Probably most people have heard of exchanging one property for another. Well sounds good, but rarely happens in the real world as most people will not want what you have and then another property becomes involved and can wind up with 3 or 4 legs before you get what you want. And, No exchanging is not that clause in the sale contract that says you will participate in a 1031 Tax Deferred Exchange, it is much more than that. That clause is a sale and a purchase.
In Exchanging there are two main components, Debt and Equity. The thing about exchanging that most people have a hard time understanding is that the Equity may not be there. In other words, Equity is that phantom potential amount of money, that is so elusive because it can be high one day and way down the next day. Most sellers think they know exactly what their equity is because that is what they "Want". Some sellers say, "Well its an exchange so let's raise the price to compsenate for the other high price". "Won't work and it is only worth so much and a good appraisal or a cash flow analysis will show the sale or exchange price.
Most people, including me would like to just sell and take the equity and walk away. Sometimes it is hard to sell and easier to trade. Exchanging is about solving another persons property problem and also solving yours. You probably do have a property problem, in that the property has not traditionally sold. If you solve your problem of "No Sale" then you will most likely solve another persons property problem. It may be as simple as helping someone move to another town and take another property that gets them out of the one they are in. In other words, they took their equity with them only not in the form of cash.
Now, "Debt", believe it or not! You also own the debt! Now this is where it becomes hard to get your equity because it's tied to the debt! If you get your equity, the lender also, wants his equity. We used to be able to let someone assume our debt, but rarely will that happen in todays lending. That great instrument, called "Assumption", allowed us to walk away with our equity and let some one else pay the debt, "No More". Today, the instrument that has replaced assumptions is called "Due on Sale Clause" and that clause is in nearly every deed of trust. If you sell or exchange you will trigger the "Due on Sale Clause" and must pay off the lender. Bummer!
The amount of debt will reduce your equity. The hard part of an exchange is handling the debt by either moving it, paying it off or some other creative thing, but, it has to be delt with and you do "Own It". Debt and the obligation you have to get the lender his money, makes the deal more difficult and means you will have to involve a lender any time there is debt.
The only thing you have to exchange in your property is equity. If you own the property free and clear of debt then the exchange is just a matter of finding someone that wants your property (Equity). Then the exchange becomes a matter of benefits exchanged and received. There are ways to balance equities and increase your holdings and gain profit by moving up in value.
Call me if you need help. I am qualified as an investment counselor CCIM and Equity specialist, EMS.
Over the years the methods of measuring the value of an investment has evolved to something we can all understand. That measurement is the called "Accumulation of Wealth" formula. It is a formula because it takes into account variations in income and expenses, income taxes and capital gains. The income is tracked or estimated over a period of years, so that at the end of the holding period the amount of after tax proceeds plus the yearly cash flows are measured and a rate of return is established. This can be after the fact which is real, or projected, which is our best educated guess based on experience and knowledge of the market and the property.
The accumulation of wealth is a true measurement of the worth of the investment to you. Its like selling widgets, if you sold a 100 widgets that cost $1.00 wholesale, then you have to pay taxes and expenses, what did you really make. So the key is to buy widgets for less or cut expenses or sell widgets for more than the competition. The idea is, that it does not matter how many widgets you sold but how much money you put in your pocket that is yours to keep. That bottom line is influenced by those factors mentioned, either pay less wholesale, reduce expenses, raise the price or do a combination of all in an effort to retain more of the earnings.
So the "Accumulation of Wealth" measurement is more accurate than a "Cap Rate" or the "Internal Rate of Return", because it measures the true or actual "Rate of Return". So, "Net Operating Income" divided by the "Sale Price" will give you a "Capitalization Rate" and hopefully that is not as far as you take it in the quest to determine a good investment. I can almost with accuracy state that the percieved return of say, 9% upfront is not 9% on the end.
That old saying that "Garbage In", Garbage Out" is certainly true in commercial or multi-family investments. What does impact all investments, just to name a few, that are obvious. Estimation of Income, usually estimated slightly on the high side, expenses can surely be understated. This is so critical. If income or expenses are skewed then the whole outcome is off. If you use projected income, then Vacancy "Must" be true to give you a reliable "Gross Operating Income". If "Gross Operating Income" is off then NOI is Off and every projection there after is suspect.
