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How to Model Your First Real Estate Investment

Wednesday, November 28

Fellow Real Estate Investors welcome back to another helping of real estate investing knowledge. The goal of my posts are to help you become better income investors by providing tips, tricks and step by step instructions that I have complied based on my experience of investing into multimillion dollars of investments across Northern New Jersey.  Last week, we defined a framework of indicators for you to utilize in helping determine your growth and risk assumptions that will fit in your real estate investment model.  If you missed this post then feel free to read the post by clicking this link. This week we will begin introducing you to key real estate ratios that I feel that you should know and understand so that you can analyze and understand your investment better. By now you should feel fairly comfortable in your skills of reviewing the income and expense side of a property’s operating statement. You will need those skills to extract the key data to plug into these ratios. Remember that a ratio or model is as good as its inputs so garbage in = garbage out. 

 

There are two broad categories of ratios that I want you to know and understand and I will explain the importance of each category as we go through this blog post.  So lets dig into this exciting real estate finance journey it may not be the most exciting for you but I am a numbers guys so this is always a fun topic for me to cover.

 

Profitability Ratio: these ratios advise you as the profitability metrics that you can expect from your potential investment. 

Ratios

Ratio Definition

Formula

Capitalization Rate aka Cap Rate

A capitalization rate is the overall or non-financed return on a real estate investment, akin to the return on total assets in accounting terms.

 

Net Operating Income

Total Equity Investment*

 

*Purchase Price + Construction Costs + Closing Costs

Return on Equity aka Cash on Cash Return

A rate of return often used in real estate transactions. The calculation determines the cash income on the cash invested.[1]

 

 

Cash Flow x. Debt Pmts

Total Cash Invested

Internal Rate of Return aka IRR

The internal rate of return is a rate of return used to measure and compare the profitability between investments.

 

IRR Calculation:

Use IRR function in excel to make this calculation easier for you.

Net Present Value aka NPV

NPV can be described as the “difference amount” between the sums of discounted: cash inflows and cash outflows. It compares the present value of money today to the present value of money in future, taking inflation and returns into account

 

NPV Calculation:

Use the NPV function in excel to make this calculation easier for you.

 

 

Debt Ratios: real estate is typically not bought all cash and debt is typically utilized. So it is important to understand debt related ratios. These ratios help you determine the type of leverage you can utilize and the potential interest rate risk.

Ratios

Ratio Definition

Formula

Financial Leverage

Financial leverage refers to the use of debt to acquire additional assets. Financial leverage may decrease or increase return on equity in different conditions.

 

 

         Total Debt

     Total Capital*

 

*Equity + Debt + Preferred Equity

Debt Service Coverage aka DSCR

DSCR ratio of cash available for debt servicing to interest, principal and lease payments. It is a popular benchmark used in the measurement of an entity's (person or corporation) ability to produce enough cash to cover its debt (including lease) payments. 

.

 

Net Operating Income (NOI)

Annual Debt Service

Break Even Ratio (BER)

Break-even ratio (sometimes called default ratio) is used to ascertain how vulnerable a property might be to defaulting on its debt in the event rental income derived from the real estate income property should decline.

 

 

 Debt Service + Operating Expense

-----------------------

Gross Operating Income


 

Utilize these ratios to help you ascertain the degree of profitability and risk associated with your potential investments. Also, utilize the NPV and IRR calculation to help you compare between different investment choices. Remember that money is finite so choose the investment that gives you the highest positive NPV (I prefer NPV over IRR as a comparison measurement tool) while making sure that the risk ratios are comparable between the investments. 

 

Enjoy crunching these numbers as trust me if you analyze these ratios then you will have a better understanding of the risks and the rewards associated with your next investment choice.

 

Until next week fellow income investors, happy investing!

 

Ankit

Confused? Then twee me @Ankit_RER

Want to Learn More: Click Here

Looking for deals: Click Here

 

 

 


[1]http://www.investopedia.com/terms/c/cashoncashreturn.asp#ixzz2BkK6j1yj

 


Market Analysis Filtering System

Wednesday, October 31

 Over the last few weeks we have discussed how to find prospective deals.  Now that you have a few prospects potentially spread across various towns or states, the next question that you as a investor need to address is which market has a higher competitive advantage between your various prospects.

