I listed a small individual 1500 sq ft warehouse space in 2006 for $275,000. It was a prime space in this park. I researched every other unit in the same industrial park to discover what everyone paid and when. Looking at the history tells you a lot. My seller had not bought at the bottom of the market. There were several units purchased after them that were considerably lower. This was the only way you could know when the market bottomed out and started back up. My seller didn't buy it at the bottom, but they bought it for a reasonable price, and they made income while holding it. If they had let me sell it for the amount of the offers we received, then they would have made a profit even though they didn't buy at the right time, or right price. What else is important?
But I wanted to crunch some numbers for you so you could see where we are today in 2010. My owner paid $163,000 in 2004. They purchased from someone who bought brand new in 1998 for $79,900. This is American capitalism at its finest. The first buyer purchased in 1998 and sold in 1974, six years and made 104% on their investment. I had offers of $199,000 when we were listed at $275,000 which were turned down. My owner dropped the listing after one year and sold in late 2007 for $129,900. Greed got the best of them while listed, and panic forced them to sell at a giveaway price. Instead of making 22% and being pleased with the investment, they lost 20%.
There are two listed in the same park now, both 1500 sq ft, Here's how they stack up:
Property 1 2
Purchased new 1998 2000
Purchase new price $77,500 $117,900
Sold 2005 2003
Sold/ Purchased Price $120,000 $137,500
Listed 2010 2010
Listed Price $169,000 $199,999
You can easily see what timing, history and markets have to do with this pricing.
Property 1 bought early, and held for seven years and made 55% on their investment. the new owner has held for 5 years and is trying to get a 40% return. I would have you offer $150,000 or less. They get 25% or less return for their five years. Very fair.
Property 2 bought late, held for three years and sold three years later and made almost 17% on their investment for their three year investment. The new owner is trying to get 45% on their investment after 7 years. I would have you offer $170,000 or less. They get 24% or less return for their seven years. Very fair.
This analysis is of two units in the same park. It does not account for build out amenities or park location. We would need to look at your needs and then the units. But you can see, crunching the numbers helps alot.
Sunday, May 30, 2010
Wednesday, May 26, 2010
Property Improvements - Cost Recovery & Class Life
There is an annual deduction against taxable income of the investment base of your improvements to a property. If you build a building on land you own, the tax laws allow you to 'recover' your cost over the life of the asset.
Class life is set by legislative statute. Properties are either classified Residential or Commercial. Residential Improvements to land are written off, or the cost recovered over a period of 27.5 years. Commercial is recovered over 39 years. These are set by statute and cannot vary.
What is even easier, is that you are required to use Straight-Line Cost Recovery. This means that you divide the property improvement by the Class Life, 27.5 or 39 years and you get to deduct that much against taxable income, to reduce your tax bill.
The only kicker, or twist is that since we do not acquire everything on January 1 of each year and sell it on December 31, then the rules have a formula for the month of acquisition and or disposition. It requires you to reduce what you can take in those months. there's a table, so use that.
Property purchase price (sample) $565,000
Allocated to land ( see allocation blog) $120,000
Allocated to Commercial Building $345,000
Asset Class - Commercial
Cost Recovery for 39 years $345,000 divided by 39 = $8,846.15
Acquisition year from table $345,000 times 2.457% = $8,476.65
This means that in the year you acquired the property you can deduct the smaller number from your taxable income to figure your tax. In subsequent years you will deduct the larger number until the year you dispose of the property, then it's back to the smaller number. This is a 12 month number. You will divide these numbers by 12 and only use the portion to the month you acquired it in.
Class life is set by legislative statute. Properties are either classified Residential or Commercial. Residential Improvements to land are written off, or the cost recovered over a period of 27.5 years. Commercial is recovered over 39 years. These are set by statute and cannot vary.
What is even easier, is that you are required to use Straight-Line Cost Recovery. This means that you divide the property improvement by the Class Life, 27.5 or 39 years and you get to deduct that much against taxable income, to reduce your tax bill.
