Demystifying Investing

I am pleased to re-publish this article with the permission of Robert Poe, Principal Broker.  He is also a CCIM, MBA, CFP and is a Managing Partner for investment firm KerNors.   It’s great to have an additional persective…and few topics are as popular as Capitalization Rate (Cap Rate) basics.

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There’s no doubt that improvements in the long term fundamentals for multifamily investments have made them the darlings of commercial real estate.  I was talking yesterday  with a researcher at REIS, one of the nation’s most respected real estate tracking firms.  His company is predicting the  East Portland and Gresham submarkets apartment values to increase by a minimum of 4% a year for years to come.  To my delight Portland multifamily investments are starting to thrive.  But it goes much further than that. I’ve recently been contacted by several investors who have been notably successful in other investment arenas who are looking at multifamily as a vehicle for future equity expansion. One felt that it would be hard to maintain the pace of growth he had enjoyed in the stock market and was looking for another venue.  I think the stability of

Rose City Commercial Real Estate works with first timers and seasoned institutional investors.  Two reminders.   First, if you want to be a genius in 5 years make smart multifamily investments now.  Second, you’re in no danger of profiting until you take action.  Call 503.577.1034 to develop a customized investment plan that meets your needs.

multifamily was enticing as well.  I often tell people that real estate never went down by a trillion dollars in twenty minutes like it did May 6th of 2010…but I digress.  Another investor who was heavily invested in bonds asked me for some guidance on what he could expect from multifamily investments.  He was concerned that his current yield of 2.95% (annually, not monthly)  would more than be eaten up between taxes and inflation.

I realize that these are just two datapoints…but I think they are emblematic of a trend I have been expecting for some time.  There’s something like $6 trillion in IRAs and 401Ks…and much of it can be used for real estate investing without creating a taxable event. Yes, its important to have the proper professional advice to prevent constructive reciept of the funds.  These new multifamily investors are savvy businessmen and women, but they have not been thoroughly exposed to multifamily investment fundamentals.  In order to give them the service they deserve I plan on reviewing real estate investing fundamentals over the next few posts, with a focus on apartments.

NEXT: When to buy from a historical perspective.

More posts in our Timing Your Multifamily Investment Series:

• When To Make Multifamily Investments-Recovery-Part 2 of a series
• When To Make Multifamily Investments-Expansion-Part 3 of a series
• When To Make Multifamily Investments-Hypersupply-Part 4 of a series
• When To Make Multifamily Investments-Recession-Part 5 of a series

Other articles you may like:

The Importance of Due Diligence in Multifamily Profits – Phase II – Books and Records | Rose City Commercial Real Estate

Demystifying multifamily cap rates, NOI, and investing basics | Rose City Commercial Real Estate

Multifamily real estate investment basics – part 1 of a series | Rose City Commercial Real Estate

Attractive cap rates attract investors to multifamily properties in Portland | Rose City Commercial Real Estate

Prospects for multifamily sector improve greatly | Rose City Commercial Real Estate

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As there is a mix of investment sophistication  levels on this site I have opted to interject a review of the basics.  For you institutional investors…hang on we’ll have some information that we think you’ll find valuable in…later posts.

Below is a brief overview of basic investment evaluation techniques including: NOI, CAP Rate, and NOI, CAP, and NOI Multiplier.  Regular readers know I focus on multifamily investing heavily…but not exclusively.  But these basic concepts apply whether your are looking at apartments or single tenant triple net deals.  If you would like more information, please contact me:  rick@rosecitycre.com, or 503.577.1034.

What is NOI?: Net Operating income

What does it measure?: Measures the revenue generating capacity from operations.

When is it important?: Two times: When you is sellin’…and when you aint. On a more serious note, NOI is the source of payment for debt service, and cash flow distributions to the owners.

Why it’s important:  It provides a way to measure the revenue producing capabilities of an asset excluding debt service considerations.

What’s the formula?: Current Revenue – Current Expenses (Exclude debt service, capital expenses.)

Example: Current Revenue, June 2009: $100,000.
Current Expenses, June 2009: $ 35,000.
NOI, June 2009 $65,000.

