Doug Marshall's Blog, page 4

How to Get the Best Possible Loan for Your Property – Part I

Today, we are starting a three part series on how to get the best possible loan for your property. Today we begin the series by looking at the three options a borrower has for finding a loan for his property, They are: 

Go back to a lender you’ve already done business with
Shop the mortgage market on your own, or
Employ the services of a commercial mortgage broker

In the past, in an effort to sound objective, I would encourage people to choose the option that best met their needs.  No longer.  I believe you always want to use the services of a competent, journeyman commercial mortgage broker.  Why?  There are four reasons why this is true and Part I of this series discusses these four advantages over shopping the mortgage market on your own or going back to a lender you’ve already done business.  

Four Advantages of Using a Commercial Mortgage Broker


He knows more lending sources than you do.

The first step in shopping for a loan on your own is finding which lenders have the most competitive rates and loan terms. That is not an easy undertaking. The primary advantage of using a commercial mortgage broker is that he knows the lenders who have the most competitive rates and terms. Not all lenders are interested in your specific loan, but a broker likely knows those lenders who are. In fact, it’s his job to know.

A good commercial mortgage broker regularly works with five to fifteen lenders, depending on who is the most competitive at the moment for a particular property type. Sometimes he knows that his most trusted lending sources do not have the rate and terms he needs to win the business. When that happens, a good broker has another ten or more lenders he has called on over the years who would be eager to do business with him again. He will find the most competitive loan terms because, if he doesn’t, he will not get your business.

He has already established a relationship based on trust with his lending sources.

This is one of the most overlooked advantages of employing his services. Developing trust between the borrower and the lender is essential for insuring a successful loan outcome. In commercial real estate, trust is everything. It is absolutely vital for getting a transaction completed.

If you’ve never worked with a particular lender, a trust relationship has not been established. On the other hand, a commercial mortgage broker may have worked on several loans with this lender. They know each other. They know each other’s idiosyncrasies, and because of their prior relationship, there is a higher probability of getting the loan closed with a commercial mortgage broker than by you going directly to the same lender. That’s right. You, the borrower, can go to the same lender and be turned down for a loan because you have no relationship with the lender.

The commercial mortgage broker, on the other hand, has done several deals with this lender, and because they know and trust each other, the lender is willing to proceed with a loan application. As a borrower, why not take advantage of these established relationships between the commercial mortgage broker and the lender? Why not leverage those relationships?

Now some people will say that using a commercial mortgage broker will cost you an additional loan fee. That could happen, but it may not. It just depends on the lender. Let’s assume for the moment that such a fee is charged to you. Many times, because the commercial mortgage broker knows where to go to get the best rates and terms, any additional fee is more than offset by a lower interest rate, a longer amortization, or more loan dollars than what you would have found shopping the mortgage market on your own. The old saying “Penny wise, pound foolish” applies here. You may save some money on the front end by not using the services of a commercial mortgage broker if he charges an additional loan fee. But you could easily pay out much more money on the back end without his expertise and relationships.

Compared to shopping the market on your own, this option takes significantly less time and effort.

If you use a commercial mortgage broker, he will do the heavy lifting of finding the right lender and processing the loan. This will save you a great deal of time and effort.

A commercial mortgage broker can be your best advocate should things go wrong.

There are times in the loan process where you need someone to be your advocate, someone who strenuously defends your best interests. This can best be accomplished by a commercial mortgage broker who has an established relationship with the lender. The lender wants to keep the commercial mortgage broker happy because she doesn’t want to jeopardize her relationship with him. He brings her deals, which is in her best interest. She wants him to continue bringing deals to her, so it’s in her best interest to be fair to his clients or next time he may go to one of her competitors.

Now compare the commercial mortgage broker’s importance to the lender with your importance to the lender. In most instances, lenders will likely see you as a “one-off” transaction and won’t consider the loss of your loan as having anywhere near the impact of losing a valued relationship with a mortgage broker. Now consider the loan officer. Can the lender’s loan officer adequately fill this role of advocate if something were to go wrong with the loan? She works for the lender. She is being paid by the lender. Whose best interest do you think she is looking after? Yours or the bank’s?

So the commercial mortgage broker is your best choice to be your advocate if things go wrong with your loan. Neither you nor the loan officer can fill that need nearly as well as the commercial mortgage broker can. A good commercial mortgage broker will “go nuclear” if the actions of the lender are so egregious that it requires drastic measures to handle what she’s done.

The Nuclear Option

Years ago, a lender approved a loan for one of my clients as proposed on the letter of interest. But prior to closing the loan, the lender changed their minds without notifying the borrower or me that they had reduced the amortization from twenty-five years down to fifteen years, effectively killing the property’s cash flow. The reduced amortization was only revealed at closing. I told my client to walk out of the closing without signing anything. The borrower was distraught.

I then wrote a letter to the loan officer’s superior that included a copy of an email from the loan officer stating that the loan was approved with a twenty-five-year amortization. I went on to say in my letter that if the borrower decides to litigate this matter, I would be more than willing to testify on his behalf. In response, the lender decided to honor the original twenty-five-year amortization. And because I chose to go to bat for my client, I lost what had been a good lending relationship. But a good commercial mortgage broker does what he has to in order to protect his client.

So these are my reasons why I believe employing the services of a commercial mortgage broker.  Those are my thoughts.  I welcome yours.

Doug Marshall is the award winning author of Mastering the Art of Commercial Real Estate Investing.  Check it out on Amazon.

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The Boy and the Starfish: Choose Your “Mike”

Readers, I’m a bit slow getting back into my blogging routine after the holidays.  So I’ve dusted off an article I wrote a couple of years ago that was originally well received.  I look forward to your comments.

About ten years ago my wife Carol and I had the idea of starting a ministry to the hungry and the lonely.  It eventually became known as The Jesus Table where people meet every Tuesday night for a meal and a conversation.  When we started we really didn’t know what we were doing.  We were learning on the fly.

One of the ideas that has become a signature part of this ministry was having table hosts at every table.  There are many benevolent meal sites throughout the Portland metro area.  What I believe makes The Jesus Table unique is our table hosts.  Every week our table hosts, host the same table.  Over time, our guests begin developing a relationship with the table host of their choosing.  The relationship starts slowly but as the years go by a deep friendship develops.  You see, our guests come for the meal (which is excellent by the way) but their much deeper need is to know that someone cares for them.

My Friend Mike

One of our regular guests at The Jesus Table for a meal was Mike (not his real name).  When Mike originally came several years ago he was addicted to methamphetamine.  But as the month’s progressed he was doing all the right things to live clean and sober.  For a couple of years Mike did well with managing his addiction.  And then one day, Mike relapsed.

The Boy and the Starfish

Mike’s relapse reminds me of the story of the boy and the starfish.  There was a young boy walking along the beach.  The night before there had been a violent storm at sea and the seashore was littered with tens of thousands of starfish.  As the warmth of the morning sun heated up the sand, the starfish were doomed to die if they didn’t make it back into the water.  The boy understood their fate and was tossing them back into the ocean when an old man approached him.  He said to the boy, “Don’t you realize your task is hopeless?” as the old man looked at all the starfish on the beach.  The boy replied, “Not to this one it isn’t,” as he tossed another starfish back into the ocean.