The only kicker, or twist is that since we do not acquire everything on January 1 of each year and sell it on December 31, then the rules have a formula for the month of acquisition and or disposition. It requires you to reduce what you can take in those months. there's a table, so use that.
Property purchase price (sample) $565,000
Allocated to land ( see allocation blog) $120,000
Allocated to Commercial Building $345,000
Asset Class - Commercial
Cost Recovery for 39 years $345,000 divided by 39 = $8,846.15
Acquisition year from table $345,000 times 2.457% = $8,476.65
This means that in the year you acquired the property you can deduct the smaller number from your taxable income to figure your tax. In subsequent years you will deduct the larger number until the year you dispose of the property, then it's back to the smaller number. This is a 12 month number. You will divide these numbers by 12 and only use the portion to the month you acquired it in.
Sunday, May 23, 2010
Allocation of Basis
When commercial property is acquired, it consists of land and improvements to the land (generally a building). The new owner needs to know how to allocate the price paid between the two, because improvements are allowed to be written off (depreciated, cost recovery) over their useful life. Land is not.
There are many ways to do this. Appraisals can be used, tax assessments, or any other reasonable method. One of the easiest defensible methods is to use the tax assessment. If you look at the tax property record you will see where the county assessor or appraiser has allocated the taxable value of the property between the land and the improvements. If you use these for allocating your basis, you won't get much argument from the IRS.
Assessor records sample:
Land $75,000 = 25%
Improvements $225,000 = 75%
Total Assessment $300,000 100%
Your sample property Purchase Price
Land $600,000 X 25% = $150,000
Improvements $600,000 X 75% = $450,000
100% $600,000
Use this simple and reliable method until you find a more advantageous defensible method that your accountant is satisfied with.
There are many ways to do this. Appraisals can be used, tax assessments, or any other reasonable method. One of the easiest defensible methods is to use the tax assessment. If you look at the tax property record you will see where the county assessor or appraiser has allocated the taxable value of the property between the land and the improvements. If you use these for allocating your basis, you won't get much argument from the IRS.
Assessor records sample:
Land $75,000 = 25%
Improvements $225,000 = 75%
Total Assessment $300,000 100%
Your sample property Purchase Price
Land $600,000 X 25% = $150,000
Improvements $600,000 X 75% = $450,000
100% $600,000
Use this simple and reliable method until you find a more advantageous defensible method that your accountant is satisfied with.
Saturday, May 15, 2010
CAP Rate or Return on Investment
These are two common terms you will encounter in commercial real estate investment. I wanted to make sure you understand the difference between them so you are not confused when making a decision.
Capitalization or CAP Rate - the percentage result of dividing the future (or expected) net operating income by the investment.
Return on Investment (or yield) this is a measure of the entire investment, for the entire period of the investment. While you can certainly calculate it on a single year, it is the net present value of all dollars in, and out, taking into consideration exactly when those things happened.
Consider three different investments, which all yield 10%.
A B C
Initial Investment (1,000,000) (1,000,000) (1,000,000)
NOI 100,000 50,000 150,000
Sale Price 1,000,000 1,050,000 950,000
CAP Rate 10% 5% 15%
Quick math shows you that in each case you netted $100,000 on your million dollar investment. But the CAP rate for each is different.
CAP Rate is stated in terms of a year. You want to know what CAP you will get on your investment. But if the investment extends over multiple periods, then you want to know what you will yield over the entire period.
Same numbers above for A, B & C, except :
NOI yr 1 100,000 50,000 150,000
NOI yr 2 100,000 50,000 150,000
CAP Rate 10% 5% 15%
Yield for entire investment 10% 7.41% 12.65%
Use your HP 10BII as follows:
1 Shift P/YR
Shift C ALL
1,000,000 +/- CFj Displays -1,000,000
100,000 CFj Displays 100,000
1,100,000 CFj Displays 1,100,000
Shift IRR/YR Displays 10% and if you change the income & sale it will display the other percentages above.
