Day 8 and Week 2 this week is about how to get started in Commercial Real Estate Investing. The last time I ran this 30 day Commercial Real Estate Challenge- I noticed more interaction and questions. This week is where we get into the fun stuff.
Here’s what we’re going to cover this week:
- The Core Concepts of Commercial Real Estate Investing- S&D
- Becoming a Programmatic Investor
- How to Find Commercial Deals
- How to Value a Commercial Property (My BOE)
- The Eightfold Path of CRE Investing
Lots to cover. I’m summarizing 8-10 real estate investing books and 10 years of buying and selling commercial properties this week.
You don’t need to be an expert in 1 week. Be patient. You may want to reread this.
(In the Facebook group- one of my private clients, Wei, went through the 30 day challenge in Nov and is doing it again- because she’s getting value of the content).
Quick recap of what you should have in place right now.
- Big Picture Vision
- Financial Goals & Objectives
- Cash Flow Targets – you know your FU #
- Your Current Wealth- where are you starting. You took inventory of your expenses and what’s required for your Financial Independence
- You have a foundational understanding of Key Terms used in CRE
- You have high level of the Commercial Real Estate Game (Players/Properties/Capital Markets and External Factors)
When you consider what you’ve accomplished in a week, in approx 30 mins/day of work- you’ve come a long way. If you miss a day- just go back and do the work.
This is not a race to complete. It’s a process. Part of the process is mastering the basics.
I was on a run recently listening to a podcast about Jon Bon Jovi.
The guy telling the story, (don’t recall his name- let’s call him Chris) says that he’s been trying to pitch Jovi on new a deal.
Chris calls in to Jovi’s office early on a Saturday morning, hoping to catch him. Someone at the studio answers and says, Jovi will be with you shortly.
While Chris is on hold, he hears a guy in the background practicing scales.
When Jovi finally get on the phone- Chris asks, “so, who’s the new singer are you working with?” Chris is thinking- who else would be practicing scales?
Jovi responds- “no new singer- that was me.”
Here’s a guy worth $410M, the 5th richest rock star (according to Forbes) and is still practicing his scales.
Hearing that, reinforced my belief- there are fundamental skills in every business that must be practiced daily.
Investing in Real Estate requires a basic understanding of Supply and Demand. A simple principle- one that I think most people intuitively hear and understand.
But in practice, I see many investors ignoring this.
I too get caught up in the micro details of a property- without considering the overarching Supply and Demand influences.
Ex. I’m working with a client in Toronto now.
He’s making an offer on a property in the GTA area (don’t want to give away too much sensitive information as this is a very desirable apartment complex).
Now, the pricing seems high and his going in returns seem low.
We had a discussion on the going in yield today vs. where it could be in 2-3 years.
I asked him to tell me the demand in the area. What was driving values?
We found that in this area, there were multiple positive influences: new jobs, light rail transit, massive immigration – all putting upwards pressure on rents.
Over time, (his thesis, backed by data) see’s demand pushing the rents higher. (Side note- buildings in the immediate area are already achieving rents a few hundred dollars/month more. So this isn’t all hypothetical- there’s concrete evidence today of similar buildings achieving higher rents right now).
On the supply side- land is expensive and construction costs are climbing.
He’s buying well below replacement.
With a 10 year investment horizon, he’s looking at double digit returns.
With a stable, predictable cash flow- a building that is in demand in a great area.
What is the formula for finding locations with these positive characteristics?
Here are some of the Key Demand Drivers for real estate:
- New Jobs
- Population Growth (immigration/ inter provincial migration)
- GDP Growth
- Transit/ new infrastructure
Investing in cities with these 4 drivers is step 1.
People need jobs to pay rent.
Following jobs now and in the future is smart.
In Canada – immigration is also driving demand. Toronto, Vancouver and Montreal are all benefiting from this trend.
Now- let’s look at the flip side of the coin: Supply.
- How much new supply is coming on the market?
- New construction?
This requires having some basic understanding of construction costs.