The Evil of Addiction

When Mike relapsed, I felt the emotional pain of losing a friend to the evil of addiction.  It hurt deeply.  The good news is that Mike’s relapse was short and he’s back on the road to recovery.  But the lesson I learned is this: I can’t help everyone who is addicted.  The task is overwhelming, but I can help one person in their addiction.  And I choose Mike.  I asked Mike if he would like to get together once a week to share a meal and a conversation one-on-one.  Sometimes we read through and discuss a book of the Bible; other times we discuss a secular book that has sound, practical wisdom on how to tackle the challenges of life.  But I believe the real hook for Mike is that he realizes someone who is normal (his word for describing the non-addicted) cares for him.

Choose Your “Mike”

There are very few families in this country today that are not adversely affected by the epidemic of drugs and alcohol ravaging our country.  If you are one of the fortunate few who don’t have at least one family member caught in the web of addiction, then you have a friend or a co-worker who is.  You can’t help everyone, but you can choose to help someone.  Choose your “Mike.”  They need to know that someone – you – truly cares.

Source: The Starfish Story: one step towards changing the world by Peter Straube, Events for Change, June 5, 2011,  https://eventsforchange.wordpress.com...

 

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My 10 Most Favorite Books of 2019

This blog post is devoted to sharing ten of my most favorite books I read in 2019. You’ll see that I like to read a variety of books. If you’re interested in learning more about a particular book, click on the book title and the link will take you to its Amazon page.

#10 – Dark Matter: A Novel by Blake Crouch, Genre: Science Fiction

I rarely read science fiction.  And my wife, Carol, reads even less than I do.  So when she recommended this book, I was more than a bit surprised.  It is written such that the science fiction aspect of the book seems reasonably plausible.  So I wasn’t having a recurring conversation with myself about “that would never happen.”  Instead I had several conversations with my wife about plot twists that kept the story flowing and unpredictable right to the very last page of the book.  Bottomline: If you want to read a real page turner this is the book for you.

#9 – Hank and Jim: The Fifty-Year Friendship of Henry Fonda and James Stewart by Scott Eyman, Genre: Biography

Henry Fonda and James Stewart are two of my favorite actors of all time, and probably yours too.  Their close friendship started when they met for the first time in a small theater group in New York.

Hank and Jim were an interesting study in contrast.  Hank was a liberal Democrat who was married five times with strained relationships with his children.  Jim, on the other hand, was a staunch Republican married to his wife, Gloria, for 45 years with close, affectionate family ties with his four children.  And yet the relationship between the two iconic actors was strong and enduring to the end.

The book takes you down memory lane discussing the movies and the stories behind the movies that both are known for.  The persona that Jimmy Stewart had on screen was very similar to who he was as a person.  In contrast, Henry Fonda in real life was cold and very aloof who had very few real friends.

I had known that Jimmy Stewart was a WWII bomber pilot but this book went into greater detail about this part of his life.  The recounting of his military service may have been the most interesting part of the book.  A fun read.

#8 – The Beekeeper’s Apprentice by Laurie R. King, Genre: Sherlock Holmes

Almost 40 years ago, I made a serious attempt to read all of the Sherlock Holmes stories by Sir Arthur Conan Doyle.  I don’t believe I read them all, but I certainly read many of them.  The Beekeeper’s Apprentice is a continuation of the Sherlock Holmes genre.

In the first chapter of the book, Holmes has retired to the countryside to study the life of bees when Mary Russell, a young teenager literally stumbles onto him.  This begins the relationship between the quirky, brilliant Sherlock Holmes and Mary Russell who has an equally brilliant mind.  Holmes realizing Ms. Russell’s many exceptional qualities befriends the recently orphaned young woman and becomes her mentor.

The author, Laurie King, continues the writing style of Arthur Conan Doyle’s.  The twists in the plot line and ability to deduce meaning from seemingly insignificant clues is classic Sherlock Holmes at its very best.  But I believe she improves upon Conan Doyle’s writing style by adding a secondary subplot between Holmes and Russell.  It almost reads like a love story.  The emotion between the two main characters is more than a father’s affection for his daughter but less than the attraction between two lovers.  It’s something in between. They slowly over time develop a deep love and concern for the other.  In my opinion it is an improvement over the original author’s writing style as it shows a more nuanced side of Sherlock Holmes.  I enjoyed this book immensely.

#7 – A Man on the Moon: The Voyages of the Apollo Astronauts by Andrew Chaikin, Genre: History of Space Flight

The book is based on in depth interviews with twenty-three of the twenty-four astronauts that walked the surface of the moon plus many others who worked tirelessly to make the Apollo space program a success.  I expected that this topic would be rather dry and predictable since I knew the history of the space race.  But the author makes the story come alive by delving into the personalities of the main characters that we have come to know only superficially.

In addition, there were many critical decisions that were made during the Apollo program that were kept from the American public.  We didn’t realize how truly dangerous it was for the astronauts to fly into space.  We thought is was all fairly routine.  This book reveals that it was not.

An example was the first landing on the moon.  The public was led to believe the lunar module landed without incident.  Not true.  Neil Armstrong realized that the lunar module was headed for a debris field of boulders that would have caused a crash landing.  At the last moment he took manual control of the lunar module.  He landed the craft several miles from the proposed landing site with only 20 seconds remaining before the mission was to have been aborted.  A bit of history that most of us are totally unaware of.

If you want to read just one book on the history of the Apollo space program, this is the book.

#6 – Leadership: In Turbulent Times by Doris Kearns Goodwin, Genre: US Presidents

The author, Doris Kearns Goodwin, reveals the leadership skills of four presidents – Abraham Lincoln, Theodore Roosevelt, Franklin D. Roosevelt and Lyndon B. Johnson.  My initial reaction to including Lyndon Johnson to this list was skepticism but by the time I finished the book I realized that I had underestimated President Johnson’s leadership skills.

It is interesting to discover that all four presidents had very significant setbacks that disrupted their lives and could have ended their public ambitions before they got started.  All four persevered through these very personal traumas that most people would have given up on life.

Goodwin acknowledges that there are no common patterns among the four leaders.  They have significantly different backgrounds, abilities, and temperaments and yet all tackled the moral crises of their times.

This is the second book that I have read by this author and I look forward to reading her other books.  She is a gifted writer with the ability to draw out the personalities of each of her subjects.  It was a surprisingly easy read.  Enjoyed it a lot.

#5 – Devil in the Grove: Thurgood Marshall, the Groveland Boys, and the Dawn of a New America by Gilbert King, Genre: Civil Rights

Here is a summary of the book on its Amazon book page:

“Arguably the most important American lawyer of the twentieth century, Thurgood Marshall was on the verge of bringing the landmark suit Brown v. Board of Education before the U.S. Supreme Court when he became embroiled in a case that threatened to change the course of the civil rights movement and cost him his life.

In 1949, Florida’s orange industry was booming, and citrus barons got rich on the backs of cheap Jim Crow labor with the help of Sheriff Willis V. McCall, who ruled Lake County with murderous resolve. When a white seventeen-year-old girl cried rape, McCall pursued four young blacks who dared envision a future for themselves beyond the groves. The Ku Klux Klan joined the hunt, hell-bent on lynching the men who came to be known as “the Groveland Boys.”

Associates thought it was suicidal for Marshall to wade into the “Florida Terror,” but the young lawyer would not shrink from the fight despite continuous death threats against him.