What is a Cap Rate?

The capitalization rate is what the yield as a percentage of the initial investment would be in year one if you acquired the property all cash.

Why it is important: First “sniff test” investors use to check out an available commercial property.

What is the formula? NOI/Sale Price = Cap Rate
Example: $65,000/$812,500= 8%.

What is NOI Multiplier?

How much each dollar of NOI would contribute to value if property was for sale.

Why we care: Knowing how much each dollar on NOI is worth helps us evaluate the impact of incremental increases in revenue and expense. (Great for rehab/repositioning!)

What’s the formula? Sale Price/NOI = NOI Multiplier
Example: $812,500/$65,000= 12.50 (Each dollar of NOI creates $12.50 of value.)

NOI, CAP, and NOI Multiplier Problems

A Portland Multifamily investment Property X had the following revenues in 2008:
• Rent $122,500.
• Extraordinary gain: harvest lumber on property $25,000.
• Pet rent $300.

Property X had the paid the following in 2008:
• Utilities, taxes, management fees, etc. $48,000.
• Cap Ex: Completely rebuild lower parking lot $19,000.
• Re-stripe upper parking lot $125.

QUESTIONS 1 & 2 are based on the information above.

1. What was NOI?    ANSWER:  $74,675  Note: The lumber revenue and parking lot expense were not operating related and were thus excluded from NOI.

2. What is the asset worth if we assume a 6.9 Cap% ?   ANSWER: $74,675 / .069 =  $1,082,246

QUESTIONS 3 – 4 are based on repositioning an 18 unit property we are buying for $1,200,000 at an 8 cap with a 5.9 % loan. Current Annual NOI is $96,000:

3. How much is each dollar of NOI worth? ANSWER: $1,200,000/$96,000 = $12.50.

4. How much more would the property be worth if we could raise the rents in 10 of the units $10/month? (Assume that a year has 12 months, all the units are increased at the same time for the full year…and that we could do this without increasing expenses…without any change in turnover.)  Answer: 10 units X $10 X 12 months equals a $1,200 increase in Annual NOI. Multiply by $12.50 = $15,000 increase in value!

Whether you’re a seasoned pro or a newbie…feel free to contact us:  503.577.1034 or rick@rosecitycre.com.

These equations apply whether your looking at Portland OR investments…or anywhere else too!

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I was asked recently  by an investor to develop a tool for analyzing his multifamily portfolio.  He further challenged me to make it something simple that he could input the data into himself, that would be quick to use, show the values of the individual properties…or the aggregate portfolio and would have a Cap Sensitivity feature that would show values at a wide range of Cap rates.

For a FREE copy of Rose City Commercial Real Estate’s Multifamily Investment Portfolio Valuator call Rick Bean at: 503.577.1034 or e-mail me at: rick@rosecitycre.com.

I gave him the spreadsheet at no charge and now I’m offering to readers of this blog as well. One of the ways I give back to the community is to advocate for multifamily investorship…and by mentoring the next wave of investors.   Let me know if you would like a copy of my simple spreadsheet.  It works for 1-4 properties but is easily expandable to dozens of income properties.

Alternatively, consider us a primary resource if you would like to have a investment specialist provide a free valuation and analysis of your investment real estate.  Single assets or whole portfolios are reviewed for free.  Contact us at: 503.577.1034, or: rick@rosecitycre.com.

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Demystifying real estate investing in 2011. 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.

GAME CHANGER: A recent change in the finance markets for apartments makes it possible to cash flow 12%, 15% or more per year off of multifamily investments. Contact us immediately for additional information at: 503.577.1034 or rick@rosecitycre.com

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 Pay-down

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 pay-down amounts to $90,351 for that period.

4. Tax Shelters and Tax Avoidance Benefits

The final benfit to investors is the tax sheltering of income. Cost Recovery (Depreciation) is the primary example. Industrial and retail properties are depreciated on a 40-year basis; housing is depreciated using 27.5-years. Note: Land is not depreciable. Using our previous example of a $3,200,000 community, let’s assume that land was 25% of the value, leaving a depreciable amount of $2,400,000 to be depreciated over 27.5 years, or $87,27.73 per year. That will act as a tax deduction to reduce profits by that amount for tax basis purposes.