To really get started in commercial real estate investing and understand if you’re buying below replacement value- you must know the following:
- land value
- new construction costs- price per sq.ft, price per door
- timelines to bring to market?
- Development permits/costs
- ease of developing (how friendly is the city you live in for new DP – Development Permits).
Cities like Vancouver are difficult to secure new DP’s- especially for higher density residential.
Land is locked- you’re surrounded by water and mountains.
You have a major influx of people moving to Vancouver- from overseas.
I’m not sure how many new high paying jobs are being created in Vancouver (I don’t invest there)- but you can see how the Supply (constrained) and Demand (growing) is driving real estate values higher.
When starting to invest in CRE- I am a firm believer starting as close to home as possible.
It’s hard to get a competitive advantage in a city you have a fly or drive to.
We’ll talk more about this later- but, even very small towns have opportunities. (I’ve got a client in a town of about 10,000 in MB where he’s finding deals all over. Very low competition).
For me, I live in Calgary.
So, looking at City of Calgary- here is what questions I’m asking.
What is driving the Calgary market today- for new jobs and GDP growth?
What will drive the jobs in the future?
I’m looking at reports from Federal, Provincial and Municipal levels on new jobs, full time vs. part time.
- What’s the avg wage?
- Unemployment – what are the trends?
- Migration – how many people are moving to AB?
- What ages are they? Has an impact (younger families typically spend more than elderly).
Armed with this knowledge you can start to make educated decisions on the city/town you live in.
In some cases, you may consider the city you’re in a good place to start investing- but with a view that in the future, you may look elsewhere.
For me, this is how I’m approaching Calgary. In the short- medium term, I’m comfortable with Calgary. But, long term- it’s harder for me to know.
So, I’ll continue to invest here (next 10 years) – but looking into the future, will continue watching what cities are attracting jobs and people. Where is the puck going?
Get Started In Commercial Real Estate Investing HOMEWORK 1:
Here is the 5 Step Exercise I give to my clients on becoming a Strategic Investor.
This will takes time. Don’t feel like you need to master it all in 1 day. But, start the process:
1. Chose the City you will invest in. Start where you live or within a short drive. You want to be able to maximize relationships you have locally.
Caveat: Start with the city you live in, unless where you live in is ‘dying’. There’s significant job loss, people are leaving to never return- and you don’t believe in investing there.
2. Research the Macro fundamentals in your city:
- Population Growth
- Job Diversity – 1 horse town or diverse economic drivers
- New Supply- building permits
- Political Environment- Taxes/ new Infrastructure
- Finance- liquidity and debt- how easy is it to get debt?
3. What are you looking for? How do you interpret these reports?
You’re looking for trends.
You’re comparing your market to other markets to see how it stacks up against other markets?
For ex: are jobs growing or declining in your city?
If growing, how fast compared to your state/province and nationally?
4. Record your findings.
Create a simple excel spreadsheet where you can enter in the fundamentals in Step 2 and track them over a 5 year horizon (or longer if you want).
You’ve done the work now- how do you feel about the city you live in?
Are you confident enough to put your money into it?
If not- then you may need to start over in a different market.
- Look at your Chamber of Commerce (jobs)
- Economic Development (great for Supply and demand)
- CMHC/ Fannie Mae/Freddie Mac – Debt
- Census Bureau (population growth)
- Type in “GDP Growth” + City
- Type in “Population Growth” + City
Q3. Comment below: When are you going to carve out an hour to do this work?
In my experience 95% of investors won’t do this work. I know this because with my 1-1 clients who pay me a lot of money, I have to push them to do it.
Even if you plan to invest passively in someone else deal- having a basic understanding of the market and what’s driving it will give you the confidence to invest. I’m a firm believer in taking full responsibility for your investments.
When I have investors in my deals that can assist me in making good decisions- they are the first investors that get the call for the next opportunity I find. Something to consider.
The research may not be a lot of fun. I’m doing this research now on a new multifamily development.
Would I rather focus on the fun stuff (making offers, meeting with bankers etc)? Yes.
But, my partners need the data to make informed decisions.