 

The profitability of income producing properties is highly dependent on the geographic area in which the asset is located. This becomes another filter tool. So how does one analyze an economic region/market area? The best way to analyze a market area is to complete a supply and demand study coupled with economic driver analysis.  

 

I.               Economic Driver Analysis

One of the best ways to identify a growing geographic market is to find markets where both economic employment is growing and profitable businesses are clustered within the geographic area. A widely accepted approach in completing the economic driver analysis is referred to as a location quotient.

 

[Regional Employmentindustry]/[Regional Employmenttotal] <> 1.0

[US Employmentindustry]/[US Employmenttotal]

 

If the industry that is being analyzed is greater than 1.0 then that industry would be identified as a base/driver industry for the geographic area. If you are trying to decide between two or more areas, pick the area that has the greatest number of base/driver industries. This is a tedious process and needs to be completed at the metro area level but once it is done you can identify areas that have future growth prospects of employment that is a leading driver for higher real estate prices.

 

II.             Supply-Demand Analysis

Supply and demand drivers of each market area affect real estate investments profitability. Each asset type has different demand and supply drivers. Since my expertise lies in multifamily asset class, I will give you a demand-supply factors table that I have utilized when analyzing market areas:

 

Key Demand Drivers

Key Supply Drivers

Number of Households

Vacancy Rates

Size of Households

Construction in progress

Median Household Income

Foreclosures / Shadow Inventory

Affordability (Price-Rent Ratio)

Age & Combination of existing stock

 

The above analyses will help you filter real estate prospects by profitable market areas so that you can identify real estate investment gems within your prospects. Next week I will show you how to start using some basic real estate finance to compare between filtered real estate investment opportunities.

 

Until Next Week- Happy Investing Fellow Investors!

 

Ankit

Questions: Tweet me @Ankit_RER  

Deals in New Jersey: Click Here


Finding New Jersey Auction Deals

Sunday, October 14

Recently I covered the topic of how to find potential deals from the comfort of your chair. Continuing along that theme; I will be talking about s how you can find deals at upcoming real estate auctions in the Northern New Jersey market.

 

What is a real estate auction?

A real estate auction is an innovative and effective method of selling real estate. It is an intense, accelerated real estate marketing process that involves the public sale of any property—most certainly including those that are nondistressed—through open cry, competitive bidding.[1]

 

Who can hold an auction?

Auctions can be held by both private entities such as auctioneers hired by the seller or realtors or public entities such as the sheriff, municipality, and the federal government. Each entity usually utilizes one of the following three types of auctions:

 

1. Minimum Bid is the lowest bid (decided by the seller prior to auction) the auctioneer will accept for a property. Once that bid is reached, the property will sell to the highest bidder.

2. Published Reserve is the lowest amount that the seller must sell a property at auction, but the bidding can start wherever the bidders choose. If the Published Reserve bid is not reached, then the seller can accept, reject or counter the highest bid.

3. Absolute Auction is where the highest bidder acquires the property, regardless of the amount. There is no reserve price below where it will not be sold. Absolute Real Estate Auctions tend to attract the highest amount of interest.[2]

 

Where can you find out about upcoming real estate auctions?

Private Entity Auction Sources:

The National Auctioneers Association's Web site (www.auctioneers.org) or the National Association of Realtors' Web site (www.onerealtorplace.com) lists dozens of upcoming auctions nationwide. Or, www.auctionweb.com offers an online list of affiliated real estate auctioneers. Some namesake private auctioneers that continuously hold auctions in the New Jersey market are as follows:

Williams &Williams                           http://www.williamsauction.com/

Sheldon Good & Company               http://www.sheldongood.com/

Real Estate Disposition Corp            http://www.auction.com

Hudson & Marshall                           http://www.hudsonandmarshall.com/

Max Spann                                         http://www.maxspann.com/

So subscribe to their email lists that way you can be update on the auctions that are coming in this area.

