Appelman Capital

Hud Loan Programs For Apartment Syndicators: Everything You Need To Know Let’s talk about one of the top loan program providers that apartment syndicators use on their deals: Hud. Hud can be a great option for apartment deals. We’re going to cover each of their common loan programs, including their permanent, refinancing, and supplemental loans. Loan 1: 223(f) The first Hud loan, which is the permanent loan, would be the 223(f). This is very similar to agency loans, except for one major difference: processing time. Plus, the loan terms are actually a little bit longer. So for the 223(f), the loan term is going to be lesser of either 35 years or 75% of the remaining economic life. So if the property’s economic life is greater than 35 years, then your loan term is actually going to be 35 years. It’ll be fully amortized over that time period. Whatever the loan term is what the amortization rate will be. If you’re dealing with a smaller apartment community under the $1 million purchase price, then this is not going to be the loan for you. In regards to the LTVs, for the loan-to-values, they will lend up to 83.3% for a market rate property, and they will also lend up to 87% for affordable. So that’s another distinction of the housing and urban development loans, which is they are also used for affordable housing. There will be an occupancy requirement, which is normal for most of these loans. The interest rate will be fixed for this loan, and then you will have the ability to include some repair costs by using this loan program. For the 223(f) loan, you can include up to 15% of the value of the property in repair costs or $6500 per unit. If you’re not necessarily doing a minor renovation, but if you’re spending about $6500 per unit overall, then you can include those in the loan. The pros of this loan are that they have the highest LTV. You can get a loan where you don’t have to put down 20%; you can actually put down less than 20%. It also eliminates the refinance as well as the interest rate risk, because it is a fixed rate loan, and the term can be up to 35 years in length. You won’t have to worry about refinancing or the interest rate going up if something were to happen in the market. These loans are non-recourse as well as assumable, which helps with the exit strategy. There’s also no defined financial capability requirements, no geographic restrictions, and no minimum population. There’s essentially no limitation on them giving you a loan for a deal if the market doesn’t have a lot of people living in it or the income is very low. There are also some cons involved when considering a Hud loan. The processing time is much longer than some. The time for a contract to close is at a minimum of 120 days to six or nine months is actually common. Other loan providers have processing times between 60 and 90 days. Hud loans take a little bit longer to process. They also come with higher fees, mortgage insurance premiums, and annual operating statement audits. Loan 2: 221(d)(4) The next Hud loan is 221(d)(4). These are for properties that you either want to build or substantially renovate. Similar to the 223(f) loan, these loans do have very long terms. The length of the loan will be however long the construction period is, plus an additional 40 years. That is fully amortized. This isn’t the loan for smaller deals, because the minimum loan size is going to be $5 million. So if you have a deal that you want to renovate and has got a $1 million purchase price, you’re going to have to look at some other options. Similarly, this is for market-rate properties as well as affordable properties, with the same LTVs of 83.3% and 87% respectively. These loans are also assumable and non-recourse as well as fixed interest with interest-only payments during the construction period. The CapEx requirements for this loan are quite different than the 223(f). For the 223(f), it was up to 15% or up to $6500 per unit, whereas for the 221(d)(4) loan actually needs to be greater than 15% of the property value or greater than $6500 per unit. The 221(d)(4) pros and cons are pretty similar to the 223(f) pros and cons. There’s the elimination of the refinance and interest rate risk, because of that fixed rate in a term of up to 40 years. They’re also higher leveraged than your traditional sources. Those longer processing time and closing times can be a pain. There’s going to be higher fees, and you also have those annual operating audits and inspections. Loan 3: 223(a)(7) Hud also offers refinance loans as well as supplemental loans for their loan programs. Their refinance loan is called the 223(a)(7). If you’ve secured the 223(f) loan or you’ve secured a 221(d)(4) loan, you’re able to secure this refinance loan, and it has to be one of those two. You can’t go from a private bridge loan to this refinance loan– that’s not how it works. The loan term for the refinance loan is up to 12 years beyond the remaining term, but not to exceed the term. If your initial term was 40 years and you refinanced at 30 years, then this refinance loan will only be 10 years, because it can’t be greater than 40 years. It will be either the lesser of the original principal amount from your first loan, or a debt service coverage ratio of 1.11 or 100% of the eligible transaction costs. These loans are also fully amortized. The occupancy requirements are going to be the same as the existing terms for the previous loan. These are also going to be assumable and non-recourse with that fixed interest rate. Loan 4: 241(a) Hud also has a supplemental loan program … Read more