The difference results from when you got the money, and how much.
If this is too confusing, call me and I will do it for you.
Capitalization or CAP Rate - the percentage result of dividing the future (or expected) net operating income by the investment.
Return on Investment (or yield) this is a measure of the entire investment, for the entire period of the investment. While you can certainly calculate it on a single year, it is the net present value of all dollars in, and out, taking into consideration exactly when those things happened.
Consider three different investments, which all yield 10%.
A B C
Initial Investment (1,000,000) (1,000,000) (1,000,000)
NOI 100,000 50,000 150,000
Sale Price 1,000,000 1,050,000 950,000
CAP Rate 10% 5% 15%
Quick math shows you that in each case you netted $100,000 on your million dollar investment. But the CAP rate for each is different.
CAP Rate is stated in terms of a year. You want to know what CAP you will get on your investment. But if the investment extends over multiple periods, then you want to know what you will yield over the entire period.
Same numbers above for A, B & C, except :
NOI yr 1 100,000 50,000 150,000
NOI yr 2 100,000 50,000 150,000
CAP Rate 10% 5% 15%
Yield for entire investment 10% 7.41% 12.65%
Use your HP 10BII as follows:
1 Shift P/YR
Shift C ALL
1,000,000 +/- CFj Displays -1,000,000
100,000 CFj Displays 100,000
1,100,000 CFj Displays 1,100,000
Shift IRR/YR Displays 10% and if you change the income & sale it will display the other percentages above.
The difference results from when you got the money, and how much.
If this is too confusing, call me and I will do it for you.
Tuesday, May 11, 2010
Effective Rental income ERI
Let's look more closely at ERI and how we get to it and how we maximize it. If you are going to be a landlord, or even a net lease investor, you need to understand how to crunch these numbers.
The difference between Potential Rental Income PRI & Effective Rental Income is vacancy & credit losses. so you need to understand those.
Vacancy and Credit Losses are income lost, or expenses incurred as a result of vacancies and tenants who default on their lease. You will have costs for collection and eviction. Non-payment from bankruptcy, disputes and compromise are some reasons for credit losses.
You can try to minimize your credit losses by taking extra precautions. Requiring personal guarantees, running credit histories, letter of credit, performance bonds and staying involved so you can act quickly in case of a problem.
Generally you calculate PRI & ERI, because the bank or another investor is trying to establish a value of your property based on its net operating income from rentals. These numbers are estimates based on the properties and what you expect to charge. here's the formula for you to remember:
Potential Rental Income - Total square feet available times price per sqft
- Vacancy and Credit Losses - could be an estimated percentage or experience %
Effective Rental Income
+ Other income - Vending income, parking income, etc
= Gross Operating Income
- Operating expenses
Net Operating Income
Consider a 5 unit building which rents each for $950 per month.
$950 X 12months X 5 units = $57,000
Vacancy & Credit losses history from previous years on this property 7%
$57,000 X 7% = $3,990 $57,000 - 3,990 = $53,010 Effective Rental Income
Property Taxes, $3,000, Repairs $850, Water & Sewar $1200, Insurance $2,000
Total operating expenses $7,050
ERI $53,010 - OE $7,050 = NOI $49,060 The bank or investor will use NOI to compute the value of your building based on this NOI. Next time CAP for Value.
The difference between Potential Rental Income PRI & Effective Rental Income is vacancy & credit losses. so you need to understand those.
Vacancy and Credit Losses are income lost, or expenses incurred as a result of vacancies and tenants who default on their lease. You will have costs for collection and eviction. Non-payment from bankruptcy, disputes and compromise are some reasons for credit losses.
You can try to minimize your credit losses by taking extra precautions. Requiring personal guarantees, running credit histories, letter of credit, performance bonds and staying involved so you can act quickly in case of a problem.
