When you hear the word analytics for the first time, you may panic, especially if you are not a spreadsheet guru.
Functioning of the commercial real estate evaluator:
· Whether the case is worth prosecuting.
· An appropriate purchase prices
· A suggested initial offer price
The commercial real estate appraiser helps you determine if a transaction is worth pursuing by comparing the actual value with the requested price. If the property is much too expensive, the online version gives you a red light telling you not to waste your time. A yellow indicator shows that there may be a market. When you see a green light, it means leave! You have come across a lot of things, and you must act quickly to get them before anyone else does. To enter the Commercial Real Estate Appraiser, you will need:
· The number of units
· The asking price
· The unit mix (how many studios, one-bed, and two-bed units)
· The average rent per unit type
We keep it super simple, so the appraiser on the commercial estate is just apartment buildings, all right? Although the quick appraisal provided by the commercial property appraiser is not perfect in every situation, we found that it is close enough to help you sort the transactions in red, yellow, and green stacks of light. So that you can avoid the biggest mistake that most new business investors make, such as getting stuck in property analysis and never making bids.
Here's what you can skip when using a commercial real estate appraiser:
· The claimed expenses (because they are highly suspect)
· The cap rate is shown in the listing (since it’s not likely to be accurate)
· Any “proforma” information (which includes projected claims about future income)
Because capitalization rates are higher or lower depending on where you invest and are subject to change over time, you can change the capitalization rate you prefer to use in your marketplace. Any good business broker can help you figure out what capitalization rate to use for your market. After making this decision, make sure you use the same capitalization rate to assess each property in the same category. The commercial appraiser shall determine the lease, and the stabilized property value for you using the following default settings, which is what we currently use for most Class C apartments:
· 5% vacancy
· 45% expenses
· 07 cap rate
We then compare those three values to get an idea of what the positives look like and whether it's worth pursuing:
· Asking price from the seller
· Actual property value
· Proforma value
To avoid wasting your time on properties where the seller simply requires too much for the property. In most cases, this is a pretty good clue that they aren’t motivated. They’re hoping that someone comes along who’s willing to pay more for the property than it’s worth. Because we’re calculating the leased-up stabilized value of the property using a 5 percent vacancy rate, you’ll have to make further adjustments with a property that has a high vacancy rate or that needs to have rehab work done.
The dictionary definition of the word analysis is “a separation of the whole into its parts.” So, during this deep dive we break down any property analysis into its parts:
And finally, we add a loan or mortgage to the overall picture. We combine them to conclude whether this deal makes money. The analysis was made simple.
The size or complexity of the deal doesn’t matter. Separate the deal into three parts:
· Analyze and compile the income part
· Analyze and compile the expense part
· Analyze and compile the debt part
Any deal can be broken up into these parts. When you have these parts, you can calculate the net operating income, cash flow, cash-on-cash return, and cap rate. It’s easy-peasy once you’ve done it a few times!
When you’re analyzing any property, keep the following in mind:
· Be leery of broker performance. Proformas are brokers’ presentations of data on the property that reflect a best-case scenario or even a perfect-world situation. For example, even though the property may have eight unrentable vacant units, the broker proforma will reflect those units as if they were producing income. So, be careful in your analysis when you see the word proforma. It isn’t how the property is performing. Here’s the bottom line: Never make offers based on proforma data.
· Look deep into the price. When analyzing apartments, always look at a sales price per door or price per unit. Get information on what the local apartments have sold for recently on a price-per-unit basis. For example, if you know for a fact that the last three sales of comparable apartments on the same street sold for $45, 000 per unit, then you know in your analysis that paying $45, 000 per unit may be too much. Knowing your price per unit allows you to make quick decisions if the real estate agent is asking too much or if you’re getting a steal of a deal.
· Not knowing expenses can cost you. One of the most understated and misunderstood aspects of property analysis is expenses. Of course, plugging actual operating expenses into your analysis isn’t easy, because often that data isn’t available. You’ll get your most reliable expense data from your property manager or a professional property manager who manages similar properties. Look at property expenses in three different ways. Look at it in expenses per unit. Divide the total expenses by the number of units. Look at expenses as a percentage of the income. For example, generally, for apartment sizes that are greater than 50 units, we take expenses to be at least 45 percent of the income. Look at expenses in the form of expenses per square foot. You get this number by dividing the expenses by the living space's total square footage.
