If You Build It, They Will Come

Development and redevelopment projects continue to be the real estate investment alternatives with the most lucrative return potential. Consequently, however, development and redevelopment projects bear the greatest risk and are generally left to only the most experienced real estate investors. Many investors fear these types of projects for several reasons: 1) they typically involve large cash outlays up front and throughout the duration of the project, 2) most, if not all, of the return associated with such projects is typically not realized until the completion of the project, and 3) most investors are not familiar with the financing, regulatory requirements, project management competencies, and steps involved with undertaking such projects-and in our business, what you don’t know CAN hurt you. This article is intended to provide a general synopsis of the development process so that investors will have a basic understanding of it.

The Process

The first step in the development process is to define the project. Within this step, the investor will need to determine whether or not the project will require a permit. Permit requirements depend upon the scope of the project or location-related constraints. There are No-Plans Permits for simple projects that do not require plans such as plumbing or electrical, Over-the-Counter Permits for simple projects such as minor additions or simple remodels, and Large Project Permits for more complicated projects such as subdivision of property, extensive remodels, or construction of new structures that will require that plans and documents be submitted for review. It will well be worth the investor-developer’s while to carefully review all relevant documentation that pertains to permit application, exemptions, and approvals within the locality of the proposed project.

The investor-developer’s next step will be to determine the property’s zoning and other site criteria to adequately evaluate any site constraints. This step of the process can range from simple to extremely complex, but the investor will generally need to complete it before the city will issue an approval or a permit. Most property in the city of San Diego is assigned one base zone, although some properties have more than one base zone. Base zones identify the uses allowed on a property and the development regulations that apply to the property. Overlay zones, which may modify the provisions of base zones, are applied to some properties. Most property in San Diego falls into one of the following types of base zones:

Residential – Areas designated for single and multi-family residences.

Commercial – Areas intended for businesses which provide consumer goods and services as well as a wide variety of commercial, retail, office and recreational uses.

Industrial – Areas intended for research and development, factories, warehousing, and other industrial uses.

Agricultural – Areas now used for agricultural and farming purposes which may be developed for urban use sometime in the future.

Open Space – Public recreational uses or area to be left in a generally natural state. In addition to zoning, the investor-developer will also be responsible to research property deed and title information for easements recorded on the property. Separate approval is required from each utility agency or private party for construction of improvements in easements, but structures in easements are typically not approved.

Still, other site criteria may dictate that additional approvals or permits may be required such as a proposed project for a property that lies within the Coastal Zone that may require a special Coastal Development Permit prior to development. The prudent investor-developer will want to contact the city and review any copies of prior permits, maps and drawings relevant to the property. Careful research in this area can preclude costly miscalculations with regard to development projects.

Depending on the site conditions for the proposed development project, it may be necessary for the investor-developer to obtain discretionary approval before commencing development through a process known as Discretionary Review. Discretionary Review is a higher level review of the proposed property use and architectural and design plans. The decision maker must be able to make certain findings and may exercise discretion in granting approval of the proposed project. If an investor-developer thinks his or her desired proposal would require discretionary approval(s), he or she may want to consider submitting the project for a Preliminary Review-a process that will indicate if any discretionary approvals are required and provide the investor-developer with an opportunity to discuss his or her project proposal with review staff.

During the next step in the investor-developer’s process, Plan Review, plan reviewers determine whether the proposed project conforms to development standards and codes and if a construction permit can be issued or a map approved. By this step, the investor-developer should have contracted for the necessary designers to prepare any and all construction and/or mapping documents that will be submitted to and reviewed by City staff. There are numerous types of approvals and these will determine the submittal requirements and disciplines involved in the review. Each of the disciplines involved in the review will either sign-off or return marked-up plans with an issues report that contains items that must be addressed prior to obtaining sign-off.