Generally you calculate PRI & ERI, because the bank or another investor is trying to establish a value of your property based on its net operating income from rentals. These numbers are estimates based on the properties and what you expect to charge. here's the formula for you to remember:
Potential Rental Income - Total square feet available times price per sqft
- Vacancy and Credit Losses - could be an estimated percentage or experience %
Effective Rental Income
+ Other income - Vending income, parking income, etc
= Gross Operating Income
- Operating expenses
Net Operating Income
Consider a 5 unit building which rents each for $950 per month.
$950 X 12months X 5 units = $57,000
Vacancy & Credit losses history from previous years on this property 7%
$57,000 X 7% = $3,990 $57,000 - 3,990 = $53,010 Effective Rental Income
Property Taxes, $3,000, Repairs $850, Water & Sewar $1200, Insurance $2,000
Total operating expenses $7,050
ERI $53,010 - OE $7,050 = NOI $49,060 The bank or investor will use NOI to compute the value of your building based on this NOI. Next time CAP for Value.
Monday, May 10, 2010
Risk Management
Remember that all investments carry some elements of risk. What I want you to consider is that each investment will be different, and each needs to be looked at individually. Some require your time and management, and some will only require your investment.
In the analysis of any investment we must assess the risk. Is the return worth the risk. As an investor, you will each have difference tolerances for risk based on your financial situation and your understanding of what you are buying.
The first numbers you will crunch before any consideration of an investment in commercial real estate is your own. You have to divide your own funds into base capital and risk capital. Use only the risk capital, to invest in Commercial Real Estate or that which if lost will not affect the future support of your current family lifestyle.
Invest so that at the end of the day, your investment success or failure does not have any effect on your base capital, it either increases or decreases your risk capital.
Don't put all your eggs in one basket. You heard that since childhood. My guess is that if you are reading this then you have not yet diversified into commercial real estate, or you are not completely comfortable with this kind of investment.
One way to avoid losing all your investment is to diversify into different investments so that market changes, fluctuations or just bad luck, cannot take all of your risk capital at one time.
Certainly there are forms of ownership that you should consider such as limited liability corporations or partnerships, which limit your loss to your investment, and leaves your base capital intact. Remember, see a lawyer or CPA to get advice on what's best for you.
Do your research into each investment. Use the internet, it is the easiest way to find out as much as you need to know. Ask your broker, ask your lawyers and CPA before you write your check. But before you get there let me crunch the numbers for you.
In the analysis of any investment we must assess the risk. Is the return worth the risk. As an investor, you will each have difference tolerances for risk based on your financial situation and your understanding of what you are buying.
The first numbers you will crunch before any consideration of an investment in commercial real estate is your own. You have to divide your own funds into base capital and risk capital. Use only the risk capital, to invest in Commercial Real Estate or that which if lost will not affect the future support of your current family lifestyle.
Invest so that at the end of the day, your investment success or failure does not have any effect on your base capital, it either increases or decreases your risk capital.
Don't put all your eggs in one basket. You heard that since childhood. My guess is that if you are reading this then you have not yet diversified into commercial real estate, or you are not completely comfortable with this kind of investment.
One way to avoid losing all your investment is to diversify into different investments so that market changes, fluctuations or just bad luck, cannot take all of your risk capital at one time.
Certainly there are forms of ownership that you should consider such as limited liability corporations or partnerships, which limit your loss to your investment, and leaves your base capital intact. Remember, see a lawyer or CPA to get advice on what's best for you.
Do your research into each investment. Use the internet, it is the easiest way to find out as much as you need to know. Ask your broker, ask your lawyers and CPA before you write your check. But before you get there let me crunch the numbers for you.
Tuesday, May 4, 2010
Loan Calculations with an HP Financial Calculator
I am not sure I can make you an expert on an HP10BII Financial Calculator on my Blog, but I can teach you one of the most basic functions which is solving for an unknown. The calculator can be purchased at an office store for around $25.
Generally in any transaction you need to find out a number that is not given to you. If, for instance you are given a loan amount, points, payment, future value, length of term and interest rate, it would seem that you know everything. You do from your side of the transaction, but you do not know what the bank is yielding. or what your actual interest rate is.