Drawing on a wealth of never-before-published material, including the FBI’s unredacted Groveland case files, as well as unprecedented access to the NAACP’s Legal Defense Fund files, Gilbert King shines new light on this remarkable civil rights crusader.”

The story of the Groveland boys opened my eyes like no other book I’ve read to the extent of racism in the deep South during the 1950s.

#4 – The Compelling Communicator: Mastering the Art and Science of Exceptional Presentation Design by Tim Pollard, Genre: Communication Skills

I read a lot of self-help and business books.  These types of books are among my favorite to read.  This year was no different, with one notable exception: the books I read in these two genre’s, for whatever reason, were not up to my standard.  That is, not until I read The Compelling Communicator.  It is the only book in these two book categories to make my list of top ten books for 2019.

As I’m receiving more requests to speak (I gave about 50 radio or podcast interviews this year promoting my book) I’ve realized I need to up my game when it comes to making presentations.  I’ve read some really well written books on public speaking but this book is the best one in this category.  Why?  Because it not only tells you how to give a memorable and compelling presentation, it also tells you why the steps to good communicating work.  It focuses on the science behind what makes a good presentation.

The author also identifies the mistakes most speakers make that ensures their presentations will be quickly forgotten.  And if the goal of a presentation is to get the audience to do something, then a quickly forgotten presentation fails miserably at accomplishing its primary purpose.  Read this book if you want to improve your presentation skills.

#3 – First: Sandra Day O’Connor by Evan Thomas, Genre: Biography

In the past two years I’ve read four biographies on U.S. Supreme Court Justices: Thurgood Marshall (see summary above), Antonin Scalia, Ruth Bader Ginsburg and Sandra Day O’Connor.  The O’Connor biography was by far the best written of the four.

What follows are a couple of paragraphs from the book’s Amazon page:

“She was born in 1930 in El Paso and grew up on a cattle ranch in Arizona. At a time when women were expected to be homemakers, she set her sights on Stanford University. When she graduated near the top of her law school class in 1952, no firm would even interview her. But Sandra Day O’Connor’s story is that of a woman who repeatedly shattered glass ceilings—doing so with a blend of grace, wisdom, humor, understatement, and cowgirl toughness.

She became the first ever female majority leader of a state senate. As a judge on the Arizona Court of Appeals, she stood up to corrupt lawyers and humanized the law. When she arrived at the United States Supreme Court, appointed by President Ronald Reagan in 1981, she began a quarter-century tenure on the Court, hearing cases that ultimately shaped American law. Diagnosed with cancer at fifty-eight, and caring for a husband with Alzheimer’s, O’Connor endured every difficulty with grit and poise.”

#2 – A Gentleman in Moscow: A Novel by Amor Towles, Genre: Political Fiction

This was by far the best novel I read this year.  The story opens in 1922 during the Bolshevik Revolution in Moscow, Russia.  The book’s Amazon page summarizes the story well: “Count Alexander Rostov is deemed an unrepentant aristocrat by a Bolshevik tribunal, and is sentenced to house arrest in the Metropol, a grand hotel across the street from the Kremlin. Rostov, an indomitable man of erudition and wit, has never worked a day in his life, and must now live in an attic room while some of the most tumultuous decades in Russian history are unfolding outside the hotel’s doors.”

The humor, the plot lines, the cast of characters and the eventual triumph of good over evil makes this book one for the ages.  A Gentleman in Moscow will be read a hundred years from now.

#1 – Grant by Ron Chernow, Genre: Biography

Over the years I have read several excellent books on the Civil War and biographies on Abraham Lincoln and Robert E. Lee.  I’ve also read the autobiography of Ulysses S. Grant.  In each of these books I’ve come away with a better understanding of U.S. Grant.  But none of the books I’ve read on Grant can compare to Ron Chernow’s deep look into the man who led the Union armies to victory in the Civil War and his subsequent two terms as President of the United States.

This book is truly outstanding and is deserving of eclipsing his other better known biography on Alexander Hamilton.  Chernow does an excellent job fleshing out Grant’s humility and moral character, his intellect and leadership skills.  The book also gives numerous examples of his gullibility of trusting, untrustworthy people resulting in many embarrassing episodes in his life.  If you’re going to read only one book in 2020 this is it.

These are my favorite books of 2019.  What have you read lately that you would recommend?

Doug Marshall is the award winning author of Mastering the Art of Commercial Real Estate Investing.  Check it out on Amazon.

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5 Lessons Warren Buffett Learned from Investing in Real Estate

As you already know, Warren Buffett, the CEO of Berkshire Hathaway, made his considerable fortune investing in the stock market.  Fortune magazine has consistently ranked him as one of the wealthiest people on the planet with a net worth approaching $80 billion.  Not too shabby!

But unknown to most people are Mr. Buffett’s two small real estate investments that he made long ago that have amply rewarded him for his willingness to invest outside his area of expertise.  And far more important than their profitability were the five common sense principles he learned from his real estate investments.

Real Estate Investment #1

In 1986, he purchased a 400-acre farm located outside of Omaha, Nebraska.  He purchased the farm from the Federal Deposit Insurance Corporation (FDIC) who had inherited it from a bank that failed.  Mr. Buffett admits that he knows nothing about farming but he has a son who loves to farm so he turned the day-to-day operations over to him.

Although Mr. Buffett admits his lack of farming acumen he could easily recognize that purchasing the farm was a good investment decision.  As he said, “I needed no unusual knowledge or intelligence to conclude that the investment had no downside and potentially had substantial upside.”  Three decades later, the farm has tripled its earnings and is now worth five times what he paid for it.

Real Estate Investment #2

In 1993, he purchased a retail property located adjacent to New York University that the Resolution Trust Corporation (RTC) was selling.   A real estate bubble had popped and the RTC had been created to dispose of assets of failed savings institutions.  His investment analysis was very rudimentary.  The property had been poorly managed by the previous owner and then by the RTC.  The vacancy at the property was well above the market’s vacancy rate for no apparent reason.  The largest tenant’s rent was $5.00 per square foot compared to all the other tenants’ rent averaging $70.00 per square foot.   He realized that when the current lease term expired for this tenant that the new rent on this space would improve the property’s cash flow dramatically.

And like the time he purchased the farm, he realized that he needed to turn the management of the property over to an experienced property manager, which he did.  Over a relatively short period of time, the new property manager was able to lease the vacant space and to raise to market the rent on building’s largest tenant.  As a result, the property’s net cash flow tripled and annual distributions currently exceed 35 percent of his original investment.

5 Lessons Buffett Learned From Investing in Real Estate

So what has Mr. Buffett learned from his two real estate investments?

Notice that he bought both properties out of foreclosure when the real estate market was at the bottom of the cycle.  “I will tell you how to become wealthy,” Mr. Buffett once said. “Be fearful when others are greedy.  Be greedy when others are fearful.”  When he bought these two properties most investors were out of the market, fearful that real estate wasn’t ever going to turn around.  Mr. Buffett knew differently and acted upon it.
You don’t have to be a real estate expert to achieve satisfactory investment returns.  But you do need to turn over management of the property to someone who is well qualified to manage the property for you.
You don’t need to do a sophisticated investment analysis to determine whether to purchase a property.  Many times a common sense look at the property will do.  Ask yourself, “What is holding this property back from operating well?”  If you can answer this question and you’re confident that you can correct the problem, then buy the property.
Investing over the long term will eventually solve most problems.  Notice he still owns these two properties, one he bought in 1986 and the other he bought in 1993.  As he likes to say, “Our favorite holding period is forever.”
He didn’t concern himself about their daily valuations.  He understood that he bought the properties at bargain prices and that overtime they would make good investments.  “Games are won by players who focus on the playing field,” he quipped, “not by those whose eyes are glued to the scoreboard.”