If you focus for 2 hours, you’d have a deeper understanding of your market than 99% of the people living in your city. More so than some professionals.
Because so few take the time to do this work. And, that’s exactly why it pays off.
Your understanding is what gives you the confidence to invest hundreds of thousands (or millions) of dollars into a property.
I’m sure Jovi would rather show up at a sold out concert and play to a sold out crowd. Instead, he’s up early, practicing scales on a Saturday.
Every time I present a new opportunity to my investors – they ask me 2 questions:
Shane, what is the demand (they ask this in many different ways) and who are we competing with (supply).
If I can’t answer these questions in 30 seconds- I’m done.
Day 9. How to Become a Programmatic Investor
What is a programmatic investor? (Tip of the hat to Derrick Lobo at Rock Advisers where I first heard the term – Programmatic)
It’s a term I use to describe an investor who is crystal clear on what he/she invests in.
You can communicate to the marketplace specifically what type of commercial properties you want to invest in and, as important – what you’re not looking for.
This clarity allows the marketplace to focus and deliver properties more in line with what you own.
If tell the marketplace: “I’ll look at everything”. Or, bring me any value add deal. Chances are, you’re not getting the first call.
First- nothing unique about wanting a value add property.
But worse, the deals you will see- you won’t know how good (or bad) they are without spending hours/days on. Even seasoned investor have a hard time staying on top of all the latest trends and metrics.
Specialists on the other had- can look at property in about 3 mins and tell you if it’s a deal they will pursue.
Trying to be a jack of all trades is probably the biggest mistake I see new (and seasoned) investors making..
Take the time to really map out what they want to invest in.
- What city.
- What property
- What size?
- What returns?
- How much leverage
- Type of tenants.
Wasting your time looking at the wrong deals will burn you out.
Wasting time of CRE professionals- will burn them out and you’ll end up seeing the deals no else wants.
My goal is for you is to see the best deals- first. So you have the unfair advantage needed to capitalize on.
In my 12 years of investing in CRE- the common theme I’ve seen is the most successful investors specialize. And, they can communicate what they do to others in 15-20 seconds.
Ex: We only buy retail properties over 20,000 sq.ft in major markets of 50,000+ in Western Canada with growing populations.
There’s nothing magical about that.
It could be tighter- you might only buy service based retail. Or, grocery anchored retail.
But, you get the picture. Your pitch communicates clearly to brokers and sellers what you invest in.
You may put yourself in a box- where you’ll miss out on deals.
There is no shortage of deals.
Plus, once you understand the players in CRE- you can adapt your pitch to the type of broker you’re speaking to (advanced strategy).
When a broker hears your pitch- they immediately know you’re a professional.
The broker will give you far more trust and faith because you’re communicating the way a pro does. See the broker’s biggest worry is that 1) you won’t close on the deal if you put it under contract (wasting his time) or, 2) that you’ll mess around at closing and come in for a drop close or retrade (asking for a big price reduction).
The agent wants to get paid and the seller wants the deal closed on the terms and time you agreed to.
If you’re viewed as an expert- who’s been down this road, you get taken seriously.
(Side note- many new investors who have not taken time or practiced their Programmatic Pitch- tell me they have a hard time getting commercial agents to call them back. This is one of the key reasons- if you sound like a newbie- you won’t get return calls).
Before we get into it how you become a programmatic investor, we should discuss the 3 Core Concepts of Investing in Commercial Real Estate:
1. Buy on cash flow today. Not for future appreciation. (forced appreciation is different).
2. When possible- secure long term debt (provided you’re holding the property)
3. Keep Sufficient Cash Reserves – in CRE, unpredictable things can happen: vacancies, long timelines, cost overruns. You don’t want to run out of cash.
Let’s drill down on finding specific properties and locations in the city you chose yesterday (hopefully the city you live in).
As a sample, here is my investing strategy.
This is right out of my Investing Roadmap:
“I focus on value add cash flowing commercial properties apartments between $5M – $15M”. And, I’m currently looking for infill land assemblies to build 30-60 MF units.
