A Sunday Morning With Tuna

This morning I got up at about 6:30 and it was off to Dunkin Donuts for a large coffee.

I then got back to the house and read through the Charlotte Observer, the Charlotte Business Journal, the Weekend Wall Street Journal, and Financial Times.

After the physical papers are finished I move on to the Google Reader online, which organizes about 40 different websites and their articles so I can review them in an easy and efficient manner. (Highly recommend it for those who read a lot online)

Then it's off to the park for a run.  It's a beautiful day today and most of the babies the ducks had a few weeks ago have grown significantly.  Very wholesome.

When I get back home and shower it's time to go to work.  This is where it gets fun.

During the week, commercial real estate agents send me information on properties when they come available for sale.  If a property looks interesting I sign a confidentiality document and they send me the financial details on the property.

This morning I did a full analysis on an apartment complex in South Carolina.  (I cannot give out name and address due to confidentiality.)  However, the following information is a brief summary of what I used to review the property:

Total Units: 80
Year Built: 1999
Asking Price: $3,600,000

Total Income (Rents): $428,890 (Yearly)  This number includes the current vacancy rate (empty apartments) and any additional income a property may have such as a laundry room, vending machines, or car wash.

Total Expenses: $281, 146 (Yearly)  This includes property taxes, insurance, management salaries, maintenance salaries, advertising, utilities, legal, accounting, and any additional costs associated with running the property.

Net Operating Income: $147,744 (Yearly)  The Net Operating Income (NOI) is the most important financial piece of information in real estate.  It is simply total income - total expenses.  (**This number does not include the monthly mortgage costs**)

When I finish running the financial numbers (I use a detailed excel program), I determine how much I would be willing to pay to receive the net operating income.  The rate of return I am willing to accept to recieve the net operating income is called the cap rate.  This is the second most important piece of information in real estate.

The owner is asking for $3,600,000.  This means that he is asking me to agree to a 4% return on my money.

$147,744 (NOI) / .04 (Cap Rate) = $3,600,000 (Purchase Price)

What would I realistically pay for this income?  I would ask for an 11% return.  An 11 cap.  So now I just figure out the purchase price I need to receive this return.  You essentially work backwards:

$147,744 (NOI) / .11 (Cap Rate) = $1,343,127 (Purchase Price)

The current cap rate for a similar property in this area is 8-9%.  As our economy continues to implode, rates begin to rise, and real estate financing become more difficult, market cap rates will continue to rise.

Summary:  This seller is most likely in serious trouble.  They may have to refinance in the near future, as I discussed in the article below and they may be trying to get out of the ticking time bomb before it explodes.  In the example of this property I would rather wait till the property is bank owned and purchase it from them.

Just for fun though, what if they property was bank owned and I could purchase it at a realistic cap rate of 11%.  The property is currently 32% vacant.  If I could decrease the vacancy to 15% by finding renters, which is very realistic in the market the property is located, what would the investment look like?

Let's assume I finance the property 100%. (Nothing down)  I would borrow 80% from the bank at a 7% interest rate.  The remaining 20% down would come from private capital/partners who I would pay 15% plus possibly a percentage of the profits when the building was sold.

1,074,400 at 7% (80%)
268,600 at 15% (20%)
Total annual cost to borrow this money: $126,060

New NOI with vacancy at 15% would be $254,996.
Now I subtract the cost to borrow          ($126,060)
Total Annual Cash Flow:                           $128,936

This means I would make $128,936 in passive income with a full staff onsite managing the property.  I used none of my own money to purchase the building.

Hold on, it gets better.

With the NOI now at $254,996, at an 11 cap, the building is now worth $2,317,873.  The building has increased in value by $1 million with no rental increases and no change in what the market would pay for the return.

This will be only a mediocre opportunity compared to the incredible deals that will present themselves during the latter stages of this depression.

It's about 1:00 now, so some of my friends are probably waking up from their long nights drinking.  Time to go pick them up and head to the bar to watch some soccer and golf.

Have a great Sunday and Happy Father's Day!