What Does Accredited Investor Mean For You? Remember back in high school when all social groups were divided into cliques? There were jocks, nerds, cheerleaders, theater kids, band geeks, and every other division of people either by interest, attitude, or even ethnic group you could imagine and it was pretty much unheard of for anyone to move from one clique to another. Geeks and drama nerds didn’t get invited to the jock/cheerleader parties (or vice versa). As adults we think we left all that drama behind, but did we really? At first glance it might seem like real estate syndications are the same way, like an exclusive party that only certain people get invited to attend. Most people haven’t heard about them because you have to qualify to be told about the opportunities. Luckily, the SEC just issued an amended definition of an accredited investor in August of 2020, expanding the pool of people who can qualify to participate in the exclusive “party” of real estate syndication investors. Most real estate syndication deals are only available to accredited investors, but some are available to sophisticated investors. Before you can get investing, you need to know which clique you’re in (sophisticated or accredited) and how to leverage your assets to gain access to the investment opportunities you deserve. In other words, you at least want a chance to be invited to the party! So, you might be wondering – Am I an accredited investor, and do the new rules help me? THE OLD DEFINITION OF AN ACCREDITED INVESTOR According to the SEC, you must qualify as an accredited investor by meeting at least one of the monetary requirements, deeming you financially stable enough to invest in private deals like real estate investment syndications. You can qualify as an accredited investor with an individual income of over $200K per year or a joint income of over $300K per year. If you don’t meet the income requirements, the net worth requirement is + $1M in assets outside of your primary residence. Remember, you don’t have to meet both requirements. If you do, great, but only one is required. If you don’t meet either of these requirements, don’t give up yet! It’s possible the amended definition of an accredited investor might include you, or you might fall into the non-accredited, sophisticated bucket of investors, which is also great news. THE NEW/EXPANDED DEFINITION OF ACCREDITED INVESTOR The August 2020 update expanded the exclusivity to extend beyond just an income or net worth requirement. Highlights of the updated definition include spousal equivalents and qualifications based on licensure, knowledge, and professional investment experience. As of the recent amendment, the joint income requirements not only qualify legally married, traditional couples but also include “spousal equivalents,” allowing non-traditional couples to pool their income and assets to meet the income or net worth requirements from the original definition. This breaks down barriers for LGBTQIA+ couples and allows all spousal equivalents to qualify as accredited investors just as any traditional partners would. Yay for inclusivity! The recent update also provides that professionals with certifications, experience, or knowledge of investment securities and the risks associated, such as those licensed with a Series 7, 65, or 82, or who are knowledgeable employees of a private fund may qualify as an accredited investor. This means that even if you don’t meet the income or net worth requirements, but you’re knowledgeable of or experienced in these types of investments, that you may have a foot in the door. The amended definition of accredited investor provides access to those who previously couldn’t qualify simply because of their lifestyle and for those who are knowledgeable and experienced with these types of investments, regardless of their income or net worth. If you are in either of these buckets, we welcome you with open arms! HOW NON-ACCREDITED INVESTORS CAN STILL PARTICIPATE It’s no secret that real estate syndication investments are exclusive, and even though you don’t quite meet the accredited criteria, you’re a high-net-worth individual determined to build wealth! So, how can you get in? You might be what’s referred to as a sophisticated investor. The SEC provides a broad definition of a sophisticated investor as someone with sufficient capital or net worth and experience to weigh the risks and merits. Industry-wide best practices classify a sophisticated investor as someone with +$100K individual income (+$200K joint) or +$350K in assets outside the primary residence in combination with sufficient experience. The key here is “sufficient experience,” which is why we want to have a conversation with you! We invite you to not only leverage your capital in a way that works as hard as possible toward building wealth, but to also leverage your relationships, namely, the one between you and Appelman Properties. Even if you meet the income or net worth requirements, we can’t share deals with you (or even mention certain deals) without establishing a relationship first. Even if the thought of talking finances on a call is something you’d rather avoid (we aren’t scary, I promise!), it’s never too early to begin a working relationship if it means you gain access to otherwise-exclusive investment opportunities. Plus, since very few deals are available to a limited number of sophisticated investors, you don’t want to miss your chance! HOW THE UPDATED ACCREDITED INVESTOR DEFINITION AFFECTS YOU The amended definition of an accredited investor expands the criteria to include non-traditional couples, experienced investors, and licensed investment professionals who, according to the original guidelines, would have been excluded before August of 2020. If that’s you, this is your invitation to the party! We’re so excited to welcome you and those you know who are newly-qualified (according to this amendment), high-net-worth individuals to the exclusive world of wealth-building real estate syndication investments. Whether you think you’re accredited, sophisticated, or unsure, the important takeaway is that we create a relationship beginning with a call in which we discuss your experience and your investing goals so that we can share deals with you and … Read more