This is my North Star so to speak.
I’m looking for the right properties with the right things wrong.
- I want vacancy.
- I want deferred maintenance.
- I want properties I can add value to
- I want properties that have been neglected and forgotten about by their owner.
- In areas where the demand is growing.
As you start to think about investing in CRE, I want you scanning your market everytime you drive through it.
You’re looking for properties with signs for lease or properties that have been of mismanaged. Problem properties.
You fix the problem, push the NOI, and crank up the cash flow. You can either cash flow it, or refinance and go into you next property.
The game of CRE investing is not complex. The hardest part is finding the right properties. (For some- the hardest part is raising the money- but, that’s actually much easier with the right deal)
Some markets it will be much easier.
Story: I had a client who in the first 3 weeks of working with me, found a great value add property. One he could double the apartment rents and 3x the retail rents (as the leases role).
Property was listed on MLS. And in a good size city (500k).
- He was clear on what to look for.
- Understood the market he was investing in
- Went to where the puck is going- IE- transit and new infrastructure.
If the deal works and he’s able to execute- this 1 property could replace his earned income.
Now, I explained this might take him 2 years to execute. It’s not like fixing a home in 90 days.
CRE takes longer. Leases are generally longer terms. And, when something is new, expect it to take 2x as long as you think.
Steps to becoming a Programmatic Buyer:
Where do you start looking?
Recall yesterday’s lesson: you’re looking for Demand.
There are a few ways you can verify demand.
1. The Complicated route (which is what the professionals will do):
Go to city websites and look for where new infrastructure is going
- where is the city expanding?
- where are new jobs moving?
- look at the data on new DP’s and BP’s
- talk to locals and find out where people want to live
- find household income and spending per capita
- look at the demographics of the area
- look at the population growth on cities website for various communities. Is it increasing? Faster than surrounding areas
For industrial- this is less important. There are other factors to consider for industrial, access to the labor pool, access to freeways and airport are important.
Doing this homework would be a good idea.
But, I’m also pragmatic and know many new investors will not take the time to go deep into this research.
The shortcut is in step 2 (caveat- I’d start at #2 first to narrow down your search and then go back to step 1).
2. “Follow the smart Money”.
Understand that some of the commercial real estate developers and investors in the market are billion dollar companies with massive payroll. It’s their jobs to look for the best locations in a city and invest.
You can piggyback off them.
Grab a map and start to circle in red, the places you notice sophisticated investors going.
- Where are they investing?
- What are they building or buying?
This is where driving your city and starting to look for signs of new development or revitalization come into play.
When you see big companies making bets on new developments- you can start to narrow in your search for ‘good locations’.
It’s not a hard and fast rule but a good place to start.
Big development companies do make mistakes- but less than avg investors.
So, if you’re new and looking at Multifamily, Industrial or Retail and don’t know where to start by focusing on the big boys in the market.
Get Started In Commercial Real Estate Investing HOMEWORK 2:
Step 1. Get a map of your city.
I’d focus on A and B locations (maybe C- Blue Collar). Stay out of D or war zones.
Step 2. Circle all the major Retail or Industrial parks in your city.
Step 3. Look for trends on your map:
If you’re into multifamily- start looking for new developments, schools, transit lines and amenities (like grocery stores).
Retail is at high traffic intersections.
– Consumer income (per capita, avg HH income, median HH income)
– Population (size?)
– How much they spend (also known as consumer expenditures % -younger families generally spend more)
– high visibility and traffic counts.
Industrial is about access:
– Access to large labor pools (public transportation)
– Freeways /Airports for ease of delivery of supplies
– Major Distribution Hub – drive time for most truckers is 11 hours. Distance they can reach in 11 hours for same day delivery?
– Neighbors- like to stay away from dirty users
Multifamily- these days, pretty much follow rapid transit.
Obviously Schools/ amenities/ close to the jobs (CBD’s central business districts).
Step 4. Get in your car and drive the area’s you think are going to keep growing.
If you’ve been in a city for a while, you should have a good understanding or growing/popular locations.