Once all disciplines have signed off on the proposed project plan, the investor-developer is now ready to schedule an appointment to obtain the required permits and/or approvals. At this appointment, there is a rather long list of documents that will be required for permit issuance (commonly called Stamp Out) that will be reviewed for completeness. Once the reviewer makes the determination that all documents are complete, the investor-developer will receive 2 sets of plans with approval stamps, an inspection plan that will indicate at what stages inspections are required for the project, an inspection record card that the inspector will sign as the construction is inspected and approved, an electrical circuit card that must be completed prior to calling for an electrical inspection, and an invoice for fees.

The investor-developer will need to coordinate all inspections throughout the construction of the project with the City who will generally offer a full range of inspection services. After all inspections are completed, the city will issue a Certificate of Occupancy that must be obtained before a building can be occupied. An investor-developer may obtain a Temporary Certificate of Occupancy when the inspector finds that no substantial hazard will result from occupancy of any structure or portion thereof before all work is completed. Otherwise, a Regular Certificate of Occupancy will be required.

As you can see from the above synopsis of the development process, there are many steps involved. Each additional step in any process incorporates with it more risk in the process itself. If you are considering a development or redevelopment project for your next investment because of the potential for extremely high returns, proceed cautiously. Do research before you embark upon it and contact us so that we can assist you.

“Earning You Many Fond Returns…”


Puzzling Pieces?

Many first time investors shy away from Commercial Investing due to the misconception that they need hundreds of thousands dollars to purchase a commercial property. Now having hundreds of thousands of extra dollars is a great position to be in however it is not necessarily the benchmark starting position for first time investors.

Historically, one of the most difficult obstacles that prevented people from purchasing commercial property is the large amount of initial capital investment or down payment— this is no longer the case.

We offer syndications to enhance an individual investor’s buying power. An investor can become part of a syndication and receive monthly cash flow and annual return respective to the amount of money invested into the property. A syndication is a vehicle that assists investors to experience the high level of returns associated with commercial properties. By utilizing a TIC agreement (Tenant In Common), multiple investors can benefit from the leverage of each others invested funds to purchase a commercial property. Syndications create larger buying power that was otherwise unavailable to an individual investor. Let’s take a look at the Smith siblings to see how they utilized the power of a syndication;

The Smiths
John, Jane, Joseph, Julie, and Jack are brothers and sisters. They each have $50,000 in capital to invest. John is rolling funds out of IRA and 401K accounts. Jane is pulling money from her residence through a HELOC. Joseph sold an investment property and will complete a 1031 exchange to reinvest his capital gains. Julie has pulled money out of a high risk mutual fund and Jack had a very big piggy bank, he always knew how to save. The Smith family decided to come together, pool their funds and put $250,000 down on a $1,000,000 eight unit property in sunny San Diego.

The Property
Money Tree Gardens is an 8 unit building selling for $1,000,000 with an annual positive cash flow of $15,000. There is 1 unit vacant at the property and each unit is $75 to $100 under market rent. The current owner has been the property manager and spends a good deal of money on upkeep and contracted services, services that are available at a lower cost. Money Tree Gardens has future potential to bring in $20,000 if vacancy was reduced, rents were maximized and less money was spent on expenses.

The Market
The market surrounding Money Tree Gardens commands higher rents than what Money Tree Gardens is currently bringing in. Nearby schools, shops and restaurants within walking distance make this area desirable to live in. Several redevelopment projects are in progress which will make this property attractive to future buyers.

The Math
This is a step by step breakdown of how the Smith family will acquire and benefit from their syndication.

$50,000 Per Smith * 5 Smiths = $250,000 Initial Investment (Down Payment)

$1,000,000 Property – $250,000 Initial Investment = $750,000 Loan Amount

$50,000 Per Smith ÷ $250,000 Initial Investment = 20% Interest owned per Smith

Current Yearly Cash Flow of $15,000—Monthly Cash Flow of $1,250

Annual Cash Flow $15,000 * 20% of Interest owned Per Smith = $3,000 per Smith/per year

Monthly Cash Flow $1,250 * 20% of Interest owned Per Smith = $250 per Smith/per month

The Sale
After 2 years of holding the property, the Smiths decide to sell their investment property. Through effective property management, the Smiths have been advised that they can sell the property at $1,300,000. Upon the sale of the property, they each experience the following return.