Loan Amount $700,000, 2 points, 7% interest, 25 yr period, Payment $4,947.45
We need to know what this is really costing us, what is the bank's yield.
Calculate the points. $700,000 X 2% = $14,000. You pay this up front to the bank, which means you don't really leave with $700,000, you get a check for $686,000. $700K - $14K in points. Your payment is based on $700K, but you only got $686K. This means the sooner you pay off the loan, the greater the yield to the bank.
If you calculate the IRR - Internal Rate of Return using your new calculator, it goes like this. Clear the Calculator. Shift C = Clear All. Type 12 Shift P/YR for 'Twelve Payments per year' Type 25 Shift XP/YR for 25 yrs times 12 payments = 300 periods will display. Type 686000 PV Type 0 FV Type 4947.45 +/- PMT Solve for I by pressing the I/YR key. It will calculate 7.23 which is the yield to the bank on your 7% 25 year loan
You will probably not hold the investment until the end of 25 years. So we will calculate the yield assuming we paid it off in five years. As a shortcut we could use some of the numbers already in the calculator. But since I want to walk you through, without confusion, I will start at the beginning, and give you the exact keystrokes for this calculation.
Clear the Calculator. Shift C = Clear All. Type 12 Shift P/YR for 'Twelve Payments per year' Type 5 Shift XP/YR for 5 yrs times 12 payments = 60 periods will display. Type 700000 PV Type 4947.45 +/- PMT Type 7 I/YR Solve for FV by pressing the FV key. It will calculate the payoff of the loan after five year. $638,135.35
Now with these numbers we can calculate the banks yield if you pay off the loan early.
Without clearing the calculator: Type FV this will stuff the above number into that field
Type 686000 PV Type 4947.45 +/- PMT Type 5 Shift XP/YR for 5 yrs times 12 payments = 60 periods will display Press I/YR it will show the yield to the bank after 5 years 7.5%
Your 7% loan cost 7.5%, now you know how to do it yourself. If you didn't get it, call me and I will do it for you.
Generally in any transaction you need to find out a number that is not given to you. If, for instance you are given a loan amount, points, payment, future value, length of term and interest rate, it would seem that you know everything. You do from your side of the transaction, but you do not know what the bank is yielding. or what your actual interest rate is.
Loan Amount $700,000, 2 points, 7% interest, 25 yr period, Payment $4,947.45
We need to know what this is really costing us, what is the bank's yield.
Calculate the points. $700,000 X 2% = $14,000. You pay this up front to the bank, which means you don't really leave with $700,000, you get a check for $686,000. $700K - $14K in points. Your payment is based on $700K, but you only got $686K. This means the sooner you pay off the loan, the greater the yield to the bank.
If you calculate the IRR - Internal Rate of Return using your new calculator, it goes like this. Clear the Calculator. Shift C = Clear All. Type 12 Shift P/YR for 'Twelve Payments per year' Type 25 Shift XP/YR for 25 yrs times 12 payments = 300 periods will display. Type 686000 PV Type 0 FV Type 4947.45 +/- PMT Solve for I by pressing the I/YR key. It will calculate 7.23 which is the yield to the bank on your 7% 25 year loan
You will probably not hold the investment until the end of 25 years. So we will calculate the yield assuming we paid it off in five years. As a shortcut we could use some of the numbers already in the calculator. But since I want to walk you through, without confusion, I will start at the beginning, and give you the exact keystrokes for this calculation.
Clear the Calculator. Shift C = Clear All. Type 12 Shift P/YR for 'Twelve Payments per year' Type 5 Shift XP/YR for 5 yrs times 12 payments = 60 periods will display. Type 700000 PV Type 4947.45 +/- PMT Type 7 I/YR Solve for FV by pressing the FV key. It will calculate the payoff of the loan after five year. $638,135.35
Now with these numbers we can calculate the banks yield if you pay off the loan early.