Step 5. Make a note of new developments.
If there are lease signs – take pictures and make audio recordings of the locations.
When I come across new sites like this- I’ll call the leasing agent or developer and ask them what they are building? When will it be ready?
How much are they asking for rents.
If they ask why I want to know- I might say I have a tenant (when I was a broker). I might say, I’m the tenant and looking for space.
You want to become the local expert.
The fastest way to do this is through conversations.
Your first conversations might be awkward. That’s ok.
When I was knew, I’d plan my conversations for 20 mins before picking up the phone.
Now, I can call a sign and roll with it. That’s thousands of calls and practice.
Keep at it and eventually you’ll sound natural.
We will get into what to say to brokers and owners in week 4- but, just know there is nothing holding you back forms starting.
Day 10 – How to Get Started in Commercial Real Estate Investing
Deal Flow and Hidden Barriers to Entry
I was on a call yesterday helping a couple of investors looking to purchase a $31M apartment building.
Shane, how should we structure this deal and our offer?
My advice- get control and keep it simple.
In a hot market (seller’s market)- there is little sense in trying to tune up the seller and grinding too hard.
It’s important to negotiate upfront- but the reality is sellers know the game. Once you have their property under contract, you, the buyer are in the driver’s seat.
(as a seller), it’s their job to get as much $ as they can upfront.
Sellers know the price can only going to go down from there (if/when the buyer finds hidden issues in due diligence).
Now, the point of this is not to give you strategies on negotiations.
There were 2 key insights that came from the conversation I wanted to share with you:
1. The importance of control. I said at this point, the agents are scrambling and trying to find someone to buy. You need to get control (an accepted PSA) on the property.
2. The Hidden High Barriers to Enter Commercial Real Estate.
One of the guys said on the phone to me.
it took some time to get the attention of the brokers in the market- but, once he did, now, he’s seeing properties all the time.
He’s a player now and in the game, even though he’s relatively new to the world of CRE investing. But, in a short amount of time he’s established himself as a credible buyer in the market.
Doing a $30M deal- he’s playing with the big boys.
The commercial brokers have identified this group as a credible player.
How did it happen?
1. They closed on a deal (smaller- but, shows credibility)
2. He’s a good guy (in the world of CRE- you can be successful if you’re an asshole- but, if you’re newbie and an asshole- good luck.
3. They did what they said they would do (his reputation was important- hence, why he was reluctant to tie up the property and retrade the deal). Now, to be clear, I was not telling him to control it with the intent to drop close (come in for a price reduction).
Back to the deal. He told me the deal had $10M in profit once fixed- so I asked- why are you tripping over pennies to make dollars (I think that’s the saying).
This deal has enough upside to pay what the seller wants.
If you find something in DD that requires you to come back for a haircut on price- then you’ll have justification.
If not- close and be happy with $10M in profit.
So, what happens if you don’t have a track record?
No connections in the CRE world?
There are so many ways to break into the market.
I’ll give you a few ideas: this is all predicated on a hot market.
In 2008/09 during the financial crisis in the US, brokers were tripping over themselves to find any buyer that was actually buying).
Here’s what I’d do and what I’ve helped clients go when breaking into CRE:
1. Find Junior brokers at big firms– don’t go to the senior broker- they’re unlikely to take your call.
2. Go to Residential brokerage’s with commercial divisions: Remax Commercial, Century 21 Commercial, Royal Lepage, Coldwell Banker.
The agents at these shops are usually easier to deal with.
3. Have someone on your team with experience and leverage them. One of the things I do for my clients is help them with credibility when they have none.
4. Go to smaller brokerage shops– they have smaller budgets and the agents usually will have off market deals they can show you.
They will want to know you can close- but if you can talk their language, they’ll take you seriously.
5. Over pay for your first deal. Even the big boys do this. I’m not suggesting overpaying so much that you lose money- but, don’t try and negotiate every $ out of the deal. Some deals make sense at the list price.
I worked on the sale of a $30M apartment complex in Dallas not long ago the property was going into the bid process.