 

Public Entity Auction Sources:

Public entities auctioning real property can include sheriff sales, IRS sales, US Marshall sales, Treasury & IRS etc.  The major issue that I had when I first started was finding out about them without spending hours searching each entities website. So how do you find out about these auctions so that you can act upon them quickly and easily. For that you need a system and I will give you mine.

 

I usually break apart this auction category into two buckets: Sheriff Sales Auctions and Other Government Auctions.

Lets attack the easy one first- Other Government Auctions. There are few good websites that compile different government department upcoming auctions:

 

Bid4Assets                                         http://www.bid4assets.com/

GovSales                                             http://www.govsales.gov/govsales/govsales/     

CWAMS                                              http://www.cwsmarketing.com/realestate.htm

 

Sheriff Sale is the other public entity auction that happens on a weekly basis at the county sheriff office. A sheriff sale auction happens when an unpaid money judgment such as a mortgage needs to be satisfied with the sale of the asset backing that judgment. Sheriff sale in New Jersey happen on a weekly basis at a fixed day and time in each county. So you need to keep on top of the sheriff sale websites to see what are the properties coming up at the next week’s auction. Below is the list of sheriff sale county websites in Northern New Jersey where you can find the upcoming foreclosure auctions (PS its FREE on these sites unlike Realtytrac or Foreclosure.com):

 

Essex County    http://salesweb.civilview.com/SalesListing.aspx

Passaic County http://www.pcsheriff.org

Bergen County  http://168.229.7.54/sheriff_sale.aspx

Union County    http://ucnj.org/government/sheriff/sheriffs-sale-information/

Morris County   http://www.mcsheriff.org/sales/

Hudson County http://www.hudsoncountysheriff.org/Sales/

 

Use the above resources and websites to find your next auction deal but be careful, as auction buying is a tricky and a high-risk strategy. I will be covering in the upcoming weeks on how you can complete due diligence on traditional distressed assets along with auction purchases to help minimize the risk associated with distressed asset investing.   

 

Happy Investing

 

Ankit

Any questions reach out to me at @Ankit_RER or [email protected]


[1] http://www.realtor.org/auction/the-basics-benefits

[2] http://www.propertyauction.com/blog/index.php/2011/01/defining-the-terms-the-3-main-types-of-real-estate-auctions/


Deal Sourcing Online

Monday, October 08

Last time we covered the topic of how to establish your investment criteria in order to setup a decision matrix to help you filter good v. bad deals. Today we will discuss using online search tools to help you find potential deals so that you can filter them down.

 

CAVEAT: The best deals are not usually found online since deals that wind up online usually deals that the realtors or their investors did not want to buy. So be careful but use online searches as a business tool to find potentials. You can make a potential into a deal by using your structuring and creative negotiating skill set.

 

My firm does real estate deal sourcing predominantly in Northern New Jersey so I am going to provide you tools and resources from this area perspective. I am break apart the search location into Residential and Commercial asset class buckets:

 

Residential (1 to 4units)

http://new.gsmls.com/publicsite/propsearch.do?method=getcountysearch

http://www.njmls.com/

 

Setup a user profile on these sites and search for deals based on your established investment criteria. A few tips on how to use these sites more efficient are:

A.   Save Properties that match your investment criteria and request updates to be sent to your email. This allows you to know as soon as an agent changes the price, remarks, or the status of the asset without you having to go back daily. The goal is to more efficient not more laborious.

B.   Setup a search criteria and request the website to send you daily deals that match your criteria. This allows you to comfortably every day sit in front of your email and see what new deals have come into the market that meet your search criteria.

 

Commercial (5+ units, retail, self storage etc.)

http://www.loopnet.com

http://www.showcase.com

http://www.marcusmillichap.com

 
Use these sites to find commercial deals online. These are typically more robust in my opinion that the residential sites so use those features to get more creative. Most investors use these online sites to search for properties in a specific geographical location and/or a specific asset class. Your goal is to be better than the next investor so what if you got creative and combined the geographic/asset search with the keyword search feature.