· Do not forget about the taxes. Be wary of property taxes stated in your analysis or given to you by the broker. Brokers who present property data rarely have the new property taxes in their spreadsheets. New taxes refer to what your new tax bill would be upon transfer of ownership. For example, the current owner may have owned the property for 30 years, and his property taxes may have increased only slightly in those years. But when you take over, the tax assessor will reassess the property value, most times based on your sales price. Therefore, your taxes may increase three to five times from what the previous owner paid. Do your research by calling the property tax assessor’s office and asking how property taxes are reassessed upon transfer of ownership.
· Verify your analysis. When we’re analyzing a deal in which the broker feels that we can either raise the rents or decrease the expenses after we take over, we always verify the broker’s projections. To verify whether raising the rent is possible. We also sell properties in the area to find out what they are getting for similar units. To verify whether we can reduce expenses, we call our property manager or contact another professional property manager and run the expense scenario.
· Get a thumbs up from your lender. When we get excited about a deal during our analysis, we send it to our lender. They look at it from their point of view: Are the numbers good enough to get a good loan on it? We may run our cash-flow projections based on a 15 percent down payment, but they may spot something in the financials that may qualify the property for only a 25 percent down payment. If your lender won’t do this for you, get another lender.
· Keep in mind that concession may penalize your future. When you’re presented with information about the tenants, ask about any move-in specials given to the current tenants. Those specials are called rent concessions, and concessions are given when the market is weak, and tenants need to be enticed to move in or renew their leases. Usually, the tenants are given one month rent-free, and it’s usually the 13th month of a 12-month lease. The problem with this is that if you’re acquiring the property, you won’t receive rent from that tenant on the 13th month of the lease. And this gets worse if 50 percent of your tenants have this concession, especially if their 13th month is the same— this means that 50 percent of the tenants will not be paying you rent that month.
The breakeven point is the point at which occupancy income is equal to our mortgage payments. In other words, if we know that our breakeven point is 70 percent occupied, we know we’re able to at least pay our expenses plus mortgage without- going into a negative cash-flow position. For a property that’s highly leveraged or has a large mortgage payment, its breakeven point is higher than usual — meaning, you have more risk if you’re negative in cash flow.
To calculate your breakeven point, add up all your property’s operating expenses and annual mortgage payments and divide by the gross potential income. Gross potential income is what the income of the property would be if it were 100 percent occupied by paying tenants.
Here’s the equation you’ll need to calculate the breakeven point:
Breakeven point (%) = operating expenses, annual mortgage payments ÷ gross potential income
For example, say that your operating expenses are $75,000, your annual mortgage payments are $35,000, and your gross potential income is $200,000. To find your breakeven point percentage, use this calculation:
$75,000 + $35,000 ÷ $200,000 =55%
This means that at 55 percent occupancy, we’re breaking even when it comes to cash flow. Anything greater than 55 percent occupancy sends us to cash-flow positive. Conversely, if we drop below 55 percent occupancy, we’re in negative cash flow.
Establish and follow guiding principles
When you’re looking at many types of income properties and analyzing them, you need to have a set of guiding principles for investment. Without them, you’d probably wander in the real estate investment game.
Here are our guiding principles:
· Make sure that you have a positive cash flow.
· Have a cash-on-cash return of 8 percent or greater. A good cash-on-cash return puts velocity on your money. It keeps your cash flow positive when you have those not-so-good months. A good cash-on-cash return allows you to brag to your investor buddies about what a well-run property you have.
· Have a cap rate of 7 percent or greater. A great cap rate means your NOI is healthy. A healthy NOI is stable and growing, which means your property value is doing the same. A great cap rate also gets you the best loan terms.
Be sure to follow these tips when analyzing your retail property deal:
· Look at the price per square foot. When analyzing retail, one of the first things we look at is the price per square foot. It’s an easy way to compare apples to apples and oranges to oranges. It’s also a way to get a reality check to see whether you’re paying too much for the property compared to other recent sales.
· Be conservative in our number crunching. What you’ll find when you own a few retail centers is that incomes given to you by either the broker or seller are overstated, and expenses are understated. Take a hard look at each item given and then take a conservative approach when running your numbers.
