RE: Investment Analysis

Ultimate goal of cash flow
- More is better than less
- Sooner is better than later
- Certain is better than uncertain

Pro-Forma Operating statement
Used to analyze annual operating cash flow of real estate investment

PGI - Potential Gross Income
- Total income a property might generate in a year in ideal circumstances

Commercial Property
Rent x SF = Total annual rent + Other Income

Residential
Rent per unit x units x 12 + Other income

Vacancy & Collection Allowance
Sometimes there is not a tenant or sometimes tenants don't pay
V&C <>10% Loose market

Effective Gross Income = PGI - V&C
Operating expenses
Net operating income = NOI = EGI - OE

PRO-FORMA OPERATING STATEMENT
Potential Gross Income - PGI
LESS Vacancy & Collection Allowance - V&C

= EFFECTIVE GROSS INCOME - EGI
LESS Operating Expenses - OE

= NET OPERATING INCOME - NOI
LESS Annual Debt Service - ADS

= BEFORE-TAX CASH FLOW - BTCF


Operating Expenses
Include
Property Taxes
Hazard Insurance
Utilities
Management Fee
Maintenance & Repairs
Bank & Legal Fees
Reserve for capital improvements

Exclude
Mortgage interest
Depreciation allowances
Actual capital improvement expenses

EG: Office building 15,840 sf GLA
10,800 rents for $12 psf
5,040 rents for $10 psf

V&C = 10% of PGI

OP Expenses
Prop Taxes 15,900
Insurance 12,000
Utilities 13,900
Cleaning 5,000
Repairs 6,000
Reserve 12,000
Mgmt 8,100
TOTAL 72,900

Purchase price 885,000
Mortgage: 75% ltv, 9% interest 30 yr ammortized

Pro Forma
PGI 10,800 x 12 + 5,040 x 10 180,000
V&C @ 10% 18,000
EGI 162,000
- Operating Expense 72,900

NOI 89,100
- Annual Debt Service 64,088

Total 25,012

Capitalization rate R = NOI/V
Measures the current income of a property relative to its value or purchase price

Cap rate is used to evaluate the quality of an investment
High cap rates good when you are BUYING

Eg: R = 89,100/885,000 = 10.07%

Cap rates are also used to estimate value V = NOI/R
If the market cap rate is 9% estimate property worth- V = 89,100/0.09 = 990,000

Cap rate limitations
Cap rates ignore income growth (and capital gains)
Cap rates ignore risk

Other ratios & multipliers

Cash-on-cash return
COCR = NOI - ADS / Purchase price - loan

eg: = 89,100 - 64,088 / 885,000 - 663,750 = 11.3%

Mortgage Constant
MC = ADS / Loan eg: 64,088 / 663,750 = 9.7%
The "cash" cost of the debt including both principal and interest

Financial Leverage
If R > MC the investment has positive financial leverage and added debt raises the COCR
MC < R < COCR

If R < MC the investment has negative financial leverage and added debt will lower the COCR
MC > R > COCR

Operating Expense Ratio - OER

OER = OE/EGI (Estimated Gross Income) = 72,900/162,000 = 45%

Breakeven Ratio - BER

BER = OE + ADS / EGI = 72,900 + 64,088 / 162,000 = 84.6%

Debt Coverage Ratio - DCR
DCR = NOI / ADS = 89,100 / 64,088 = 1.39

Small Property Investment
Key Rules
- You make all your money the day you purchase the property
- The bets real estate investments you make are the ones you don't

Research the market
- Pick a neighborhood and research it for 6-12 months
- Drive it several times a week
- Build a database (Every Property)
Asking & Selling prices
Size, BR, Bath etc
Quality and condition
How long on market
Rentals
Rental rates
How long vacant
Lease terms