Steed Talker

Frequently Asked Questions in Real Estate Investing

In the USA accredited investor is a term used by the Securities and Exchange Commission (SEC) to refer to a person who has a reduced need for the protection of regulatory disclosure filings. They must meet one of the following: Net individual income of $200,000 in the last two years, or joint income with spouse of $300,000 in each of the previous two years and have a reasonable expectation of the same for the immediate future. Or, a current individual or joint net worth of a least $1,000,000 excluding primary residence. Banks, Insurance companies, general companies, charities, trust, and employee benefits plans with assets in access of $5,000,000 also qualify as accredited investors.

One who finds, analizes, brings to closing, invests their own funds, and manages the investment operations from start to successful completion — often referred to as a general partner

The percentage return on investment that accounts for the time invested. To calcuate, take the total profit and divide it by the amount of the investment. Then take the resulting quotient and divide by the number of years invested. This equals the Annualized return on investment (ROI), i.e. the investment is $100,000. Each year, the rental property’s cash flow was $10,000 for a five-year total positive cash flow property of $50,000. Divide by five years equals a 10% Annualized ROI ( {50,000 / 100,000} / 5 = .10).

The increase in value of real property over time. Black Knight’s reports a 25-year average home appreciation rate of 3.9%. Real esate appreciation rates vary widely from local to local.

Uncollected rent that a former resident owes.

The expected rate of return on investment that is expected from the generation of income from a real property. It is calculated by dividing the net operating income (NOI) by the properties assessed value or purchase price, i.e. a 300 unit apartment complex with an NOI of $1,944,000 that was purchased for $27,771,428 will have a Cap Rate of 7% (1,944,000 / 27,771,428 = .07

Funds used to improve an asset. CapEx Expenditures are recognized on the balance sheet rather than on the income statement.

The funds remaining after all expenses are paid constitutes the cash flow. This is both operating expenses and debt service. Cash flow is Net Operating Income (NOI) minus debt service, i.e. a 300 unit complex has an NOI of $162,000, debt service of $106,068 generating a cash flow of $55,932 (162,000 – 106,068 = 55,932)

The actual cash or profit generated in any given period divided by the amount of investment remaining. CoC is a snapshot of a period of time within the full range that the investment is held, i.e. say year two (the period of time) generated a positive cash flow of $6,000 on an investment of $100,000. The CoC for year two is 6% (100,000 / 6,000 = .06)

The cost associated with the purhase of real property that are over and above the purchase price of the property, i.e. attorney fees, origination fees, due diligence fees, underwriting fees, application fees, recording fees, credit search fees, acquisition fees, misc. fees.

The funds required to pay the principal and interest on the mortgage of a real estate property. Principal is the original amount borrow and the interest is the rent paid for the privilege of borrowing the money. For example, a $25,000,000 loan amortized over 30 years for 3.5% interest will result in monthly payments of $112,261. Interest on the first payment will be $72,917 and the principal will be $39,344. Each month the interest portion decreases and the principal portion increases. The interest portion is an expense recognized on the income statement. The principal portion increases the equity and is recognized on the balance sheet.  Some mortgages are Interest Only.  In this case, there is only an interest payment but not principal payment.  

For income purposes depreciation expenses are deducted from the real estate income. For tax purposes, depreciation reduces taxable income. Depreciation is one of the most powerful tools available to real estate investors that allows them to keep more income earned.

EGI includes actual positive gross revenues generated by the property before expenses. It’s calcuated by adding the gross potential rent (GPR) and other income minus vacancy loss, loss to lease (LtL), concessions, employee units, model units, and bad debt.

Equity investment is the value of an asset less the amount of all liabilities. In terms of a real estate investment it’s all the money that will be returned to the general and limited partners if and when the property is sold or refinanced. It is the down payment plus closing costs, financing fees, reserve funds, and fees paid to the general partners for operating the syndication.

An equity multiplier is just a number that tells us how much we have multiplied our investment. It can only be calculated after the investment has been terminated, proceeds have been distributed, and all cash invested has been returned.

Suppose if $100,000 was invested, and the investor ends up with $200,000, the investor doubled their money. Take this example: $100,0000 investment with $184,000 profit gives 1.84 Equity Multiplier (184,000 / 100,000 = 1.84)

The fees charged by the lender for financing the purchase of the property. On average the fees can range from 1.5% to 1.8% or so. For a 300 unit apartment complex with a purchase price of $27,771,428 with an 80% loan to value debt of $22,217,142 and  a 1.75% finance fee, the financing fee will be $388,800.