I use actual income and actual expenses. If you cannot get that out a a seller or agent then its time to walk away. When you do get expenses be sure to look at those things that will surely increase. In analyzing income look at the market and see if the rents or actually in the market and if "Vacancy" is true. These three things if not accounted for will make or kill your deal and they are lack of income, rising expenses and high vacancy.
What we do not want to do, ever, is come out of pocket each month to make expenses or debt service as that will certainly not accumulate any wealth. I have seen expenses and income change at different rates and an investment become upside down in a few short months. Now that is what is called a "Sinking Feeling", (Not a sinking fund) :} Upside down is when we start to look to others for answers and blame the broker or counselor and banker for getting us into this mess. It is kinda hard to blame the banker as they use ratios for lending and risk assesement and if the deal does not fit in their guidelines then they ask you to put more money into the deal or they just do not loan.
If the broker or counselor is relying only on the going in "Cap Rate" or "IRR" or "MIRR" then I would want to know how much money will I put in my pocket each month after all expenses and income tax. If I cannot put a $1,000 a month into my pocket then I will not do the deal as structured. A $1,000 a month will give very little cushion in multi-family projects. If you clear $200 per month in a rent house your probably okey if the market holds. When we re-model a house to flip, the minimum return is $20,000 after all fees to banks and selling fees. I will say that 20 grand can be eaten up in a hurry, especially if you have to hold a property 6 or 8 months.
My advice, ask the broker or banker for a cash flow analysis and net sale proceeds at the end of the investment. then measure the return. Also, always be concerned about the monthly amount of money in your pocket, after tax. Money in the pocket is always good and that is what its all about.
There is quite a bit of confusion on the subject of Cap Rates or return on investment. Seems like most residential brokers just work back wards into a Cap Rate. I mean set a price and then divide the "Net Operating Income" by the sellers value. The listing broker usually will just ask the Seller this question, "What Do You Want for a Price". Now, that is just not how it is done with investment properties. Investments are like the stock market. The stock broker never calls the investor up and says, "What do you want for your stock"! No, the stock market is market driven and investment real estate is market driven. I think I am correct in saying that the reason a person would invest in real estate is to make a profit, not a killing, but a profit. Now that is where the rub comes in. Un-savvy real estate brokers and sellers, tend think they are selling too low and their property is always worth more. Buyers always think the price is too high! Often times seller, broker and buyer are not trained in how to establish value of an income stream. They are either un-aware of the market, want to make a killing and hope the broker is a miracle worker, or just rely on the broker or their own concept of value or their buddy to price the investment.
Here's the deal!, if you pay too much, it does not matter what the Cap Rate is. Also, if you price the property to high, most astute investors will ignore the investment and move on to one that makes sense. What matters to an investor is the amount of money that will be put in their pocket each month and that is where the true worth of an investment is measured. Rate of return is based on several things and starts with what is called the "NOI" Net Operating Income, that is what is left after Vacancy and Expenses of Operation. With NOI a person will pay debt service. Now after you use the NOI to make the mortgage payment you will see what is left over at the end of the month, and this amount or lack thereof, will determine the cash flow before tax. "Cash Flow Before Tax is just that!, The tax man must be paid before you are entitled to a return or a profit. Now the "After Tax" cash flow must be figured. Then truly you will be able to put the cash left over in your pocket. So; Gross income, less Vacancy, Less expenses, Less Debt Service, Less Income Tax, will be yours to spend.Be sure there is some left, cause the tax man, the City utilities, the property tax and insurance people do not care if you make a return, they still get paid.
Numerous times there is nothing left after expenses and debt service. Did the broker or the seller try to tell the investor that this thing will never make a profit, because the rents are maxed out? Did the broker try to tell the Seller that an investor will not pay that much because there is nothing left over at the end of the month. Did the Broker tell the investor that taxes and expenses go up, but not at the same rate as income? Probably not!
All parties to a transaction need accurate income and expenses and then based on the purchasers goals and requirements a price and rate of return on the investment can be figured. The listing brokers obligation is to inform the seller that a purchaser will not buy an investment with no upside or big risk and low cash flow. A bank certainly will not finance an overpriced listing or a risky investment. Banks use a tool called "Debt Coverage Ratio" which means that the "Net Operating Income" must be a certain amount bigger than the debt. Usually that Debt to Income ratio is 1.20, 1.25 or 1.15, depending on several things. In other words the NOI must exceed the debt by 100 percent plus 25%. So a 25 % cushion. If rents went down or expenses went up the cushion will still allow the mortgage to be made. Banks and risk! what a novel idea. They measure the risk quite well and will for the most part will not loan on a risky under preforming deal. If they do the risk will be in their favor and you may put up 60% of the money instead of 30% of the money. Its all about risk!