Without clearing the calculator: Type FV this will stuff the above number into that field
Type 686000 PV Type 4947.45 +/- PMT Type 5 Shift XP/YR for 5 yrs times 12 payments = 60 periods will display Press I/YR it will show the yield to the bank after 5 years 7.5%
Your 7% loan cost 7.5%, now you know how to do it yourself. If you didn't get it, call me and I will do it for you.
Monday, May 3, 2010
Fixed Rent versus Percentage Rent
If you rent Office Space, you will generally charge (or pay) a fixed rent per square foot of space rented. But if you rent Retail space, the landlord may want to share in the success of the tenant and charge a percentage rent based on the sales increases of the tenant.
This does not endorse either method. Most smaller tenants refuse to rent where landlords do this. That might be short sighted. Read on. Larger tenants generally pay percentage of their sales as the cost of doing business and being in a location where their sales actually increase because of the location. Also, the landlord has a stake in the success of the tenant, encouraging the landlord to create a good tenant mix and keep the location attractive & up to date.
Fixed Rent means the rate is fixed per square foot for the duration of the lease. Your total useable space times the rate per square foot equals the annual rent. Divide the annual rent by twelve months equals monthly rent, before CAM & Sales tax.
Percentage rent will include a base rent. If the base rent is $144,000 per year, with a 4% rate. then the Breakpoint is $3,600,000 in sales. Base Rent $144,000 divided by Percentage Rate 4% equals Breakpoint. What this means is, the tenant will pay the base rate until their sales exceed the Breakpoint. At sales above the BP, the tenant will pay 4% of the amount over. Sales $3,800,000 - BP $3,600,000 = Excess Sales $200,000 X 4% = $8,000 additional rent for that year. The percentage is the same as if the sales had been 4% of the larger sales. $3,800,000 X 4% = $152,000 - Base Rent $144,000 = $8,000.
So remember, Percentage rents can be a good for both the vendor & landlord.
This does not endorse either method. Most smaller tenants refuse to rent where landlords do this. That might be short sighted. Read on. Larger tenants generally pay percentage of their sales as the cost of doing business and being in a location where their sales actually increase because of the location. Also, the landlord has a stake in the success of the tenant, encouraging the landlord to create a good tenant mix and keep the location attractive & up to date.
Fixed Rent means the rate is fixed per square foot for the duration of the lease. Your total useable space times the rate per square foot equals the annual rent. Divide the annual rent by twelve months equals monthly rent, before CAM & Sales tax.
Percentage rent will include a base rent. If the base rent is $144,000 per year, with a 4% rate. then the Breakpoint is $3,600,000 in sales. Base Rent $144,000 divided by Percentage Rate 4% equals Breakpoint. What this means is, the tenant will pay the base rate until their sales exceed the Breakpoint. At sales above the BP, the tenant will pay 4% of the amount over. Sales $3,800,000 - BP $3,600,000 = Excess Sales $200,000 X 4% = $8,000 additional rent for that year. The percentage is the same as if the sales had been 4% of the larger sales. $3,800,000 X 4% = $152,000 - Base Rent $144,000 = $8,000.
So remember, Percentage rents can be a good for both the vendor & landlord.
Internal Rate of Return - IRR
Here's a simple way to think about the investment return: How much did you put into the property, when did you put it in, how much did you get out of the investment, and when did you take it out. IRR tracks every dollar in the investment for the time it is in the investment. It is a great tool for keeping score.
The formula uses these elements. IRV. I=Income, R=CAP Rate, V=Value.
Income divided by Value equals Cap Rate, or Income divided by Cap Rate equals Value.
Sample: $35,000 Income divided by $275,000 Investment equals Cap Rate 12.73%
$35,000 / $275,000 = 12.73%. Or.... $35,000 / 12.73% = $275,000.
This is a fun formula and it tells you a lot. We really will crunch some numbers when you start tracking monthly income instead of annual and they are all different. Not complicated, but you will need an HP calculator. I will refresh you on using an HP calculator in future blogs. For now we use simple math.
The formula uses these elements. IRV. I=Income, R=CAP Rate, V=Value.
