Buying A Real Estate Note Is Like Buying A Boat | David E Wish

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