Hire a CCIM (Certified Commercial Investment Member). I am available for people wanting to sell or purchase or in need of expert testimony in court cases involving income producing properties.
A very important part on an analysis of any income producing property or even a business opportunity is to have accurate and relevant information concerning income and expenses. A form often used in commercial real estate is called the APOD and stands for "Annual Property Operating Data". This is a great form, but often not used correctly. For instance the first line ask for "Projected Income", in other words if you have 15 units in an apartment house what is the total amount of income when 100% full, 100% of the time at the maximum rental amount that the market will sustain. What I really look for and require from an owner is actual income, what is the owner actually collecting in income? That is Key. Start with projected income and then reduce it to actual income with the vacancy factor.
Projected income is like saying if I had a PhD I could make $150,000 a year. Well if I didn't have to make payments I would not be selling real estate!
The second line in the calculation process is the "Vacancy Factor", how much money do you expect to lose due to no income from several units, 5%,10% or even 25%? What the vacancy factor can do is reduce projected income to actual income or vice versa. Actual income divided by projected income will give you a vacancy factor, or "Income Loss Factor". One of these figures will have to be true to real life. Either use actual income or get projected income down to actual income by using the vacancy factor. One or the other has to be true or your figures from here on out will be at best "speculation" an could be the difference in having a good property that will make money or go broke.
The next line item is Income and Expenses. I always use true real life figures and even add in things that I know will change or that the owner missed. Probably the largest single expense item missed is property taxes. Taxes always go up and if you mis-figure this expense, it can cost you big time. I have seen properties with low tax rates, more than double or triple with a new owner. The reason is the taxes usually are looked at about every 3 years and a new buyer may have a low rate for a year or two and then when the assessor picks up the new value the taxes will go up. Now, if you missed that in your analysis, you may not have any money left to pay yourself a dividend or make loan payments. The figure that is so vitally important is NOI or "Net Operationg Income". That is what is left after vacancy and expenses. This figure is what will pay the mortgage and give you an income, so it is the most critical figure in your analysis. If Net Income is not good, you most likely will never see a profit or even get a loan.
Lenders look very closely at projected versus actual income, and they certainly look at the reasonableness of expenses and then compute the Debt Coverage Ratio and then adjust either expenses, income and loan amounts. Can this kill a deal? You Bet if your analysis is suspect or plain old amateurish then you will not get a loan or put the lender at risk.
That is why it is vitally important to hire a CCIM commercial broker to help with the analysis and presentation package. A 5 year analyis is critical to a commercial or multi-family project. Due diligence and proper analyses of income and expenses will save a lot of problems in the future.
If your comtemplating a commercial or multi-family purchase or sale, then here is the kind of Realtor that you want. A CCIM can run the cash flow analysis (Income and Expenses) to determine if you will make any money on the sale or purchase and how much or how little and then can adjust the price accordingly. Call or e-mail me.
A Certified Commercial Investment Member (CCIM) is a recognized expert in the disciplines of commercial and investment real estate. A CCIM is an invaluable resource to the commercial real estate owner, investor, and user, and is among an elite corps of more than 9,000 professionals who hold the CCIM designation across North America and more than 30 countries. Nearly 10,000 additional professionals are pursuing the CCIM designation.
Recognized for its preeminence within the industry, the CCIM curriculum represents the core knowledge expected of commercial investment practitioners, regardless of the diversity of specializations within the industry. The CCIM curriculum consists of four core courses that incorporate the essential CCIM skill sets: financial analysis, market analysis, user decision analysis, and investment analysis for commercial investment real estate. Additional curriculum requirements may be completed through CCIM elective courses, transfer credit for graduate education or professional recognition, and qualifying non-CCIM education. Following the course work, candidates must submit a portfolio of closed transactions and/or consultations showing a depth of experience in the commercial investment field. After fulfilling these requirements, candidates must successfully complete a comprehensive examination to earn the CCIM designation. This designation process ensures that CCIMs are proficient not only in theory, but also in practice.
With such a wide range of subjects to be mastered and in a dynamic business such as real estate, the educational process doesn't end once the designation is earned; there is a strong commitment among CCIMs to continuing education.