It was the 1st time I was on this side of the sale- usually, I was the buyer trying to win the deal.
The call for offers went out and we had something like 20 bids.
Of the bids, there were 5 at the top and 1 outlier. One group that was about $1M more than anyone else.
We got on the phone with them to vet the buyer.
The first thing the buyer, a sophisticated family office from NY said was: you’re talking to us because we’re probably high by $500k-1M right?
Well, we can assure you we’re not stupid. We see the market rents moving up by $100-150 in the next 18 months, and then they went to tell us why they believed that (jobs, affordability etc).
They increased their non-refundable money and bought the deal.
They essentially overpaid for a property.
Even though they owned 2,000 MF units- competing with groups with 50,000 MF units, they were unknowns.
Now, I’m not saying you need to do this at this level.
I’m demonstrating that even the most successful investors will overpay to lock up a property and get in the game.
It’s how the game is played.
Each of these examples is to demonstrate how the game of CRE is played.
Get Started In Commercial Real Estate Investing HOMEWORK 3 / Action Items:
1. Find 5 smaller boutique commercial brokers in your market.
If you’re in Calgary- you know one person already (why I write these articles)
2. Connect with them on Linkedin. What do you say- you could say nothing, just click “connect”.
Or, you could say something like:
I came across your profile on LinkedIn and am looking to invest in (asset class/size) in Calgary (location). Do you have a few mins to discuss?
Now you start a conversation with them. Follow them and see what they are doing.
You will want to go for coffee or lunch with the brokers- but, that’s a little further down the road.
For now, just create a database of commercial agents in your areas that you can build relationships with.
3. Where do you find deals?
- CRE brokers
- Res brokerages with commercial agents
- Who do you focus on? Juniors to start.
Your goal is a face to face. Take them for coffee. Don’t pick their brain- tell them what you’re looking for.
Ask to get on mailing list.
At this point- you just want to start seeing deals. And, understanding the marketplace.
It takes time to master this. Don’t expect to be an expert in 1 week.
Recall: you’re looking for vacancies, rental rates, absorption. Trends over time.
Finding properties with the right things wrong.
Don’t be surprised if a commercial agent doesn’t get back to you. They’re busy and sometimes forget. Don’t take it personal- just keep going until you find someone that you resonate with.
Day 11 BOE for Commercial Properties
It’s only taken 11 days to get to the place where most new investors to commercial real estate want to start.
Let’s get into the numbers!
I get it.
But, without an understanding of what and why, then you’ll end up spinning your wheels on the wrong deals, in the wrong markets.
Ok, so where are we on this journey?
Let’s zoom out for a minute:
- First you made the commitment to invest in CRE.
- Next, you took the time to get clear on where you are at today (financially) – both net worth and your burn rate.
- You have a clear FU # to aim for. Considered Milestone 1.
- Achieving your FU # may not be your ultimate target- but, it gets you to financial independence.
- Then you determined where you would invest- Macro: City.
- You understand what type of properties you’re looking for- The right things wrong- so as to add value or force appreciation.
- You know who controls the deal flow- for the most part, these are CRE brokers.
The next natural question, once you start to see deals- how do I actually underwrite (term used by analysts) to determine the value of property.
I’m going to give you a simple framework for underwriting CRE properties.
Today I’ll show you how to underwrite a retail property- and the principles could be applied to industrial or office.
We’ll look at multifamily later.
The Concept I want to introduce you to is: BOE or Back of the Envelope.
This is how you’ll find 95% of sophisticated CRE investors starting on any property.
They will breakout a piece of paper or, some will just do it in their head and quickly calculate a few key numbers.
- Price per sq.ft foot or price per door.
- They will understand the rents in the area- is this property over or under market?. Can I add value?
- They will understand the replacement value: so, if the property is priced over replacement, they will want to understand why?
If a property is in a highly desirable area- you may not be able to replace it (you’d have to tear it down). So it’s really land value, also called a covered land play.
The BOE allows investors to determine the NOI, apply a market Cap to calculates the value of a property.
