:
• Arrange deals & inancing alternatives
● Tax advisers and attorneys ● Others:
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• Comm banks, Engineers, Architects, Contractors
Thank You