$1,300,000 – $750,000 (Loan Amount) = $550,000 Sales proceeds (before tax)

$550,000 * 20% Per Smith = $110,000 gained on invested funds Per Smith

The Work
With this type of investment, the Smith family didn’t need to do any work at all. The Smiths were provided with exceptional services to locate an opportune property, management of the property and sales representation. The Smiths were then able to roll the gains into another property and experience twice as much monthly and yearly return.

If you have any questions regarding syndications, feel free to give me a call today.

 

“Earning You Many Fond Returns…”


The Good, The Bad and The Loss

Vacancy and Credit Loss is the amount of revenue that remains uncollected due to un-rented units and current tenants that are not paying their full rental amount. In general, vacancy and credit loss is a combined annual figure which is expressed as a dollar amount and as a percentage of the Gross Scheduled Income. Historical data from each specific property should be used to calculate the future vacancy and credit loss amount.

Vacancy on its own is a curable problem from which many properties suffer. Vacancy also creates much more of a loss than what appears on the surface. Having un-rented units greatly reduces the net operating income of the property and has an exponential effect on the overall value of the property. Credit Loss differs from vacancy in that there is a tenant in the unit however they are not paying their total rental amount or they are not paying rent their rent at all. (This dollar amount is endearing referred to as “The Delinquency” by property managers) This problem is again curable and also severely impacts the net operating income.

Other uncollected funds can also be captured under the category of vacancy and credit loss. In some instances an on-site property manager, maintenance employee or owner may be living in a unit. In the accounting, the property can charge rent to that unit and then credit the charge, resulting in no money paid and an increase in credit loss. Another instance can be a rent credit to a resident. An example of this situation is if a resident has been overly inconvenienced due a lengthy maintenance repair (not on my watch, of course!). A landlord may decide to monetarily quell this uneasy tenant. This type of credit can be captured under vacancy and credit loss. When analyzing a property as an investment, it is extremely important to know what exactly is in the vacancy and credit loss category. Any oversight may result in missing real revenue or double counting a negative. Knowing the details of this number will also assist in judging if and how the amount can be reduced.

As I mentioned earlier, the full impact of this loss is far greater than the mere miss of cash flow for the month. Would you like an example? I thought you would…

We are running Willow Grove Apartments; it has 12 two bedroom units that rent for $1,100 per month.

$1,100 x 12 units x 12 months = $158,400 annual gross potential income.

In this example, over the past year, unit number 4 was vacant for three months and unit 7 was vacant for two months.

$1,100 x 5 months of vacancy = $5,500 loss of revenue (vacancy and credit loss category)

At face value, $5,500 doesn’t seem that painful, especially because it was spread out over 12 months. So you ask “Where are these grave implications of vacancy and credit loss?” The true loss is only revealed when you calculate the value of the building by the market CAP rate. We will say that Willow Grove Apartments is in a 5% CAP rate area.

Gross Scheduled Rent $158,400
-Vacancy and Credit Loss $ 5,500 (3.47%)
Effective Rental Income $152,900
-Operating Expenses $ 53,515 (estimated)

Net Operating Income $ 99,385

The value of this property in a 5% CAP rate area is $1,987,700

$99,385 NOI / 5% CAP = $1,987,700.

But what if this property was 100% occupied during last year?

Gross Scheduled Rent $158,400
-Vacancy and Credit Loss $ 0
Effective Rental Income $158,400
-Operating Expenses $ 53,515 (estimated)

Net Operating Income $ 104,885

The value of this property in a 5% CAP rate area is $2,097,700

$104,885 NOI / 5% CAP = $2,097,700.

The Difference?

$2,097,700
-$1,987,700
$ 110,000

When it comes to managing an income generating property, it’s not just about raising the rents. Curing vacancy and credit loss is vital step in increasing the net operating income and the overall value of your property. If you would like more information about property management, please contact me today.

“Earning You Many Fond Returns…”


How Do You Measure Up?