Income divided by Value equals Cap Rate, or Income divided by Cap Rate equals Value.
Sample: $35,000 Income divided by $275,000 Investment equals Cap Rate 12.73%
$35,000 / $275,000 = 12.73%. Or.... $35,000 / 12.73% = $275,000.
This is a fun formula and it tells you a lot. We really will crunch some numbers when you start tracking monthly income instead of annual and they are all different. Not complicated, but you will need an HP calculator. I will refresh you on using an HP calculator in future blogs. For now we use simple math.
Sunday, May 2, 2010
NOI - Net Operating Income
One of the most important numbers in commercial real estate is Net Operating Income. This is something you need as an investor or user of commercial real estate. NOI tells you everything regarding the investment . It is what the property will produce when all expenses have been deducted from Gross Operating Income. This is an important number in all steps of the ownership process.
When you buy a property, you want to know the NOI. What is the property producing after all expenses. It is one way to actually value a property. If you put your money in savings and the bank offers 2% interest. You know for a fact that when you take it out, you will have your original deposit and an additional 2% annually in interest. The same for an investment in Real Estate. You want to know the what this property is producing in income from the tenants, and what the costs are that must be spent to earn that income. The difference is NOI.
A real estate investment is different than buying a CD. RE is not as liquid, and you can lose some or all of your investment. For that reason, we require a higher return, for the risk we are taking. You calculate that higher return as NOI.
Think of NOI as what's left for you at the end of the period. It is the return on your investment. The simplest way, is to look at what's left in your bank account, for this property the first year you own it. This is your profit on a cash basis.
Sample: Gross Rents( less credit or collection costs plus vending income) equals Gross Operating Income (GOI) less operating expenses OE: (Taxes, maintenance, insurance, repairs, utilities and management fees) equals NOI. GOI $56,000 - OE $34,000 = NOI $22,000
Now crunch that number and it will tell you what this investment will pay. NOI divided by Investment equals = IRR Investment Rate of Return. NOI $22,000 / Investment $275,000 = IRR 8%. We will talk more on IRR later, but remember, we need to know NOI if we are buying Real Estate as an investment.
When you buy a property, you want to know the NOI. What is the property producing after all expenses. It is one way to actually value a property. If you put your money in savings and the bank offers 2% interest. You know for a fact that when you take it out, you will have your original deposit and an additional 2% annually in interest. The same for an investment in Real Estate. You want to know the what this property is producing in income from the tenants, and what the costs are that must be spent to earn that income. The difference is NOI.
A real estate investment is different than buying a CD. RE is not as liquid, and you can lose some or all of your investment. For that reason, we require a higher return, for the risk we are taking. You calculate that higher return as NOI.
Think of NOI as what's left for you at the end of the period. It is the return on your investment. The simplest way, is to look at what's left in your bank account, for this property the first year you own it. This is your profit on a cash basis.
Sample: Gross Rents( less credit or collection costs plus vending income) equals Gross Operating Income (GOI) less operating expenses OE: (Taxes, maintenance, insurance, repairs, utilities and management fees) equals NOI. GOI $56,000 - OE $34,000 = NOI $22,000
Now crunch that number and it will tell you what this investment will pay. NOI divided by Investment equals = IRR Investment Rate of Return. NOI $22,000 / Investment $275,000 = IRR 8%. We will talk more on IRR later, but remember, we need to know NOI if we are buying Real Estate as an investment.
Saturday, May 1, 2010
Rental Terms & Calculations as a Tenant or Owner
Total Rentable Area, Usable Area & Common Area
Here's something you need to learn whether you are a tenant or the landlord. If you measure a building from the inside rough walls before you add the interior, it would give you the Gross Measured Area (GMA). But... the building will have stairways, elevator shafts and vents. The landlord does not charge for this space. Things that penetrate the floor are subtracted from the GMA to give you Total Rentable Area (TRA).