How about you?  What common sense principles have you learned from investing in real estate?  I would be interested in hearing from you.

Sources: Buffett’s annual letter: What you can learn from my real estate investments by Warren Buffett, Fortune magazine, February 24, 2014; The World’s Most Powerful People, 2016 Ranking – #15 Warren Buffett, Fortune magazine, September 2016

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How To Make A Compelling & Memorable Presentation

Every presentation is ultimately about getting action.  We present for a reason.  We want people to do something, so says Tim Pollard, author of The Compelling Communicator.  Like most people, it’s not a skill that comes naturally to me.  Recognizing this weakness I’ve decided to make a concerted effort to improve my presentation skills.

I have read several books on this subject.  Other books I would also recommend are Talk Like TED: The 9 Public-Speaking Secrets of the World’s Top Minds by Carmine Gallo and TED Talks: The Official Guide of Public Speaking by Chris Anderson.

All three books are good reads but I would rank Tim Pollard’s book a step above the other two.  Why?  Because The Compelling Communicator not only tells you how to give a memorable presentation, it also tells you why the steps to good communicating work.  It focuses on the science behind what makes a presentation memorable.

The author also identifies the mistakes most speakers make that insures their presentation will be quickly forgotten.   And if the goal of a presentation is to get the audience to do something, then a quickly forgotten presentation fails miserably at accomplishing its primary purpose.

With that introduction, let’s walk through the highlights of The Compelling Communicator.  Understand this: this book is almost 300 page long.  It’s hard for me to do it justice with 1,000 word blog post.  Consider what follows as my main takeaways from the book.  But if you’re interested in how to give a good presentation I highly recommend you read the book.  Here are some excerpts from the book:

Four Key Takeaways from the Book

You always want your audience to do something, even if it’s only mental assent. Since this action is the purpose of the presentation, make sure you know what it is.
The single biggest key to extraordinary communication is one simple idea: Whenever you communicate, what you are trying to do is: Powerfully land a small number of big ideas.
If we are trying to powerfully land a small number of big ideas, then the defining question of any presentation design has to be: What are those ideas and where do they come from?
For any presentation to be declared successful, it must live on after the presentation.  Its big ideas need to stick; they need to be remembered, retold, and acted upon in the days and weeks to come.

Key #1: Make Sure You Know Action You What Want The Audience To Take

Almost all presentations contain a ton of material that the audience doesn’t actually need to know.  Somewhere between 50% to 70% of the material in a typical presentation simply isn’t needed.  In contrast, relevance comes from starting with the action you want your audience to take, and working back from there.

Hence, the first question is: What is the desired outcome of this presentation?
From which naturally flows the second question: Exactly what argument (content, structure, illustration) will get me to that outcome?

Key #2: Powerfully Land a Small Number of Big Ideas

The human brain doesn’t do very well at storing and retrieving facts and data, especially large quantities of facts and data.  But the brain traffics very well in ideas. Everything we do as presenters needs to be about finding and nailing those big ideas.  When you give an audience the big idea that emerges from your data rather than just the data, it’s exactly what the reductionist brain wants.

Many presentations follow a pattern of long on facts, but short on insight.  Instead of fully landing a small number of big ideas, they weakly land a larger number of trivial ones.

Your audience has a finite capacity to absorb information, and when you overload that limit, they shut down.

The brain processes new information with “working memory.” We can think of working memory as the brain’s first port of call for new information, so it’s what you use to process what you’re seeing, hearing, smelling and so on.  The problem is, working memory is extremely limited.

You must not exceed the brain’s capacity to absorb, and because this is truly a biological limitation, it’s not a rule you can bend simply because you feel like it.  When you overload an audience with information, the audience is not giving up because it’s irritated and doesn’t want to follow, it’s giving up because it can’t follow.

Key #3: Presentation Design is What Matters Most

Presentation design is about asking and answering a series of questions that govern everything that follows, such as:

What is the action I want from this presentation?
What argument will most likely get me to that outcome?
What is the right flow of that argument?
What are my big ideas and how am I going to land them in the most compelling way?

Key #4: How to Make a Memorable Presentation

How do you make a memorable presentation?  By using the correct blend of three tools:

Their narrative
Their visuals
And the handout they give to the audience

It is the correct use of and interaction between these three things that creates long-term stickiness, and of particular importance is the handout or leave-behind.

You must create a handout with the specific purpose of providing the critical information the audience needs to remember, so they don’t get distracted taking notes.

It should contain your key ideas and all the pertinent information that supports those ideas.  And to integrate it properly into the presentation, as you present, you need to follow and frequently reference where you are in the handout.

For a typical one-hour presentation, a simple one-page handout will usually suffice.  Word is often perfectly adequate to create the handout but InDesign is exceptional.  It doesn’t need to be flashy; it only needs to contain the important information.

The presenter’s highest standard of success is “retellability.”  You want your story to stick so well that it can be retold.

I thought the book was excellent primer on how to give a good presentation that is memorable.  If you would like a short summary of the book click on this link.

That’s my opinion.  I welcome yours.  What are your thoughts about making a good presentation?

Doug Marshall is the award winning author of Mastering the Art of Commercial Real Estate Investing.  Check it out on Amazon.

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5 CRE Metrics Every Successful Investor Needs To Know – Part V

Before you can analyze the merits of a for-sale listing you need to have a basic understanding of the property’s numbers.  By that I mean you need to thoroughly understand:

How a property is valued
How a loan amount is calculated
How a property’s cash-on-cash return is calculated
How loan amortization impacts a property’s cash-on-cash return
How leverage (the amount of debt borrowed to purchase the property) affects a property’s cash-on-cash return

“In your sleep”

You not only need to know the importance of these numbers, but you need to know how to do these calculations “in your sleep.”  They need to become second nature to you.

In the first part of this five part series we discussed how a property is valued. In the second part of the series we discussed how the loan amount is calculated.  The first two CRE metrics admittedly were very basic but absolutely necessary for a foundational understanding of CRE underwriting.  The third part of the series, how a property’s cash-on-cash return is calculated, was an introduction to that topic.  It was anything but basic.  We discussed the important difference between Return on Investment and Return on Equity.  The fourth part of the series discussed how loan amortization impacts a property’s cash-on-cash return.   The fifth and final metric all successful real estate investors should know “in their sleep” is how financial leverage affects a property’s cash-on-cash return.

CRE METRIC #5 – HOW LEVERAGE AFFECTS A PROPERTY’S CASH-ON-CASH RETURN

Let’s begin with the basics. Do you understand what I mean when I say leveraging a property? It means the buyer is using debt to help purchase the property. And the more debt the borrower puts on his property, the more he is leveraging the property. In other words, a property that has a 65% LTV loan is more leveraged than a property with a 50% LTV loan. And a property with a 75% LTV loan is more leveraged than a property with only a 65% LTV loan.