Every investor has that certain item they look for in order to identify a good investment property; some use Gross Rent Multiplier (GRM), others use Price per Square Foot, others use Price per Door, while still others use Capitalization Rate (CAP). This certainly begs the question, who is right? Even more profoundly, is there a right or wrong when measuring the value of an investment? Let’s compare these different ways
of comparing.

The Gross Rent Multiplier (GRM) of a property is simple math; it is the number of times the value of a property can be divided by the gross potential rental income. For an example, if a property is listed for sale at $2.5 million and it brings in $250,000 in gross rental income, than the property has a GRM of 10. Okay, but what does that mean, is 10 a good number?

I use GRM as a filter when looking through investment property options. It would be rather cumbersome to extensively analyze every property that is listed for sale. Therefore you can use GRM to weed out the properties that do not generate enough cash to meet your objectives and it is an easy way to decide if the property is extremely overpriced. GRM however has one major shortcoming; it does not take any operating expenses into consideration. Let’s use another example but this time we have two buildings for sale and both have a GRM of 10. In this example both properties are expected to generate $250,000 of income. However property number one has 35% expenses which is $87,500 and property number two has 47% expenses which is $117,500. Since they both have a GRM of 10, are they still worth the same amount? If both properties are located in a 5.5% CAP rate area then property number one is worth $2,954,545 and property number two is worth $2,409,091. That is over a $500,000 difference in building value with only $30,000 variation in expenses. GRM can be a handy quick look tool but I wouldn’t put my money on it.

Price per square foot (PPSqFt) is another easy math problem; it is the building price divided by the total square footage of improvements. An example is a 12,000 square foot building listed for sale at $1.9 million. The price per square foot on this property is $158.33. This can tell you, when compared to other market data, if $158.33 is priced higher or lower than other buildings for sale. Price per square foot contains the same limitation as GRM in that it does not factor in expenses. Additionally, price per square foot doesn’t look at income either. In this case you could end up with a 12 unit property, renting out apartments at $25 per month and 500% expenses… Oh My!

Price per door is yet another way to evaluate the worthiness of an investment property. Everyone loves a low cost per door, more doors for less money. I too look for a low cost per door, but again it does not consider income or expenses. As an example, let’s take two properties that are currently on the market. (Please note this is a dramatization. Some names and locations have been changed to protect the innocent listing agents.) We will call property number one Peach Street and property number two will be Apple Avenue.

Peach Tree

16 units total, all studio apartments
Total square footage is 4,080 and the price per square foot is $365
Total gross potential annual income is $111,600
Price per door is $93,125

Apple Avenue

16 units total, all 3 bedroom 2 bath apartments
Total square footage is 15,600 and the price per square foot is $143
Total gross potential annual income is $211,200
Price per door is $140,000

Which property is a better value? I suppose it depends what you are shopping for. Are you in the market for “potential” income? Do you want to buy square feet? If you really need to purchase a whole bunch of doors, I highly recommend Home Depot…they have much better pricing!

As investors we need to look at the bottom line, at the Net Operating Income (NOI) of the property. In order to make sure that the property can qualify for a loan or that we receive the ever so powerful positive cash flow, we need to take everything into account. We must look to the property’s Capitalization Rate (CAP rate).

The CAP rate of a property is the NOI divided by the purchase price. Because this calculation is based on NOI, it takes in account potential rent, minus vacancy and credit loss minus operating expenses.

The CAP rate method of evaluating investment properties is the most comprehensive of all the above mentioned techniques. Using GRM, price per square foot and per door can useful tools, but please use them with caution.

If you need any assistance determining the value of a commercial property, please give me a call today.

 

“Earning You Many Fond Returns…”


TIC Talk

I often speak with investors who have questions about syndications, how they are structured and how it all works. I’d like to take this opportunity to explain our process and how syndications can be beneficial to both new and experienced investors.

What is a syndication? The purpose of a syndication is to pool together capital from several investors and use it to leverage them into larger properties than they would be able to purchase alone. We can put together syndications on small multi-family properties and large commercial properties. Our intent is to place investors that have similar investment goals, risk levels and capital and with other like-minded investors. Since we do syndications on several types and sizes of buildings, you can always take a step up from your average investment property to expand your portfolio.