Only 6 percent of the estimated 150,000 commercial real estate practitioners nationwide hold the CCIM designation, which reflects not only the caliber of the program, but also why it is one of the most coveted and respected designations in the industry. The CCIM membership network mirrors the increasingly changing nature of the industry and includes brokers, leasing professionals, investment counselors, asset managers, appraisers, corporate real estate executives, property managers, developers, institutional investors, commercial lenders, attorneys, bankers and other allied professionals. Through this business network, CCIM members successfully complete thousands of transactions annually, representing more than $200 billion in value.
Certified Commercial Investment Members are in more marketplaces in North America -- 1,000 cities -- than all major real estate companies combined. Regions and chapters provide designees and candidates the opportunities to promote business and educational goals through local and regional forums and meetings.
Depends! The industry standard varies across the Country. A good Capitalization rate for Western Colorado is probably around 9.5% for some income producing properties. The Cap Rate for Multi-family could be different than a commercial building. A business opportunity is very difficult to sell based on a cap rate. Business Opportunities are more about making a living, so the approach to value is different, even though the methods of calculating are the same. More important than a Cap Rate, is a different way to measure the quality of the income stream. There are several methods. The best measure is Common Sense. I look at the income and do a rental market study to see if the stated income is really in the market, under market or over market. Then I look at expenses and determine if they are also reasonable. From there the determination of Net Operating Income can be found, financing can be plugged in and then the 5 or more year forecast can be done. Basically, you want to cover expenses, have a safe cushion on income and make a profit. Like 9.5% more or less on your investment.
That old saying,"Well if you did this remodeling", then you could increase income, Or "rents are Low". It is a given, if the owner could increase rents, or rents are low, they would increase rents to generate more income. That is what generating income is about and that is why investors buy an income stream---to make a profit.
Seems awfully hard to find good cash flow properties these days, that make sense financially. In commercial real estate it is the numbers that matter to the banks, investors and of course to the owners. Banks want safety, investors want return and owners want all the cash they can get, and me to. No matter how great the property, it is only as valuable as the income. Trying to sell an income producing property like a house puts the property in an unsaleable position, eventually makes owners angry and buyers move on to the next deal. A property across the street from my office is listed very high and people look at it all the time, but no deal, could it be!! The reason is the income cannot support the price and it doesn't matter what the brick an mortar seem to be worth, it still comes back to income. I am always looking for good salable properties.
We are looking for properties that will actually pay their way. That means that income must be more than expenses and cover Debt Service. Lenders look for a 1.25 Debt Coverage Ratio and that means that debt is covered by 25%. Investors want and need to make their investment back and also make a return on their investment, otherwise it "ain't worth it". It is a rude awakening to realize one day that income is less than expenses. That is what seems to be happening in the market around this small town of Montrose. Sellers, and only because of their Brokers, are trying to get every dollar out, which means, just like in the stock market, if there is no upside, there is no investment. Income producing is all about selling rights to appreciation, depreciation and cash flow. Selling cash flow is as different from selling a place to live as a VW bug is to a Hummer, they are both vehicles, but that is about all. That price listed on a commercial or multi-family property must have a margin or its like the bread man selling at or below cost. It won't work.
If you find a property that is seemingly a good deal in western colorado, let me know and I will pay a referral if we get the deal together.
I like to consider my self a real estate broker that specializes in Commercial Real Estate. Over the years, I have been involved in all areas of real estate and finally decided years ago that to be a better professional, I needed to get real good in one area. So I specialized in Commercial Real Estate and even narrowed that down to real estate that generates income. That area of expertise includes leasing, sales and business opportunities. Any commercial or multi-family property that produces income and is held for investment will get my attention. In becoming a specialist, I completed all the CCIM courses and I am a candidate member of the CCIM institute, (Certified Commercial Investment Member), and regularly use all the CCIM resources in my analysis of properties.
It seems in my market area, probably one of the hardest things to accomplish is to find income properties that will make sense financially and actually make a return on the investment. I know that owners of commercial or multi-family real estate and real estate brokers have a real problem pricing income properties. Then when the property sits for months or years unsold, people wonder why they invested in real estate in the first place.
There is a fine line between market value which we all want to achieve and investment value which is the only way an income generating property will usually sell. I usually ask are you selling this building as housing or are you selling the ability to make cash flow, which is investment value. If you are purchasing a place to live that has a value, but if you are purchasing to generate income that has a value, as well, and the two are different.