Lowering the interest rate or lengthening the amortization improves the property’s cash-on-cash return. Why? Because in both examples, the monthly mortgage payment is reduced. And reducing the monthly mortgage payment increases the property’s cash flow after debt service (CFADS). Right?

So what does increasing the loan amount (adding more leverage) do to the property’s cash-on-cash return?

A. It increases the cash-on-cash return

B. It decreases the cash-on-cash return

C. It has no impact on the cash-on-cash return

D. Not enough information to make a determination

The answer is D. It depends. It depends on whether we are in a positive, neutral or negative leverage environment.

The Impact of Positive Leverage

For the past 25 years we have generally been in a positive leverage environment. By that I mean, if a borrower added another dollar of debt when financing his rental property, it would have a positive impact on the property’s cash-on-cash return (COCR). The more the property was leveraged, the better the return. Purely from a financial return point of view, it has made perfect sense over these years to add as much debt as possible when financing a rental property.

The Impact of Negative Leverage

Occasionally, the real estate market enters into a “perfect storm” scenario where cap rates continue compressing while interest rates increase dramatically. When these two factors converge a negative leverage environment results. By that I mean, the more a property is leveraged, the worse its COCR.

This “perfect storm” scenario existed for much of 2018. Cap rates had been slowly but steadily compressing ever since the Great Recession of 2009. But it didn’t matter to the average investor because interest rates during this time had slowly but steadily declined as well. Real estate investors could pay more for a property because the steady decline in interest rates promoted a healthy COCR.

But this all changed beginning in the fall of 2017. From October of 2017 through October of 2018 interest rates zoomed up 100 basis points, i.e., interest rates rose a full one percent. While this rise in interest rates was going on, cap rates held steady. Sellers were unwilling to lower their prices assuming buyers would capitulate to their asking prices because it was still a seller’s market.

During this time I had a client who was in the process of purchasing a NNN lease, single tenant building. The property had Net Operating Income of $227,369. The question I asked my borrower was how much debt did he want to finance on his purchase? I showed him four financing options: No leverage, 50%, 65% and 75% leverage. Shown below are the results of leverage on the property’s COCR. Each column represents one of the four financing options.

An Example of Neutral Leverage

Owning the property debt free resulted in a COCR of 6.2%. And as you can see the more debt that was added to finance the property, the lower the property’s COCR.

Being curious, I wondered at what interest rate would adding debt result in neutral leverage? By neutral I mean it would not help or hurt the property’s COCR. It turns out in this particular case that an interest rate of 4.65% resulted in neutral leverage as shown below.

An Example of Positive Leverage

Some of you may be thinking that adding debt of any amount will always have a negative impact on the property’s COCR. Not so. To prove my point, shown below I lowered the interest rate to 4.0%.

As you can see, with a 4.0% interest rate, the more you leverage the property, the higher, the COCR.

How a Negative Leverage Environment Occurs

Let me repeat myself. (I’m old, that’s what old people do.) A negative leverage environment is a direct result of rapidly rising interest rates while capitalization rates remain the same. During the twelve month window, from October 2017 to October 2018, interest rates rose a full point. Everything being equal, when interest rates rise, mortgage payments increase which reduces the property’s cash flow after debt service (CFADS). A lower CFADS reduces the property’s COCR. If this trend were to continue long enough, buyers will stop buying. It’s as simple as that.

To reverse this trend, either cap rates must rise (i.e., property values decline) to compensate for higher interest rates or interest rates need to rapidly decline to where they once were. Fortunately for the real estate market, interest rates have declined dramatically. As of this writing (August 16, 2019) interest rates have declined 150 basis points since October of 2018. That’s huge!!

Why Should We Care?

Why should we care that we are no longer in a negative leverage environment? A continuing negative leverage environment would have been one more nail in the coffin of the current real estate market cycle, to go along with:

Moderating rent increases
More product coming online which will slowly increase vacancy rates
Rent concessions in some neighborhoods for the first time in years
More regulations to reign in the rights of property owners

Fortunately, the real estate market dodged a bullet to the forehead when rates plummeted, and it is now once again in a positive leverage environment.

That’s my opinion.  I welcome yours.  What are your thoughts about the impact of positive, neutral and negative leverage on investing in commercial real estate?

Doug Marshall is the award winning author of Mastering the Art of Commercial Real Estate Investing.  Check it out on Amazon.

The post 5 CRE Metrics Every Successful Investor Needs To Know – Part V appeared first on MarshallCf.

5 CRE Metrics Every Successful Investor Needs to Know – Part IV

Before you can analyze the merits of a for-sale listing you need to have a basic understanding of the property’s numbers.  By that I mean you need to thoroughly understand:

How a property is valued
How a loan amount is calculated
How a property’s cash-on-cash return is calculated
How loan amortization impacts a property’s cash-on-cash return
How leverage (the amount of debt borrowed to purchase the property) affects a property’s cash-on-cash return

“In your sleep”

You not only need to know the importance of these numbers, but you need to know how to do these calculations “in your sleep.”  They need to become second nature to you.

In the first part of this five part series we discussed how a property is valued. In the second part of the series we discussed how the loan amount is calculated.  The first two CRE metrics admittedly were very basic but absolutely necessary for a foundational understanding of CRE underwriting.  The third part of the series, how a property’s cash-on-cash return is calculated, was an introduction to that topic.  It was anything but basic.  We discussed the important difference between Return on Investment and Return on Equity.  I recommend that you review that article before proceeding with today’s discussion on loan amortization as the cash-on-cash return example provided in the previous article is carried forward into today’s presentation.

CRE METRIC #4 – HOW LOAN AMORTIZATION IMPACTS A PROPERTY’S CASH-ON-CASH RETURN

Amortization is the gradual pay down of a mortgage with regular payments over a specified period of time.  The loan amortization period sets the amount of periodic payments required to pay off a debt obligation.  Each payment is used to pay interest on the loan and reduce its principal.  That is a textbook definition of amortization.  However financing commercial real estate has a few unique caveats that need to be mentioned.

Bullet Loans

Almost all commercial real estate loans are bullet loans.  A bullet loan is a loan that requires a balloon payment at the end of the term.  A typical real estate loan is a 10-year fixed rate loan amortized over 25 or 30 years.  At the end of the 10th year the loan is due and the principal balance must be paid.  So what does the owner do at the end of the 10th year to pay off the loan?  He either refinances the property or he sells it.

As a result, very few commercial real estate properties are without debt.  It really makes no sense to own a property free and clear because it adversely impacts your ROE.  In other words, to optimize your property’s ROE, it’s typically better to leverage your property with a modest amount of debt than to own a property without any debt.

Actual/360 vs 30/360 Amortization Methods

Historically, mortgage payments have been calculated based on a 30/360 basis. In other words, it is assumed that each month has 30 days and therefore each year 360 days. This allows for easy calculation of interest rates and amortization schedules. Your calculator or computer uses a 30/360 calculation for determining mortgage payments.

Actual/360 payments became popular in the 1990s. Not surprisingly, it is a way to make an interest rate sound better than it actually is.  This amortization method has the borrower paying interest for the actual number of days in a month. This results in the borrower paying interest for 5 or 6 additional days a year. A lender using an Actual/360 amortizing method can quote a lower spread and rate on a transaction but actually collect the same or greater amount of interest each year.