One who finds, analizes, brings to closing, invests their own funds, and manages the investment operations from start to successful completion. The General Partner (GP) is the active investor in a real estate syndication.

The total theoretical revenues possible if the property is 100% leased and rents paid the entire year plus any other revenues such as cable fees, laundry, parking, late fees, pet fees, and etc.

The total amount of projected rental revenue if the apartment complex is 100% leased for the entire year at the market rent rate.

It’s the interest rate that brings a series of cash flows both positive and negative to a net present value of zero or to the current value of the investment. It is perhaps the most important tool for passive investors when qualifying a potential real estate investment. To simplify, the IRR is a percentage that accounts for time, fluctuating cash flow, and the amount invested at any given point.

In this example, the initial investment is $100,000. Year one cash flow is $4,000, year two $6,000, year three $7,000, year four $8,000, year five $9,000. Year three, the property was refinanced and $50,000 returned to the investor. Year five the property is sold with sales proceeds of $150,000. This yields an IRR of 22%. The IRR calculation is a complex equation but with the help of a spread sheet it’s easily calculated (the above example was calculated using an excel spread sheet.)

Real estate syndicators use debt to increase returns on the investment and amplify buying power. Leverage enhances the benefits of both appreciation and depreciation.

A limited partner places one’s funds into a partnership, usually a syndication, that is managed by an active investor. The Limited Partner (LP) is a passive investor in a real estate syndication.

It’s the difference between the market rent and the actual rent reported as percentage, i.e. 300 unit apartment complex with market rent of $3,420,000 and actual rent of $3,240,000 has a LtL of 5%, i.e. (3,420,000 – 3,240,000) / 3,420,000 = .05

Market rent is the prevailing rate of rent expected in any particular market. The market rent is generated by performing a market comparison or comparative market analysis (CMA), which compare similar area rentals to the property underconsideration for purchase.

An agreement with a financial institution that allows an entity (individual or syndication) to borrow funds to acquire real property.

All revenue generated from the real property less the operating expenses. NOI is the income generated before taxes, principal and interest, capital expenditure, and depreciation. As an example a 300 unit apartment complex generates total monthly income of $270,000 and total operating expenses of $108,000 has an NOI of $162,000. Annualized that will be $1,944,000.

Expenses incured through normal business operations. Examples are salaries, equipment, marketing, management fees, legal fees, utilities, contract services, repair/maintenance, etc. OPEX expenses appear on the income statement.

Places one’s funds into a partnership, usually a syndication, that is managed by an active investor — often referred to as a limited partner.

It’s the sale price per unit. Each sector or real estate has a different per unit definition: Retail and office the per unit is square feet, apartment is per housing unit, hospitality is per hotel key.

For example, a 300 unit apartment complex sells for $27,771,428. The Price Per Unit is $92,571 (27,771,428 / 300 = 92,571).

It outlines the basic terms of the investment and discloses the primary risks associated with the investment. There are at least four sections: An introduction that provides a brief summary of the offering with basic disclosures that includes information pertaining to the general partners; section two provides a discription of property and outlines the primary risk factors; section three is the legal agreement; and section four is the subscription agreement.

The percentage rate that the investment yields. The ROI is a simple calculation. Take the total profits earned and divide by the total investment, i.e. 90,000 total profits divided by 100,000 investment equals 90% (90,000 / 100,000 = .90). This calculation doesn’t account for time and is therefore in and of itself not particularly useful. To be of more use, it must be annualized.

A group of individuals who pool their capital to invest in the purchase of real estate that they as individuals would not be able to afford.

Incentives that are given to attract tenants such as two months free rent, reduction in application fee, free parking, etc. Concessions are generally given upon move-in.

Sometimes referred to as the operating account fund, it’s an account fund established over the purchase price of the property. This fund is established to cover necessary and unexpected expenses such as a decline in occupancy, lump sum payments for insurance and taxes, and excessive capital expenses. The fund is generally created by raising additional funds from the limited partners above the purchase and acquition costs of the property.

The profits distributed at the sale or refinance of a real estate property. A 300 unit apartment complex

An investor who has demonstrated insight and success as an investor generally not seen as one able to sustain a loss without damage to their overall net worth.

Revenue lost from units that are not occupied, i.e. a 300 unit apartment with average rents of $900 per unit per month. 25 units are vacant for a vacancy loss of $22,500 per month annualized at $270,000 (25 X 900 = 22,500 X 12 = 270,000).

The percentage of vacant units. The vacancy rate is calcuated by dividing the number of vacant units by the total number of units, i.e. a 300 unit complex with 25 vacant units has a vacancy rate of 8.3% (25 / 300 = .083)