Are Bridge Loans Good For Commercial Real Estate? Are you curious about what role bridge loans play in the world of commercial real estate? Take a look at what you need to know. Imagine that you’ve found the perfect office building to acquire, but won’t have the cash to close until your current property has sold. Or maybe your renovation project is taking longer than anticipated to complete, but your balloon loan is coming due in the next few weeks. In situations like these and others, commercial real estate investors and developers turn to bridge loan financing to raise cash fast. In this article we’ll discuss how bridge loans work and how bridge loans serve as an alternative form of financing for commercial real estate. Defining Commercial Bridge Loans As the name implies, a bridge loan ‘bridges’ or ‘fills the gap’ between a short-term loan used for work such as new construction or redevelopment and more permanent long-term financing. In some markets bridge loans are also known as interim financing, gap financing, or swing loans. A bridge loan allows the borrower to pull cash out of the property to pay off an existing loan or settle other debt obligations. Bridge loans can also be used to help a commercial real estate investor cover part of the cost of acquiring a new property and entice the seller with a quick close of escrow. Commercial real estate bridge loans: Are short term, usually between three months up to three years Have relatively high interest rates and fees Usually are fast to fund Backed by collateral such as real estate May be issued by banks, private lenders, and alternative lenders such as debt funds The Difference Between Bridge Loans and Traditional Loans Some of the key differences between bridge loans for commercial real estate and traditional loans include: Closing time frame Waiting for a traditional loan to be underwritten and processed can cost valuable time and create missed opportunities. By contrast, the closing time frame for a bridge loan can be three weeks or less. A commercial real estate bridge loan allows an investor to move quickly when time is of the essence, then arrange permanent financing after the bridge loan closes. Loan qualification Qualifying for a real estate bridge loan can also be easier than being approved for a longer-term loan. While bridge loan lenders may have credit score minimums, they will also consider loan qualification factors such as debt-to-income ratio (DTI), the borrower’s track record and other assets, and the viability of the investor’s business plan, and future refinancing and payback plans. Fees and interest The tradeoff for the faster loan funding and easier qualification of a bridge loan is that the fees and interest rates are more expensive compared to a traditional loan. Closing costs and fees associated with commercial bridge loans typically include appraisal and escrow fees, title policy costs, and administration and loan origination fees. Interest rates vary based on the borrower, lender, and specific loan terms but generally range above the prime rate for a traditional loan. Use of loan A bridge loan lender is more willing to dig deeper into a borrower’s plan to acquire, upgrade, or reposition a property and evaluate the investor’s track record of success for similar projects. On the other hand, a traditional lender prefers to finance the property after the renovation is done and the building is leased up. Commercial real estate bridge loan lenders are willing to be more flexible with how the bridge loan is used in part because of the shorter loan term. Prepayment penalty Unlike a traditional commercial lender, bridge loan lenders normally want the loan to be paid off quickly. A commercial real estate bridge loan does not have a prepayment penalty, with payback periods generally ranging from three months to one year or more. Real estate investors can benefit by paying off a bridge loan early without incurring fees or other penalties. Understanding How Commercial Bridge Loans Work Commercial bridge loans are structured by the lender to meet the specific needs of each borrower. Financing fees and interest rates for a bridge loan are normally greater than with a traditional loan, but funding is faster and the loan terms and conditions are more flexible. The loan-to-value (LTV) of a commercial bridge loan is between 65% and 80% of the property’s appraised value. If a building is being renovated, the lender will use loan-to-cost (LTC) which takes into consideration capitalized capital expenditures. Common bridge loan scenarios Take advantage of an immediate opportunity to acquire a property then refinance with a more affordable long-term traditional commercial real estate loan. Use a commercial real estate bridge loan to acquire a new property before the current one is sold, such as a business needing to expand or downsize. Make improvements to attract tenants willing to pay higher rents and increase long-term gross rental income to make qualifying for a commercial bank loan easier. Stabilize an office building so that the long-term cash flow and debt obligations will qualify for a traditional loan. Things to Look for in a Commercial Bridge Loan There are two things to look for in a commercial real estate bridge loan: 1. Funding timeframe While traditional lenders are normally slow to fund, the funding timeframe for a commercial real estate bridge loan can be a few weeks or less. Investors who need to fund quickly to acquire a property or jump-start a repositioning project may find a bridge loan the ideal short-term solution. 