· Replace your reserves. One of the most overlooked expenses when analyzing retail is the replacement reserve. Replacement reserve is an amount set aside every month to pay for property items that wear out and need. To be replaced, such as roofs, siding, sidewalks, parking lots, heating, air-conditioning equipment, and so on. When these items come up for repair or replacement three to five years after you take ownership, the money must come from somewhere — refinancing, your pockets, your partner’s pockets, or a reserve account you cleverly set up ahead of time.
· Look at the parking ratio. The parking ratio for your retail center is more important than you think. The standard, to begin with, is four spaces per 1,000 square feet. If you don’t have enough parking, it can create a problem down the road.
· Consider class. All commercial properties fall under classifications — A, B, C, or maybe even D. Class A properties are newer, have top-of-the-line features, are in the best locations, and attract the highest-quality tenants. As you go into the lower classes, location, age, and construction become less desirable. Pay attention to what class property you’re evaluating because as classes differ, so do location, price, rent, and occupancy.
· Match rent rolls to estoppels the rent roll is a list of tenant names showing what they pay in rent, in addition to when the lease agreement expires. Estoppels are letters sent to the tenant by someone other than the landlord to confirm in writing, the terms of the lease, including rent amount, lease expirations, and any other options they have agreed on. Estoppels are used because the tenant may not be paying the landlord the appropriate rent, or the landlord may have made a side agreement with the tenant that can’t be confirmed or enforced by new owners. When the tenant-signed estoppels are received, you can compare them to the rent rolls and signed leases for income verification.
· Check-in with your lender early. Before digging too deeply into your analysis, call up your lender and present the rent roll, the type of tenants, and financials to them. Have the lender review this deal from their perspective. Some lenders may not like certain businesses. For example, securing a loan for a shopping center with a dry cleaner or automotive repair place has been more difficult lately because of environmental concerns. Even movie theater chains and office buildings have come under scrutiny because of recent changes in the marketplace.
Analyzing an apartment deal
The apartments are a great place to start since they’re easy to analyze and everyone needs a place to live. Let’s look at a sample deal together so you can follow along with the process.
Apartments are offered at $1,650,000. It’s a well-maintained 20-unit (all 2-bed/1-bath) complex located in an up-and-coming area one block from City Hall. Each unit rents for $1,575 per month, and the building is currently 100 percent occupied. The owner has spent more than $100,000 in rehab and upgrades in the last 12 months. All new furnaces and air conditioners were installed. The owner is retiring to NY, which is the reason for selling. Professional property management is in place, and the building is managed very well. It has a good rental history. Covered parking is included. Tenants are responsible for their own electric and heat utility bills; the owner pays for the property’s water and garbage removal. The total building's square footage is 22,160 square feet.
The following financial data were given for yearly operating expenses:
· Insurance: $13,500
· Real estate taxes: $28,830
· Maintenance: $44,700
· Electrical (common area): $3,900
· Water/sewer: $28,200
· Property management (5 percent): $18,630
· Garbage removal: $3,450
· Supplies: $8,100
· Reserves: $18,000
· Accounting: $4,200
So, adding that up, the total operating expenses are $171,510. Now, separate this whole deal into its three simple components of income, expenses, and debt. Here’s the income breakdown:
· Gross income $1,575*20 units! 12 months = $378,000 per year
· Vacancy rate = $378,000 per year * 10 percent (assuming) = $37, 8000
· Effective gross income = $378,000 - $37, 800 = $359, 100 per year
Here’s the expense breakdown:
Total operating expenses = $171,510
To figure out the debt breakdown, assume that the interest rate is 5.5 percent today with a 25-year amortization period:
· Asking price = 1,650,000
· Down payment = 20 percent of the asking price, which is $330,000
· Loan amount (principal) = $ 1,650,000 - $ $330,000 + $ 1,320, 000
· Loan payment per month = $ 18,106 (we used a mortgage calculator for this figure)
· Loan payments per year (debt service) = $8,106*12 months = $ 97, 272
Now, you have everything you need to figure out whether this deal makes money or not, using these four easy steps:
· Calculate the net operating income (NOI)
Net operating income = effective gross income - operating expenses $359,100-$171,510 = $187,590
· Calculate the annual cash flow
Annual cash flow = net operating income - debt service
$187,590 - $97,272= $90, 318
· Calculate the cash-on-cash return.
Cash-on-cash return = annual cash flow ÷ down payment
$90,318/$330,000 = 27.41 percent
· Calculate the cap rate
Cap rate = net operating income ÷ sales price
$187,590/$1,650,000 = 11.4 percent