Investment Property

October 31, 2014 by Peter Maclennan Leave a Comment

2014 World Series & Real Estate Investing

Madison Bumgarner “MadBum” 2014 World Series MVP

As you may have heard, the San Francisco Giants won the 2014 World Series in a thrilling Game 7 defeating the Kansas City Royals. What is interesting about the win is that it was built upon skillful pitching and base hits. The Giants did not hit any home runs in Game 7 and had only one double in the deciding game.

What does this have to do with real estate?

Base Hits Matter

The Giants won because they were able to get base hits. They were able to get men on base and put them into scoring position. Base hits allowed the runners to slowly advance around the bases and eventually get to home plate to score runs.

In real estate everyone likes to go for the big score. The home run deal that serves up 10%, 15%, or more in return.

However, sometimes it is the smaller deals, the singles and doubles that end up winning the game.

It is the small portfolio of single family homes acquired over 20-30 years that provide the income and wealth that transfer on to the next generation. It is the small acquisitions made with discipline and prudence that provide for the life and retirement you have only imagined.

A Lifetime of Singles

I met an investor who was purchasing his 8th house. I asked him about it. He said, “It took me a lifetime to accomplish it.” And yet, his 8th property acquired in a good area is worth in excess of $400,000. If all of his properties are worth about the same, he has a portfolio of close to $3,200,000. That isn’t too shabby for a lifetime of work.

To have saved $3,200,000 via the stock market he would have needed to deposit $13,260 per year earning an average of 12% per year over a 30 year time period. If that represents 10% of his savings, he would have needed to average an income of $132,600 over that 30 years.

Ready to get started in real estate? Give me a call at 925.385.8798.

Photo Credit: DSC_4813 by wong1982428 used by creative commons license

July 15, 2014 by Peter Maclennan 1 Comment

Calculating Net Operating Income or NOI

Calculating NOI graphic
It seems like each industry has their own acronyms. The same is true for real estate.

In real estate, the letters NOI stand for Net Operating Income. The net operating income is a number on paper 9 times out of 10. It is not an actual figure that will show up in an investor’s bank account nor is it the number that will be used for tax purposes. NOI is useful in comparing the returns of various properties and for determining if a property is financeable. Think of NOI as the return a property would generate if it was purchased for all cash and regardless of taxes and depreciation.

Actual vs. Pro Forma

NOI can be calculated on an actual basis with the actual rents and the actual expenses. NOI can also be calculated on an expected or pro forma basis based on future estimated rents and estimated expenses. NOI is calculated on an annual basis in most cases.

Start with Income

To begin the calculation of NOI begin with the annual gross rental income for the property. Gross rental income is all the expected income from the property. If the property is a NNN property this will include CAM reimbursements.

Vacancy

Next you will need to deduct vacancy expenses. Vacancy expenses are an estimate of the amount of time that a property will be vacant in any given year due to tenants moving or not paying their rent. Usually this is expressed as a percentage of time. A property in a desirable location may have a low vacancy factor of 5% of the time. Another property in a questionable location may have a much higher vacancy factor and may be empty for 25% of the time or more.

By multiplying the vacancy factor by the gross income you arrive at the vacancy expense. Next you subtract the vacancy expense from the gross income. This will give you the Effective Rental Income.

To the Effective Rental Income you add Other Income. Other Income is usually miscellaneous income from parking fees, laundry, billboards, etc. Now you have arrived at the Gross Operating Income.

Minus Expenses

From the Gross Operating Income you subtract the property’s Operating Expenses to arrive at the Net Operating Income. Operating Expenses include all cash expenses paid to keep the property running at maximum efficiency. They will include property taxes, property insurance, management fees, utilities, advertising costs, accounting fees, legal fees, licenses, and other expenses.

Using NOI

NOI is used to calculate a properties Cap Rate (capitalization rate) for properties. NOI is also the number most lenders use to determine if a property has an adequate debt service coverage ratio (DSCR or DCR) to qualify for a loan.

NOI is a useful tool in helping investors analyze and compare investment properties.

August 29, 2013 by Peter Maclennan Leave a Comment

Reasons for a 1031 Exchange

One of the benefits of real estate ownership is the ability to defer payment of capital gains tax on the sale of a property. This deferment is accomplished through a 1031 exchange or a Starker exchange.

Last week, I attended a seminar on 1031 exchanges. The speaker listed 4 main reasons why real estate investors take advantage of the 1031 exchange.