Interest Only Loans

To entice borrowers to borrow from them, some lenders offer interest only (I/O) loans.  An I/O loan is a loan in which the borrower pays only the interest for some or all of the term, with the principal balance unchanged during the interest-only period.

It is not uncommon for lenders to offer two or more years of interest only with the remaining term of the loan being amortized.  Why would borrowers like I/O?  As you will see in the example that follows, I/O is a great boost to a property’s COCR during the interest only phase of the loan.

An Example of the 3 Amortization Methods

Shown below are examples of each type of amortization method.  In each case, the loan amount is $684,000 and the interest rate is 5.0%.

To summarize the three amortization methods are:

30/360 – Interest calculated on 30 day months
Actual/360 – Interest calculated on actual days in the month
Interest Only – No amortization of the loan

 

 

 

Summarized above are the results for each of the amortization methods.  Notice that the annual mortgage payments are identical for the 30/360 and Actual/360 amortization methods.  But notice that the Actual/360 amortization method results in slightly more interest expense than the 30/360 amortization method. This is due to calculating the interest expense based on 365-day year rather than a 360-day year like the 30/360 method. More interest expense for the Actual/360 method means less principal pay down.

The Benefit of Interest Only Loans

But more importantly notice that the Interest Only/No Amortization method results in significantly less annual mortgage payments, $34,200 compared to $47,983 for either of two amortization methods.  So let’s revisit the ROE calculation.

Recall that original Return on Equity (ROE) was calculated to be 3.8% based on cash flow after debt service (CFADS) of:

$60,000 NOI – $48,000 DS = $12,000 CFADS

That is true assuming the loan is amortized by either the 30/360 method or the Actual/360 method.  But the CFADS changes significantly if the mortgage payment is Interest Only as shown below:

$60,000 NOI – $34,200 DS = $25,800 CFADS

With Interest Only the property’s ROE is:

$25,800 NOI ÷ $316,000 Owner’s Equity ($1,000,000 Value – 684,000 Existing Loan Balance = 8.2%

So which would you prefer?  A 3.8% ROE or an 8.2% ROE?  It seems like a no brainer to me.  And that is why an interest only loan for the first couple of years should be preferred over an amortizing loan.

Those are my thoughts.  I welcome yours.  What is your opinion of interest only loans?

Doug Marshall, CCIM is the award winning author of Mastering the Art of Commercial Real Estate Investing.  Check it out at Barnes & Noble.

The post 5 CRE Metrics Every Successful Investor Needs to Know – Part IV appeared first on MarshallCf.

5 CRE Metrics Every Successful Investor Needs To Know – Part III

Before you can analyze the merits of a for-sale listing you need to have a basic understanding of the property’s numbers.  By that I mean you need to thoroughly understand:

How a property is valued
How a loan amount is calculated
How a property’s cash-on-cash return is calculated
How loan amortization impacts a property’s cash-on-cash return
How leverage (the amount of debt borrowed to purchase the property) affects a property’s cash-on-cash return

“In your sleep”

You not only need to know the importance of these numbers, but you need to know how to do these calculations “in your sleep.”  They need to become second nature to you.

In the first part of this five part series we discussed how a property is valued. In the second part of the series we discussed how the loan amount is calculated.  The first two CRE metrics admittedly were very basic but absolutely necessary for a foundational understanding of CRE underwriting.  Today, we will discuss how to calculate a property’s cash-on-cash return.

CRE Metric #3 – How a Property’s Cash-on-Cash Return Is Calculated

What is the most important metric to use in deciding whether or not to purchase a property?  I suppose this question is open for debate but for me it’s not. Assuming the perceived risk between investment alternatives is more or less the same, then in my opinion, the most important metric for purchasing a property is its cash-on-cash return.  There are many other metrics that are also worth considering but they are secondary to a property’s cash-on-cash return.

So how is cash-on-cash return calculated?

Assume the following underwriting parameters:

$1,000,000 purchase price
$684,000 loan amount
$60,000 NOI
$4,000 per month mortgage payment

So let’s do the math.  The cash flow after debt service (CFADS) is:

$60,000 NOI – ($4,000 per month DS x 12 months) = $12,000 CFADS annually

The total cash invested in this property is the purchase price less the loan amount or $1,000,000 – $684,000 = $316,000 total cash invested (TCI)

Therefore, the cash-on-cash return (COCR) is:

$12,000 CFADS ÷ $316,000 TCI = 3.8% COCR

Is the projected COCR acceptable?

So the first question to ask yourself, “Is the projected COCR acceptable?”  It depends.  If you live in New York City or most places in California, a COCR in this range would be unheard of.  Investors in these two locations rely almost solely on appreciation to justify buying a rental property.  Now if you lived in the Midwest, it’s not uncommon for investors to experience COCRs at or near double digits.  So why aren’t we all buying real estate in the Midwest?  Because property appreciation in this region, the second benefit of owning real estate, is generally modest at best, counterbalancing the excellent COCRs.

So again, it all depends.  For me, a 3.8% COCR is borderline.  As a rule of thumb, a property needs to project a COCR of 4% or greater before I would make an offer.  However, there is one very important exception: If the property shows significant upside potential in the first couple of years then I very well could consider a modest 3.8% cash-on-cash return acceptable in the first year of operation.  Other seasoned real estate investors may think otherwise, and I wouldn’t feel the need to argue with them.  It’s all a personal choice.

Our buyer decides to buy the property at the asking price of $1,000,000 because he believes the property is being poorly managed.  With a new on-site manager reporting directly to him he strongly believes the property’s NOI in the first year will increase by $6,000 to $66,000.  Assuming that is true the property’s cash flow after debt service increases to:

$66,000 NOI – ($4,000 per month DS x 12 months) = $18,000 CFADS annually

And the property’s cash-on-cash return is now:

$18,000 CFADS ÷ $316,000 TCI = 5.7% COCR

That in my opinion is a very acceptable first year return on the buyer’s equity.

Two ways to calculate COCR

Before we move on to the next topic, I need to explain something that I glossed over.  Did you catch it?  When I calculated the total cash invested (TCI) I subtracted the loan amount from the purchase price.  In this example the total cash invested in this property was $316,000 ($1,000,000 – $684,000).  But is that true?  No, not really.  What about the closing costs?  What about the loan or mortgage broker fee, pro rata share of the property taxes and the title and escrow charges just to name some of the more significant closing costs?  These costs are not small and together they make a tidy sum.  So in reality the total cash invested is:

Purchase Price – Loan Amount + Closing Costs = Total Cash Invested

Let’s assume that closing costs total $20,000.  Then the total cash invested is $336,000, not $316,000.  And how would that affect COCR?

$18,000 CFADS ÷ $336,000 TCI = 5.4% COCR compared to 5.7% without the closing costs included

So adding in the closings costs to the TCI does have a small effect on the property’s COCR.  So why didn’t I include closing costs in the total cash invested?  Was it because I’m lazy or that it’s not important?  No, not at all.  There is a reason for my excluding the closing cost, which is a very important concept to understand

Return on Investment vs Return on Equity – Which is Better?

A real estate investor can choose to focus on a property’s Return on Investment or they can focus on property’s Return on Equity.  So how are these two metrics calculated?  And more importantly, how are they different?

