Commercial Real Estate Investing

November 4, 2016 by Peter Maclennan Leave a Comment

Water-Efficient Fixtures & California SB-407

In 2009, then California governor, Arnold Schwarzenegger signed SB-407 into law. The law requires that water-efficient fixtures be installed in homes and commercial properties.

The law defines non-compliant water fixtures as:

Any toilet manufactured to use more than 1.6 gallons of water per flush.
Any urinal manufactured to use more than one gallon of water per flush.
Any showerhead manufactured to have a flow capacity of more than 2.5 gallons of water per minute.
Any interior faucet that emits more than 2.2 gallons of water per minute.

Residential Property Owners

One of the main features of this law is that as of January 1, 2017 all water fixtures in a single-family home are to be replaced with water-efficient fixtures. Most homes that have undergone a major, permitted remodel after 2014 were required to update plumbing fixtures to water-efficient fixtures to obtain a building permit.

b) On or before January 1, 2017, noncompliant plumbing fixtures in any single-family residential real property shall be replaced by the property owner with water-conserving plumbing fixtures.

and

(c) On and after January 1, 2017, a seller or transferor of single-family residential real property shall disclose in writing to the prospective purchaser or transferee the requirements of subdivision (b) and whether the real property includes any noncompliant plumbing fixtures.

Disclosure on Transfer (Sale)

This law requires that the seller must disclose to buyers if the fixtures in their home are in compliance with this law.

Do you know if all of your fixtures are in compliance? I certainly don’t. This will likely require you to either update all the fixtures to low flow, or have an inspection certifying that they are low flow.

Commercial Real Estate and Multifamily Properties

Commercial properties and multifamily real estate have to be in compliance by January 1, 2019. For purposes of the law, the authors defined commercial real estate and multifamily real estate:

(a) “Commercial real property” means any real property that is improved with, or consisting of, a building that is intended for commercial use, including hotels and motels, that is not a single-family residential real property or a multifamily residential real property.

(b) “Multifamily residential real property” means any real property that is improved with, or consisting of, a building containing more than one unit that is intended for human habitation, or any mixed residential-commercial buildings or portions thereof that are intended for human habitation. Multifamily residential real property includes residential hotels but does not include hotels and motels that are not residential hotels.

Duplexes, Triplexes, and Fourplexes

Based on the definition of multifamily residential real estate as containing more than one unit intended for human habitation, most duplexes, triplexes, and fourplexes should fit into this category.

Disclosure on Sale or Transfer

Again the law requires that the seller of commercial real estate or multifamily property disclose to the buyer if the property is in compliance.

Plumbing Police?

Does this mean that the state is going to create the plumbing police? Beats me. The law does allow for local communities and water retailers to enact ordinances to enforce compliance. Check with your local municipalities and water district to see if they have an enforcement mechanism.

If you are considering selling residential real estate in the near future you will need to work with your real estate professional to comply with this law. Hiring a property inspector can go a long ways towards this.

It looks like the plumbers, handymen, and handywomen of California are going to have a lot of faucets to fix.

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.

July 18, 2013 by Peter Maclennan Leave a Comment

Bay Area Apartment Rents Slower Increase

The San Francisco Business Times published an article this week about the slowing growth of Bay Area apartment rents. According to the article apartment rents in San Francisco grew by 9.9% in 2012. Apartment rents in the East Bay increased by 6.9%. A leading apartment advisor predicts that growth will be 3.2% in San Francisco and 3.3% in the East Bay.

Home Ownership and Supply

I believe two factors are contributing to the slow down in rental growth. First, we have seen the residential real estate market take off and a lot of buyers have gotten off the sidelines and are buying homes. This means that a lot of renters are moving to be homeowners. Second, a number of new rental projects are being constructed. Both of these items are increasing the supply and causing rental rates to slow.

Bay Area Apartment Owners

Existing apartment owners have benefited from the increased rents (the exception may be in rent-controlled areas like San Francisco, Oakland, & Berkeley). Cash flow is up and sales of apartments are at record low cap rates.

What does the tapering of rent growth and the increase in interest rates mean? Well, it probably means that the market is reaching the peak of the value cycle. Interest rate increases mean that buyers will have to pay less for properties to cover rising financing costs.

If you have questions about your apartment complex, please give me a call at (925) 385-8798.

March 14, 2013 by Peter Maclennan Leave a Comment

Apartment Demand

Bisnow (Denver) posted an article stating that from 2011 to 2012 apartment prices of properties with 100 units or less rose almost 34%. They attribute demand to low vacancy and rising rents.

“The Denver market has exploded,” Greg (here with his partner Kyle Malnati) told us during a chat this week. From 2001 to 2011, the average price per apartment unit in Denver climbed from $61k to $70k, a healthy rise. In 2012? The average price skyrocketed to $94k (specifically apartment buildings of 100 units or fewer). What’s driving it: a perfect storm of investor demand, low vacancies, rising rents, and an overall lack of product for sale. (A storm like this means it’s rainin’ cash.) Vacancies haven’t been this low since before the dot-com bust, he says. [Read more…]

It appears from this article that investors with cash are seeing the benefits of commercial real estate. Most industry experts agree that apartments are one of the safest asset classes to use as an inflation hedge. The short duration of their leases allow landlords to adjust rents regularly as property values rise.

What do you think is driving the demand?

As always you can call me to talk about building wealth through real estate at (925) 385-8798.

925.385.8798

Water-Efficient Fixtures & California SB-407