If the price and value are acceptable to the investor (this will become more intuitive as you learn your market) – an investor will determine quickly if a deal is worth spending time on.
One of the biggest challenges new investors have is spending way too much time on bad deals.
A simple BOE could save you from a flawed deal from the start (in most cases).
A BOE along with a conversation with the broker to understand the deal- should tell you enough in 5-10 mins to determine if the property fits your investing criteria.
The most important number you need to understand is NOI and how it’s calculated.
The BOE is going to give you a basic understanding on how to calculate the NOI of a property.
If your BOE calculation gives you comfort- you’ll start to go into more details and verify your assumptions on the income and expenses.
Important: how you calculate the NOI will be based on your assumptions on the income today and going into the future.
I’m not going into assumptions today.
We are calculating NOI today. Future NOI calcs are outside the scope of this training.
- Income – Expenses = NOI
- Cash on Cash = (NOI- Debt Payment)/ Equity
- Cash on Cash with equity pay down = ((NOI + Principle Pay Down Yr1)- Debt))/ Equity
These are the basic formulas for today.
In the Cash on Cash calcs- you are using the Free cash flow after Debt. The actual money you put in your jeans before taxes and depreciation.
Let’s take a sample Retail Property that I’m helping a client with now.
- 10,000 sq.ft Retail.
- Rents are $20 psf
- OP Costs are $10 psf
- Vacancy is 20% or 2,000 sq.ft
- Assume NNN Leases
- $10k in signage income
Calculate the Value if we assume a 6% Cap Rate
Step 1. Calculate the Income
- 8,000 sq.ft (rented) x $20 psf = $160,000
- Signage Income = $10,000
- 8,000 sq.ft x 10 psf reimbursement of Expenses on leased space) = $80,000
- Gross Income = $250,000
Step 2. Calculate Expenses
10,000 sq.ft x $10 psf = $100,000
Step 3. Calculate NOI
$250,000 – $100,000 = $150,000 NOI
Step 4. Calculate Value at 6%
$150,000/.06 = $2,500,000
This is the basic BOE.
When we apply leverage (debt) let’s see what happens.
- Assume 70% leverage- $1.75M in debt
- At 4% on 25 Year Am
- My Annual P&I = $110,000
Returns with Debt
- $150,000 (NOI) – $110,000 (P&I) = $40,000
- My Cash on Cash = $40,000/$750,000 (the difference between Purchase price and debt)
- My cash on cash is 5.33%
- My cash on cash with equity paydown (how much principle reduction) = $40,000 + 42,000 = $82,000
- $82,000/$750,000= 10.93%
Basic returns I calculate on every deal
- Cash on Cash
- Cash on cash with equity paydown
From these numbers you can calculate IRR and NPV, which are important. When you invest in CRE, you’re really buying a future stream of cash flow.
So, understanding the future cash flows and determining the IRR and NPV are important, but outside the scope of a BOE. This is really where being an expert and understanding your market comes in.
Your future cash flow projections will only be as good as your assumptions on rents, vacancies, expenses and debt.
Get Started In Commercial Real Estate Investing HOMEWORK 4:
Using the same example above, calculate the following:
You fill the 2,000 sq.ft of vacancy at the same $20 psf rates
Now, you’ll have a 100% occupied building- but, for prudent underwriting, apply a 5% vacancy factor. Even though you’re full, you will still deduct 5% from the income for a vacancy allowance.
It will cost you $25 psf in Leasing Fees and TI’s to do this.
- What is the new NOI
- What is the new Value?
- Calculate the Debt You could Put on the Property assuming you need 70% leverage
- Assume 4% debt
- 25 Year Amortization
- Use P&I payments
How much Value did you create by filling the vacancy?
What is your cash on cash return (assuming you are able to refinance the property and pull out the new equity you created by filling the vacancy)?
All you need for these calculations is a calculator and amortization schedule (I use a HP 10bII calculator) for all my calcs.
You could use excel or go online and find a simple mortgage table to help.
Post your answers below and I’ll share the answers on the weekend to those who try.