What is a TIC? We structure our syndications on a Tenants In Common (TIC) agreement; tenants in common is a method of holding title to a property. The owners on a TIC agreement have an undivided fractional ownership interest in the property and ownership shares do not have to be equal. The TIC agreement covers the entire life span of the investment and outlines how the relationship is created and will function. The TIC agreement also allows an investor the option to complete a 1031 exchange if
desired. The IRS recognizes a TIC as a group of individuals versus a business and therefore allows TIC investors the option of completing or not completing a 1031 exchange.

Do I get cash flow? Absolutely! The amount of your cash flow depends on your percentage of ownership. Cash flow is delivered to our owners on a monthly basis. We can structure properties to produce an approximate 10% to 15% cash on cash return. Yes these are properties located in southern California that have very positive cash flow.

How does the property operate? We will conduct all aspects of property management to ensure your property achieves its maximum potential. Our detailed analysis will spell out the management plan and you will receive monthly progress reports. All accounting, leasing, maintenance and management issues are taken care of. You will never need to hear a resident complain or worry about a leaky pipe or paying a bill. The property itself will generate enough money to pay for all of its operating expenses, the mortgage and the remaining cash flow goes to the owner.

What Internal Rate of Return can I expect? In addition to the cash flow, our investment properties will produce an estimated 25% plus internal rate of return. Because we are able to secure excellent financing products we are able to increase the leverage. In some cases we have used 80% or more loan to value which creates high returns for our investors.

What is the minimum investment? We do not have an established minimum or maximum investment amount. The minimum investment amount will be different for each syndicated property. Again, we align “like” investors and create small, medium and large investment opportunities to meet a wide range of investment goals.

Can I sell my ownership? Yes. We generally hold syndicated properties for a two year period and this is agreed to by all owners before closing. The TIC agreement allows you to sell your ownership shares in the property if the need ever comes about.

Can I have an example? For the example, we will use a real property that we are currently syndicating. It has a 14.99% cash on cash return and a 29.17% internal rate of return (there is still some room if you want to get in on this one!). We plan to hold the property for two years. It will have an increase in income by the 6 month mark and another increase by the 18 month mark.

The total initial investment is $749,616. This amount includes the down payment, closing costs, loan fees, due diligence inspections etc.

Our example investor is Hank. Hank is a smart guy and likes the idea of getting into a high return, hassle free investment and decides to invest $150K into our property. $150K of $749,616 makes Hank a 20% owner.

For the first six months, we expect the total cash flow to be $56,202. Hank is a 20% owner so he will receive $11,240 over the first six months or $1,873 monthly. By the 6 month mark, we will have increased the rents and over the next 12 months we expect $127,560 in cash flow. That is another $25,512 to Hank or $2,126 monthly for 12 months. At the 18 month mark, there will again be room to increase the rents. For the last 6 months of the investment period, the property will generate $70,696 in cash flow.
And to Hank, who has long forgotten where this property even is, will receive another $14,139 or $2,356 for 6 more months.

Now we place the property for sale and sell it at the average market CAP rate for that area which happens to be 5.53%. Our sales proceed (including all costs of sale) is $1,286,397. I call Hank to tell him that he just turned his $150K into $257,279.

Total Cash Flow over two years = $50,891
Total Sales proceeds to owner = $257,270

Total in = $150,000
Total out = $308,161

Happy Client = Priceless.

Feel free to contact me if you have any questions about our syndications.

If you have any questions about our syndications, please give me a call today.


Investment Project Management

Since the preceding article is about the value of planning your real estate investment as a project, it is only fitting that I follow it up with an article that addresses the importance of managing your real estate investments as a project. While there is an old axiom that states that the failure to plan is synonymous with planning to fail, the lack of proper execution and control throughout any investment life cycle will most assuredly result in failure as well. That being the case, managing your investment as a project will allow you to introduce the necessary project management processes that are necessary to insure that your projects stay on track and yield the desired returns that you planned for.