A more rapid depreciation methodology is provided by Cost Segmentation, or familiarly, Cost Seg. This is performed based on findings of a cost engineer during their on-site inspection and review of the property. There is great acceptance of this approach by the IRS, but it is not fully understood by investors and many Tax Accountants. Cost Seg. on Assets under $1 Million is not always cost effective due to the fixed costs of the on-site inspection. Savings on multimillion dollar properties are substantial, and can change a 1.1 DSCR property into a 1.25. That means that Cost Seg utilization can be the difference in some loans being approved!  For additional information on Cost Segregation contact us at 503.577.1034, or Rick@rosecitycre.com

Duties of Professional Investment Brokers

It is incumbent on the Real Estate Professional assisting a client with a multifamilty acquisition to have an understanding of that client’s risk profile, investment horizon plus target cash flow and appreciation rates. It is also beneficial to have an awarenes of how important their client deems tax shelter options.

Contact us for more information at: 503.577.1034 or rick@rosecitycre.com

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When it Comes To Seizing Recessionary CRE Opportunities, Investors Don’t See a Specific Market or Property Type Holding a Special Advantage

By Mark Heschmeyer (As seen on CoStar.com)

Whether you’re looking to invest in Portland multifamily assets, Vancouver distressed properties, or Salem Industrial land…this CoStar interview with key players shows how the pros are looking at this market. I’m going to serialize it…its too good to miss. To work with an investment pro contact me at: Rick@rosecitycre.com.

CoStar sampled a number of commercial real estate executives asking them what strategies they found to be the best in pursuing distressed deals. In general, investors almost universally agree that a distress opportunity must have clear value and make sense for the buyer’s specific investment goal; the more uncertainty an opportunity presented, the less sense it made. Beyond that, there was only one consistent answer:

“There are as many strategies as there are investors,” said David W. Popp, senior vice president, Transwestern in Bethesda, MD. “Just as each investor may have their own distressed asset strategy, each property or portfolio must be considered independently on their own merits.”

“We don’t approach any given assignment with a preconceived bias in terms of quick flip, stabilize and hold, discount rate to achieve occupancy, etc,” Popp said. “Achieving the specific goals and objectives specified by our client is paramount and these may change based on the characteristics of the property, loan terms, strength of mortgagor, etc.”

Jeffrey Rogers, president and chief operating officer of Integra Realty Resources in New York concurred, saying no clear-cut strategy has emerged as the best practice. It all depends on what type of investor you are.

“The type of investor you are largely depends on the type of investment capital you have to deploy,” Rogers said. “For example, if you are running an investment fund raised with institutional money, which requires a certain return (typically in the double digits now) that needs to be achieved before the investor can share in the profits, you need to look for situations which offer adequate yields. In such a situation, the stronger markets like New York and Washington, DC, are not as attractive because of the relatively higher prices and lower yields.”

“If you are a REIT paying a dividend of 4%-6%, the stronger markets appeal to you because you can afford to focus on quality and take less risk in a secondary market,” Rogers continued. “The big REITs may earn a lower yield, but the return to investors is a lot lower. So, it really depends on where you get your investment capital and on your time horizon.”

There was no specific market or property or asset either that jumped out as having any particular advantage either.

“If investors want stability and a relatively safe investment, they would tend to prefer multifamily in 24-hour markets such as New York City,” Rogers said. “If the investors are willing to take on greater risk for a higher yield, they might prefer retail in this current market. The vacancy rate in retail is generally higher than the vacancy rate in multifamily in this market, but the upside is greater as well.”

Or an investor may not even prefer property, Rogers added.

“Properties acquired between 2003 and 2007 with significant leverage are underwater and no longer have equity. Thus, the target is the debt not the property. The goal is to buy the debt at discount. Depending upon your ultimate strategy, once you own the note, you can negotiate with the owner or you can move to foreclose to gain control of the property.”

Want the whole article? Come back for more…or go to By Mark Heschmeyer (As seen on CoStar.com)

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