While these calculations may seem somewhat challenging at first- as you underwrite deals everyday, you’ll quickly understand the math and in time do these #’ers in 5 mins on any CRE property.
Day 12: Using Buddha’s Eightfold Path in Commercial Real Estate
Buddha’s Teaching and Learning Framework.
Credit goes to Alex Mandossian for bringing this to my attention, on his recent podcast, All Selling Aside.
Buddha, developed the “Eightfold path” to explain and help others on their journey towards enlightenment.
I wanted to share this concept with you to show you the progression along any new endeavor, follows a similar framework or process.
Buddha’s teachings have been around for more than 2500 years and influenced more than 600M people. The process works.
Here is the Eightfold Path and how it can be applied it to investing in CRE:
- Right Understanding – do you have a basic understanding of the fundamentals of CRE?
- Right thought – what are you looking for? Do you know what is important in an investment?
- Right speech – how do you communicate to people in this business?
- Right action – are you taking the appropriate actions?
- Right livelihood – this is a lifestyle, not a 1 time event
- Right effort – continued effort. Not 1 day or 1 week or even 1 year.
- Right mindfulness – taking feedback from your actions and course correcting
- Right concentration – focused attention, not scattered.
This Eightfold Path relates perfectly to the BOE exercise you did yesterday.
I noticed when some of the answers came in- people were trying to shortcut the process.
The BOE is a quick way to determine the value of a property- however, it’s not a 1 step move.
First, is the right Understanding – do you fully understand NOI and how it’s calculated?
It requires the right thought– how value is influenced by NOI and Cap Rates.
The right speech– do you really understand what NOI is, Cash on Cash and cash on cash with equity pay down. It’s ok if these terms are new to you- just means you’ll want to take the time to write out the definition and make sure you get it.
How does slippage and vacancy going to affect the value?
Right action– doing the work. Taking out a piece of paper and going step by step.
The Right livelihood– are you taking the 30 mins a day to actually do this. Looking at properties all the time. Talking to people who might be prospective investors.
For me, I committed to sharing this information for 30 days. While I’m currently under contract on $9.5M worth of CRE, and 9M under construction- I am investing about 2 hours each morning to write and share a video.
Every morning I ask- why am I doing this? So few people are reading it. I doubt anyone would even notice if I just stopped?
This is what Steven Pressfield calls the resistance. The limiting beliefs in our head that prevent us from following through.
Right effort– goes without saying. A BOE might take me 5 mins, because I’ve done it 5,000 times. If its the first one you’ve done- it may take 20 mins
Right mindfulness– are you submitting the work and asking for feedback? What are your expectations as it relates to investing in commercial real estate?
If you expect it will be difficult (on your 1st deal) – then, when obstacles arise, you’re not thrown off.
(I like the fact that investing in commercial properties is not easy. Because I know the competition will stay low. Compare that to fixing and flipping houses, investing in the BRRR strategy, buying an up down duplex to rent out- the competition here is fierce).
Right concentration– are you focused and uninterrupted while doing the work?
Or, are you trying to figure this out on your phone and doing a quick calc in your head. I can tell you, most of the math can be done in your head- but, most people can’t do 25 year mortgage calcs in their head.
So, better to start familiarizing yourself with the tools now.
Get Started In Commercial Real Estate Investing HOMEWORK 5:
- Go back through the first 12 days and see where you’re at. You’re busy. And if you missed a day or video- just go back and complete.
- Have you done the homework? This 30 days (4 weeks) is to give you a foundation in commercial real estate. To help you decide- do I want to commit to this, or not?
- Are you tracking or, are you waiting to get to the ‘fun stuff’ before you start?
Request the 3 Forms for Investing in Commercial Real Estate
- 8 Non-Negotiables to Investing in Commercial Real Estate
- The Debt to Cash Calculator
- The Commercial Real Estate Small Business Plan
Request the 3 Forms for Investing in Commercial Real Estate
- 8 Non-Negotiables to Investing in Commercial Real Estate
- The Debt to Cash Calculator
- The Commercial Real Estate Small Business Plan