The interior measure of the walls in each space, will give you the Total Useable Space in each space (TUS). With this information we can 'crunch' some numbers and find out the efficiency of the building being measured.
Total Useable Space divided by Total Rentable Space equals Efficiency Percentage.
Example: TUS 13,500sqft / TRA 15,000sqft = 90%. In this example the building is ninety percent efficient. You can look at it other ways too. TUS 13,500 / E% 90% = TRA 15,000.
Again whether you are the tenant or landlord you need to understand the COMMON AREA and how that expense is allocated from the landlord to the tenant.
Within the TRA are areas 'common' to all tenants, like hallways, the lobby, fire corridors, the mail room, public restrooms, and vending or break rooms. Tenants share this space and are charged based on their prorated percentage of Total Usable space(TUS) in the building.
We can calculate the number by using the other numbers mentioned earlier. Total Rentable Space less Total Usable Space equals Common Area Space. The landlord will incur some costs to maintain this space, CAM common area maintenance. Generally the expenses for cleaning, repair on this area as well as the same on the parking lot , snow removal, painting the building, new roof etc, are also allocated to this category.
Example: assume that one office on the first floor has 4,500 sqft of TUS. That particular space will share the common expenses of the whole building on their percentage of the building's Total Usable space. Tenant TUS divided by Building TUS = Tenant percent of TUS. TTUS 4,500 / BTUS 13,500 = 33.33%. If the Shared expenses to maintain the common areas is $10,000 then this particular tenant on the first floor will be charged one third of it. $10,000 X 33.33% = $3,333.33.
Often when renting, CAM is quoted as a price per square ft. In this example, $3,333.33 / 4,500 sqft = $.75 per sqft. (or 75 cents per sq ft
Please note there are many types of leases, and many types of expenses to be shared or paid by the tenant and or landlord. This example is purely for you to learn how to calculate some of them.
Here's something you need to learn whether you are a tenant or the landlord. If you measure a building from the inside rough walls before you add the interior, it would give you the Gross Measured Area (GMA). But... the building will have stairways, elevator shafts and vents. The landlord does not charge for this space. Things that penetrate the floor are subtracted from the GMA to give you Total Rentable Area (TRA).
The interior measure of the walls in each space, will give you the Total Useable Space in each space (TUS). With this information we can 'crunch' some numbers and find out the efficiency of the building being measured.
Total Useable Space divided by Total Rentable Space equals Efficiency Percentage.
Example: TUS 13,500sqft / TRA 15,000sqft = 90%. In this example the building is ninety percent efficient. You can look at it other ways too. TUS 13,500 / E% 90% = TRA 15,000.
Again whether you are the tenant or landlord you need to understand the COMMON AREA and how that expense is allocated from the landlord to the tenant.
Within the TRA are areas 'common' to all tenants, like hallways, the lobby, fire corridors, the mail room, public restrooms, and vending or break rooms. Tenants share this space and are charged based on their prorated percentage of Total Usable space(TUS) in the building.
We can calculate the number by using the other numbers mentioned earlier. Total Rentable Space less Total Usable Space equals Common Area Space. The landlord will incur some costs to maintain this space, CAM common area maintenance. Generally the expenses for cleaning, repair on this area as well as the same on the parking lot , snow removal, painting the building, new roof etc, are also allocated to this category.
Example: assume that one office on the first floor has 4,500 sqft of TUS. That particular space will share the common expenses of the whole building on their percentage of the building's Total Usable space. Tenant TUS divided by Building TUS = Tenant percent of TUS. TTUS 4,500 / BTUS 13,500 = 33.33%. If the Shared expenses to maintain the common areas is $10,000 then this particular tenant on the first floor will be charged one third of it. $10,000 X 33.33% = $3,333.33.
Often when renting, CAM is quoted as a price per square ft. In this example, $3,333.33 / 4,500 sqft = $.75 per sqft. (or 75 cents per sq ft
Please note there are many types of leases, and many types of expenses to be shared or paid by the tenant and or landlord. This example is purely for you to learn how to calculate some of them.
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