Tax Deferral

Currently the federal capital gains tax is 15% or 20% based on your income. California’s top capital gains rate is 13.3%. At the top tax rate a real estate investor in California could be paying almost 33% of their gain in taxes. An investor’s ability to build long-term wealth is hampered if they need to pay taxes on each transaction.

Buy “More” Property

A 1o31 exchange allows the investor to buy bigger or better property. An investor might decide to exchange into a property that is larger in price or they may decide to go into property that increases their cash flow.

Diversification

Diversification is the theory of spreading investment across multiple assets in order to reduce risk. Your grandma might say, “Don’t put all your eggs in one basket.”

Geographic Diversification. Having real estate investments in different locations and metropolitan areas spreads risk across diverse economic bases. It also limits risk to natural disasters that may devastate one area and impact real estate values.

Asset Class Diversification. Another way to diversify is to invest in different types of real estate assets. Industrial, retail, office, and multifamily assets are affected in different ways by different economic events. By owning different types of property, an investor can minimize the risks that any one asset class might suffer.

Long-Term Ownership Issues

A 1031 exchange can help alleviate some issues that arise when properties have been held for a long-time.

Management Burdens. A lot of owners of residential rentals get burned out after dealing with tenants, trash, and taxes. By exchanging out of their rental property and into a triple net investment property an investor can maintain their cash flow, but without have to deal with management problems.

Lack of Depreciation. One of the benefits of real estate investment is the ability to shelter income by the use of the depreciation expense. Properties held for an extended period of time (27 years or more) lose the ability to be depreciated. A savvy investor can exchange into a more valuable property to increase their tax basis and begin to depreciate their assets again.

Concluding Thoughts

The 1031 exchange is a valuable tool in the hands of a real estate investor. It can help defer capital gains taxes, buy more property, diversify risk, and alleviate issues arising from long-term ownership of the same assets.

March 21, 2013 by Peter Maclennan Leave a Comment

How to Be Penny-Wise & Pound-Foolish as a Landlord

penny-wise and pound-foolish

def. – to be extremely careful about small amounts of money and not careful enough about larger amounts of money

In America we might say a person is stepping over dollar bills to pick up a penny.

Landlords tend to be extremely conscience of the costs of managing a property, especially costs that go to repair and maintenance of their properties.

In general this is an excellent strategy and necessary to build wealth. However, at times it a landlord may be penny-wise and pound-foolish. Below are a few ways that a landlord might tell that they are falling into this trap.

1) Cut costs at the tenants’ expense.

Tenants that pay on time and don’t cause problems are one of a landlord’s greatest assets. If a landlord continuously sacrifices the comforts of his tenants to order cheaper parts or to find a cheaper solution, a landlord jeopardizes keeping these good tenants happy. They may migrate to a location with a landlord that makes keeping good tenants a priority.

2) Cut costs by always looking for the cheapest labor.

“You get what you pay for.” Sometimes this is very true when it comes to labor. Sometimes the cheapest labor does the cheapest work or takes longer to fix the problem because of a lack of experience. Knowing when to pay more for experience and skill is a fine art that a landlord develops with time.

3) Always do the work yourself.

This goes along with point #2 above. It is easiest to think that the cheapest labor is your own labor. However, business people always need to be reminded of the opportunity costs of the work that they are doing. While a landlord is fixing a pipe what other opportunities are they missing out on?

4a) Accept any warm-bodied tenant.

Oh no it’s vacant! In a mad rush to fill a vacancy, some landlords will take the first warm-bodied tenant. This process will likely give you an underqualified tenant that ends up being more of a liability than an asset. Taking the time to find a quality tenant with the ability and history to pay on time is important.

4b) Only accept A++ tenants, no matter the location.

This is the converse of the warning above. Some landlords hold out until the “perfect” tenant comes along. This can be detrimental to the overall cash flow. Sometimes a good, paying tenant is better than the “perfect” tenant that isn’t coming to your project.

It is important that landlords and business owners balance costs with wise spending.

What are some other ways that landlords can be penny-wise and pound-foolish?

February 28, 2013 by Peter Maclennan Leave a Comment

Buyers of Commercial Real Estate

Commercial real estate owners want to know the most likely buyer of their commercial investment property. This knowledge can help the owner to strategize on the marketing of their property.

The indications below are general guidelines and specific to the San Francisco Bay Area. They are not hard and fast rules, but merely meant to help investment property owners understand to whom they will be marketing their property. [Read more…]

925.385.8798

2014 World Series & Real Estate Investing

Base Hits Matter

A Lifetime of Singles