 

Here is how you can make the keyword search combination to find your next creative or below market deal:
 
Go to the Search Properties for Sale link. Fill in your locations and the asset types that you are interested in investing into. Now here is the creative part, look at the bottom of the screen for the section titled “Keyword”. Now get creative with your search terms.

 

Think about keywords that might work in helping you find creatively structured or distressed deals. Here are some of the ones that I use in my daily reminder search: owner financing, motivated, reduction, make a deal, owner financing.

 

Next click Search and Happy Hunting!

 

I hope that you find these resources and tip/tricks helpful in finding your next real estate deal.

 

Happy Investing

 

Ankit

http://rernj.com/deal-of-the-week/

Find out about our deal of week in NJ 

Questions: Tweet me @Ankit_RER

 


Investment Criteria to Find Deals

Wednesday, September 12

Financing is usually the biggest impediment to completing real estate deals since without capital you have no deal. On the same token, financing is irrelevant if you cannot find a deal that is worth raising capital behind. So this month we will be covering tips, tricks and methods to finding deals. We will start with defining your investment criteria so that you can use that as a filter system to find deals that match your investment style.

 

Prior to beginning your investment search for deals, I would recommend that you sit down over a cup of coffee/tea and lay out the investment criteria for your target or “sweet heart” deal. So you must be asking what are the investment criteria’s that I should have at a bare minimum. Below I highlight a few metrics that I would recommend pondering over and having as a part of your investment criteria:


Market Area- this is basically the area of your target investment. Some investors want to invest in their “own backyard” while other feel comfortable going out of their state and even out of country. So this criteria filed can be as board as the state/city or as refined as the zip code.

Maximum Investment Price­- some gurus out there say that it does not matter what the price is as long as the deal makes sense. There is truth to that statement but the honest truth is that money is not unlimited and every investor has a different capital investment budget so that should be kept in mind as you decide on your maximum investment price. Since looking at deals that you can raise capital behind will be a waste of your time in the long run and time is a very precious commodity when it comes to finding and acting on deals.

Asset Type- this is criteria is important by my standards as a investor should start in one asset class and get comfortable prior to jumping into others. The asset classes can range from single, multifamily (2 to 4 or 5+ units), retail, industrial, special purpose, hotel and healthcare. Within each broad category there are sub-classes so pick your asset class on the basis of your interest and expertise.

Return Criteria- everyone is looking to purchase or invest in real estate to do one thing: Make Money! Hence it is important to understand what is your target investment strategy? There are two broad criteria of investment strategies: Flipping or Cash Flow. B

Based on the target strategy, you need to establish return metrics that a deal must have for it be marked as a “Prospect” within your search. For Flips investments, it is important to define the “minimum spread” between market value or the After Repaired Value (ARV) and your all in investment.  For cash flow investments, you can setup measures such as Cap Rate, Cash on Cash Return, Equity Multiple (we covered how you can calculate these measures in prior e-newsletters so feel free to contact us to resend them to you if you need them for reference)

 

Happy Investing


Ankit 


Valuing Real Estate in a Changing Market

Wednesday, August 08

 Valuing Real Estate in Changing Markets

Pricing an investment property can be done through a number of methods ranging from the income approach to the sales comparison approach. Today we offer rules of thumbs to use when try to value assets in an appreciating or a depreciating market.

Market: Appreciating

Rule of Thumb: Use Active Listings instead of Sold Listing to come up with a fair market value of the asset

Rationale: Sold comps are always 2 to 3 months behind in timeline given the period of time needed with financing hence the sold listings can under value the asset in an appreciating market

 Market: Depreciating

Rule of Thumb: Use Under Contract Listings adjusted by a median discount percentage rate

How to calculate the discount percentage:

Discount percentage is calculated by Sale Price/Under Contract List price for similar comps across a 6-month period of time. (Utilize the median discount percentage instead of average discount percentage)  

Rationale: Sold comps can be higher in valuation given that the market value is declining on a weekly/monthly basis. Active listings can be irrelevant given that the market can be saturated with over-priced properties due to unrealistic sellers