These project management processes include executing processes such as project plan execution, quality assurance, team development, information distribution, solicitation, source selection, and contract administration; and controlling processes such as integrated change control, scope verification, scope change control, schedule control, cost control, quality control, performance reporting, risk monitoring, and risk control. While the confines of this article are far too limited for me to go into any great detail on all of the project management processes, let’s just suffice it to say that they are all valuable and relevant
to the success of any investment project.

I will, however, go into some detail with regard to the performance reporting process-probably one of the most critical project management processes for the simple reason that getting anywhere in life has very much to do with knowing where you are at any given time. The inputs into the performance reporting process are the project plan, work results, and other project documents that pertain to the project context and the outputs are performance reports and change requests. The appropriate tools and techniques used within the process itself consist of performance reviews, variance analysis, trend analysis, earned value analysis, and information distribution tools and techniques.

The earned value management technique that I mention in the paragraph above is literally at the heart of effective project management and allows you to determine where you are within the context of your investment project relative to where you should be in terms of time cost and scope. It allows you to see whether you will hit your mark by continuing on the course that you are on, whether you will need to make radical adjustments in order to hit your mark, or whether the odds against hitting your mark are too great and you need to scrap the project altogether and cut your losses. We use earned value measurement techniques to keep our projects on track in terms of time, cost, and scope. If you would like to find out more about how to apply earned value measurement techniques to your own investment projects and maximize your returns, get a hold of me and let’s talk.

“Earning You Many Fond Returns…”


Investment Project Planning

The Project Management Body of Knowledge (PMBOK) promulgated by the Project Management Institute (PMI) defines a project as “a temporary endeavour undertaken to create a unique product or service.” The PMBOK goes further to suggest that while projects and operations share many characteristics such as being performed by people, constrained by limited resources, planned, executed and controlled, it differentiates a project from an operation in that projects are temporary and unique, while operations are ongoing and repetitive.

Whether you are purchasing investment property to rehab and immediately sell (fix ‘n’ flip) or purchasing it to hold as an investment for the remainder of your natural life, it is critical that you map out your investment opportunities as projects from start to finish in order to compare the value of one investment opportunity to the value of another and select the one that is the most valuable to you (remember that the difference between the value of the most valuable opportunity and the value of the opportunity that you select represents foregone opportunity cost).

“So,” you might ask, “how do I plan my investment as a project from start to finish if I intend to hold the property for the rest of my natural life?” There are at least two approaches to this that are effective. While it may seem slightly morbid, the simplest approach is to make an assumption as to the remainder of your natural life. Insurance companies do this when determining how much to charge you for life insurance. In fact, your assumption does not have to be a shot in the dark because some very reliable actuarial demographic data exist that these insurance companies use. However you arrive at this assumption, it will allow you to base your present value calculations on a definite time frame across all of the opportunities that you are evaluating.

Another alternative is to take an interim planning approach by selecting an arbitrary point in the future on which to base your present value calculations for each opportunity that you are evaluating. While this approach is inherently less risky than the first approach (mainly because the assumption as to how long you will live is a much larger one that the assumption that you will still be alive at some point in the future), you must keep in mind that the opportunity that you select as the most valuable using this approach is only the most valuable up to the point in time that you select and is not necessarily the most valuable before or after that point. This caveat is extremely important since it is not unusual for investments to be either increasing or decreasing in value over time or reaching a breakpoint.

In addition to facilitating the selection of the most valuable investment opportunities, planning your investment as a project insures that the project planning processes that are necessary to insure the success of your investment and the realization of your return are not overlooked. These project planning processes include scope planning, scope definition, activity definition, activity sequencing, activity duration estimating, resource planning, cost estimating, cost budgeting, risk management planning, schedule development, and project plan development. We apply these processes to all of the investment projects that we develop and can assist you with your investment project planning. Please do not hesitate to contact me if you have any questions about how any of these processes are effectively applied.

“Earning You Many Fond Returns…”