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Return on Investment (ROI) measures the gain or loss generated on an investment relative to the amount of money originally invested, including closing costs.

Return on Equity (ROE) measures the gain or loss generated on an investment relative to the amount of equity in the property.

So the first time we calculated the property’s COCR we were calculating ROE.  The second time we calculated the property’s COCR we were calculating ROI.

My preference between the two metrics is Return on Equity.  Why?  My answer is easier to understand by looking at the property’s return several years in the future.  So let’s assume the value of this property seven years from now is $1,900,000 and that the property’s NOI at that time is $100,000.  In seven years the loan has been amortized down to $568,762 from the original loan balance of $684,000.  What is the property’s COCR, based on ROI and ROE?

Let’s begin by re-calculating the property’s cash flow after debt service

$100,000 NOI – $48,000 DS = $52,000 CFADS a.k.a. Owner Distributions

Now let’s calculate ROI and ROE.

Return on Investment (ROI)

$52,000 CFADS ÷ $336,000 TCI = 15.5%

Return on Equity (ROE)

$52,000 CFADS ÷ $1,331,238 Owner’s Equity ($1,900,000 Value – $568,762 Existing Loan Balance) = 3.9%

The property’s ROI is 15.5%.  What does that mean?  It means the return the buyer is now receiving on his original investment of $336,000 is a healthy 15.5%.    That’s a very good return, but it’s also misleading and here’s why.  On the face of it, a 15.5% return means you should be very happy with your investment.  Right? Who wouldn’t be happy with a 15.5% return?  So the happy investor would be prudent to leave this property alone and let it continue as is.  Correct?  Hold on.  Not so fast.

Now let’s analyze the property’s ROE of 3.9%.  What does that mean?  It means the owner is receiving a below average 3.9% return on the equity he currently has in the property.  The question this mediocre return begs to ask is this: Should I consider either refinancing this property or selling this property sometime soon?  The answer is yes.

Why ROE is better than ROI

For me, when the ROE dips below 4% I need to take some action to boost the property’s return.  Does that make sense?  But if you are measuring a property’s success based on ROI, you’ll never see the need to take action.  Why?  Because the property’s ROI will continue to improve as the property’s NOI increases over time while the amount of the original investment stays the same.  So instead of a 15.5% ROI, over time this property’s ROI will increase to 18%, 20% or more while the ROE continues to decline.

To illustrate my point, shown below is a hypothetical projection of the property’s NOI and property value.

Notice that the property’s ROI continues to increase over time.  And notice the property’s ROE peaked in Year 4 and then slowly declines thereafter.  In Year 7 the property’s lower ROE suggests some action needs to be taken to improve its return.

This may suggest that the property should be refinanced.  When a property is refinanced the owner re-leverages the property with more debt.  It benefits the owner two ways: 1) he gets cash back from the refinance that he uses as he chooses; and 2) a re-leveraged property in most instances will improve a property’s ROE.  Sometimes the owner realizes that the best course of action is to sell the property and if the proceeds of the sale are re-invested in another rental property, then that too will likely result in a better ROE than the status quo.

And that is why I prefer using ROE over ROI.  Over time, ROE has the potential of helping the owner make informed decisions about what should be done to maximize the property’s return.  ROI does not.

Notice that over the 10-year projection the property’s ROE averages about 4%.  And yet the owner’s equity in the property increased over this same time period by almost $1.3 million.  Even with a modest ROE the investor’s equity in his property increased 5 times over the holding period.  Wow!  Not too shabby!  During times of rising property values, a property’s ROE may still be modest as is shown in this example but result in exceptional equity grow.

Another Advantage of ROE vs ROI

One final thought about the chart above.  In this example the property’s capitalization rate has compressed over the ten-year projection from 6.0 percent in year 0 to 5.25 percent in year 10.  This is exactly what has happened to real estate since the Great Recession.  Cap rates have slowly but steadily compressed since 2009.  If the property had maintained a 6 percent cap rate over this time period the property would only be valued at $1,821,000 in year 10, not $2,081,000 as shown in the chart above and the property’s ROE would have improved to 4.7%, not 3.9%.

The point I’m trying to make is this: Regularly monitor your property’s ROE to determine if there is a trend in this important ratio.  If so, it may be suggesting you need to take action to maintain an acceptable ROE for your property.

Doug Marshall, CCIM is the award winning author of Mastering the Art of Commercial Real Estate Investing.  Check it out at Powell’s.

The post 5 CRE Metrics Every Successful Investor Needs To Know – Part III appeared first on MarshallCf.

5 CRE Calculations Every Investor Needs to Know – Part II

Before you can analyze the merits of a for-sale listing you need to have a basic understanding of the property’s numbers.  By that I mean you need to thoroughly understand:

How a property is valued
How a loan amount is calculated
How a property’s cash-on-cash return is calculated
How loan amortization impacts a property’s cash-on-cash return
How leverage (the amount of debt borrowed to purchase the property) affects a property’s cash-on-cash return

“In your sleep”

You not only need to know the importance of these numbers, but you need to know how to do these calculations “in your sleep.”  They need to become second nature to you.

In the first part of this five part series we discussed how a property is valued.  Today we discuss how the loan amount is calculated.  For some of you, this series will be very basic.  You mastered these five real estate calculations long ago.  You truly can do these calculations “in your sleep.”

However as I went through the process of writing these five articles I was surprised how many little tidbits I had forgotten, or maybe not forgotten but I hadn’t fully appreciated their significance.  So for seasoned real estate professionals and investors don’t dismiss these articles out of hand as unworthy to read.  I’m confident that there is content in these five blog posts that you will find of value.

CRE METRIC #2 – HOW THE LOAN AMOUNT IS CALCULATED

Calculating a property’s loan amount requires the use of a financial calculator. I have both a handheld calculator and an app on my smart phone. I recommend an HP 10bii financial calculator that you can get on Amazon for $24.99. Yes, you can go cheap and buy the HP 10bii app for $4.99 for your smart phone. You choose which option is best for you, but I much prefer the calculator.

Most loans are limited by the lower of a maximum loan-to-value ratio or a minimum debt service coverage ratio. But before we determine the loan amount based on these two underwriting parameters, we first need to understand the concept of Debt Service Coverage ratio (DSCR).

What is a Debt Service Coverage Ratio (DSCR)?

How to calculate a property’s DSCR

Shown below is how a DSCR is calculated:

For example, if the NOI for a property is equal to the total debt service for the property, the DSCR is 1.0. In other words, all the cash flow generated from the property is going towards servicing the debt. What happens if there is a temporary downward blip in the NOI which happens from time to time? Then there is not enough cash flow to pay the mortgage. This is not a good thing is it? In fact, if a property consistently has insufficient cash flow to service the monthly mortgage payment the owner will have to pay the mortgage from other sources of income or lose the property to foreclosure.

Lenders would much prefer an owner consistently pay his mortgage payments on time rather than go through the process of foreclosing on a property. To that end, lenders will require that borrowers have a DSCR greater than 1.0 to minimize the chances the borrower can’t pay his mortgage payment. Depending on the lender and the property type, I’ve seen DSCRs as slow as 1.15 and as high as 1.35, occasionally higher.

So what does a 1.25 DSCR mean? It means that that for every $1.25 of cash flow generated by the property, only $1.00 of it can be used for servicing the debt. The remaining cash flow goes into the borrower’s pocket to be used as he deems necessary including as a rainy day fund when the NOI is less than the monthly mortgage payments.

How to size the loan based a lender’s DSCR

Shown below is the same formula as the previous one, except now we are solving for debt service.

 

To illustrate, let’s assume you are purchasing a property for $1,000,000 and the lender uses the following criteria for calculating the loan size:

70% Loan-to-Value (LTV) ratio, or
1.25 Debt Service Coverage (DSCR) ratio whichever is less

Calculating the LTV loan amount is simple. It’s 70% of the purchase price or $700,000. Calculating the loan amount based on a 1.25 DSCR is bit more complicated requiring the use of a financial calculator.

It’s a two-step process:

Let’s assume the proposed loan terms offered include a:

5.0% interest rate
25-year amortization

How to calculate the maximum monthly mortgage payment

Let’s also assume that the property has a $60,000 NOI. You now have enough information to calculate the monthly mortgage payment which is the first step in the process:

Total Debt Service = $60,000 NOI ÷ 1.25 DSCR = $48,000

Monthly Mortgage Payment = $48,000 ÷ 12 months = $4,000 per month

In this case, $4,000.00 represents the maximum monthly mortgage payment that the property can support and still meet the minimum 1.25 DSCR required by the lender.

How to calculate the loan amount

The second step in the process is to solve for the loan amount, where

PMT (payment) = $4,000.00
N (number of months for amortizing the loan) = 25 years x 12 = 300 months
I/YR = 5.0% interest rate
Solve for PV (loan amount) = -$684,000 (rounded)

So what’s with the negative outcome? For financial calculations to work, one of the inputs or the outcome needs to be negative. Don’t let that bother you. Just forget about the negative sign. It’s irrelevant. The loan amount in this example is $684,000.

What is the maximum loan size for this property?

So what is the maximum loan amount based on the lower of a 70% LTV or a 1.25 DSCR? A 70% maximum LTV results in a $700,000 loan amount and a minimum 1.25 DSCR results in a $684,000 loan amount. In this case, the loan amount is constrained by the 1.25 DSCR. As you can see, it yields a lower loan amount of the two financing criteria limiting the loan to $684,000.

Those are my thoughts.  I welcome yours.

Doug Marshall, CCIM is the award winning author of Mastering the Art of Commercial Real Estate Investing.  Check it out at Barnes & Noble.

The post 5 CRE Calculations Every Investor Needs to Know – Part II appeared first on MarshallCf.

5 CRE Calculations Every Investor Needs to Know – Part I

Before you can analyze the merits of a for-sale listing you need to have a basic understanding of the property’s numbers.  By that I mean you need to thoroughly understand:

How a property is valued
How a loan amount is calculated
How a property’s cash-on-cash return is calculated
How loan amortization impacts a property’s cash-on-cash return
How leverage (the amount of debt borrowed to purchase the property) affects a property’s cash-on-cash return

“In your sleep”

You not only need to know the importance of these numbers, but you need to know how to do these calculations “in your sleep.”  They need to become second nature to you.

This is the first part of a five part series on the five real estate calculations every investor needs to know.  For some of you, this series will be very basic.  You mastered these five real estate calculations long ago.  You truly can do these calculations “in your sleep.”

However as I went through the process of writing these five articles I was surprised how many little tidbits I had forgotten, or maybe not forgotten but I hadn’t fully appreciated their significance.  So for seasoned real estate professionals and investors don’t dismiss these articles out of hand as unworthy to read.  I’m confident that there is content in these five blog posts that you will find of value.

CRE METRIC #1 – HOW A PROPERTY IS VALUED

In the simplest of terms a property’s estimated value is defined as:

So what the heck does that mean?

Net Operating Income (NOI) is the net rental income of a property after operating expenses are deducted.  These expenses should include, among other things, property taxes, insurance, repairs and maintenance, utilities, on- and off-site management costs, general and administrative expenses, etc.  NOI does not include the interest expense from the mortgage payment or depreciation.  Another way of defining NOI is the net cash flow from the property before deducting debt service.

The Capitalization Rate

The Capitalization Rate, better known as the cap rate, is the ratio between the net operating income generated from a property and its current market value.  The cap rate is calculated as follows:

So if you know two of these three factors, you solve for the third.  If you are looking to purchase a property, the seller’s marketing flyer will show the asking price for the property.  At some point in the negotiating process the seller will give you his historical operating statements from which you can determine the property’s NOI.  With these two figures you can then calculate the seller’s proposed cap rate for the property.

For example, if you’re interested in purchasing an apartment with an asking price of $1,000,000 and an NOI of $60,000 then the property has a cap rate of:

$60,000 ÷ $1,000,000 = 6.0%

What does a property’s cap rate mean?

So you now know how to calculate a property’s cap rate but do you know what a 6.0% cap rate means?  Is that a good cap rate for that property or isn’t it? Or a better way of putting it, what is a reasonable cap rate for this property?  And more importantly, who determines what a reasonable cap rate is for a particular property type, its age, its condition and its location?

Ultimately, the market determines what cap rates should be.  It’s a function of the law of supply and demand between willing sellers and willing buyers.  If there are more buyers than sellers, a.k.a, a seller’s market, then asking prices generally increase over time.  And conversely, if there are fewer buyers than sellers (think the Great Recession) values generally decline, sometimes rather quickly.

How are cap rates established?

Cap rates are established by a myriad of investors who decide in each real estate market how much they are willing to pay for an investment property of a particular property type, age, condition and location that generates a specific Net Operating Income.  It’s as simple (or not so simple) as that.

So how do you use cap rates in such a way that it is not just an academic exercise in determining a property’s value?  Let’s assume for a moment, that properties of similar characteristics have cap rates in the range of 6.5%, not 6.0%.  Then you should counteroffer with the following:

$60,000 ÷ 6.5% = $923,000 (rounded)

This is just one real world example of how to use cap rates.  It doesn’t mean the seller will accept your counteroffer, but it does provide justification for a lower price for the property.

The Game Buyers & Sellers Play

At its most basic level the sales process is the seller trying his very best to convince the buyer that the for-sale property has a better NOI than it actually has.  It’s all a part of the real estate sales game.  The seller’s goal is to maximize the sales price by either inflating the NOI as much as is reasonably possible.  Or the seller can achieve the sam result by using a cap rate that is below market for his property.  Those are the only two variables he can manipulate.

On the other hand, a seasoned real estate investor is aware of this game.  The first step in the buying ritual for him is to determine an accurate understanding of the property’s NOI. Once he has that figured out, his next step is to determine if there are any realistic adjustments he can make to increase the property’s NOI once he purchases the property.

Are rents below market?  Is the property being poorly managed that if corrected would improve the property’s NOI?  Are operating expenses above normal? If so, are there simple solutions to lowering these expenses within a normal range?  If the buyer makes capital improvements how much could he expect rents to increase after improvements are completed?  These are some of the questions he’s pondering.  If he can find some logical reason for a higher future NOI then it’s possible that the overinflated asking price by the seller may in fact be reasonable.  If not, then the buyer needs to walk away from negotiations if the seller is firm on his price.

Those are my thoughts.  I welcome yours.

Doug Marshall, CCIM is the award winning author of Mastering the Art of Commercial Real Estate Investing.  Check it out on Amazon.

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