2. Facilities A good bridge loan for commercial real estate will offer the borrower the option to increase the loan balance during the loan term for the purpose of paying for capital improvements, tenant improvements, or leasing commissions. The advantage from a borrower’s perspective is that unlike traditional loans which fund all the proceeds in an up-front lump sum, borrowers can draw down on additional proceeds when and if needed. This helps to reduce and keep interest payments to a minimum. … Read more

What Is A Commercial Real Estate Letter of Intent? (LOI) Experienced commercial real estate investors and tenants always use a LOI when entering into a potential transaction or buy, sell, or lease office space. Although LOIs are frequently used to buy or lease commercial real estate, parties sometimes make critical mistakes that could easily be avoided. In this article we’ll describe how to structure and write an LOI, and explain why a LOI is one of the most important documents in commercial real estate. What is a LOI? A LOI – or letter of intent – is a written non-binding document between two parties that serves as the basis for a proposed future action or agreement. In some markets an LOI may be called a Letter of Understanding, a Memorandum of Agreement, or a Memorandum of Understanding. The LOI is used to: Outline the key aspects of a proposed transaction that the parties agree on Signify that the parties are committed to moving forward on a deal Serve as a guiding document for drafting a formal binding contract Although a LOI is non-binding overall, the parties may mutually agree that some sections of the LOI are binding, such as the purchase price or financing structure used to acquire a property. When is a LOI Used in Commercial Real Estate? A LOI is used in commercial real estate to put the major points of a proposed purchase or lease into writing. The party presenting the letter of intent should research and tour available properties on the market before submitting a LOI to the owner or landlord. Normally a letter of intent will be drafted by the commercial real estate broker representing the buyer or tenant after touring the property and conducting informal discussions with the owner. The LOI will outline key deal points such as price, due diligence period, financing, and close of escrow or date of possession. Even though a letter of intent is non-binding, providing one demonstrates the buyer or tenant is committed to moving forward on a deal and intends to proceed in good faith. Of course, sometimes a party may change the terms of the initial LOI or withdraw from the deal entirely based on new information when conducting due diligence and verifying information provided by the parties. Why is a LOI One of the Most Important Documents in Commercial Real Estate? Buying, selling, and leasing commercial real estate can be time-consuming, complex, and expensive, even for the most experienced investors and tenants. A LOI helps to ensure that both parties have a “meeting of the minds” before getting too deeply involved in a transaction. A letter of intent serves as a middle step between initial discussions with the property owner and drawing up a legally binding sales contract that could easily run 20 pages or more. The LOI provides a quick and easy way to memorialize the basic terms of the proposed transaction before negotiating other terms of the contract and paying a real estate attorney to draft or review the sales contract or lease agreement. LOIs are also a good way for a seller or landlord to determine how serious a prospective buyer or tenant is. Because an LOI is free to make and non-binding, some prospects present as many letters of intent as possible in the hope that one is accepted. If the terms proposed in an LOI are significantly different from a property owner’s Offering Memorandum, that could be a sign that the party presenting the LOI may not be serious about completing the transaction. What is Included in an LOI? An LOI should include the following items: Parties Name of seller, buyer or tenant Address and contact information Responsible parties authorized to execute a final sales or lease agreement Property o Address and suite number of a lease is being negotiated o Building description including lot size and square footage o Amount of parking and signage o Property gross income, operating expenses, and NOI based on seller’s representations o Type of rent such as FSG or NNN, including any CAM charges, if the LOI is for a lease Offer Purchase price including earnest money and terms of financing Due diligence period and general description of documents seller or landlord will provide Lease terms including rent and annual increases, rent abatements or tenant improvements (TIs), length of lease, occupancy, and rights to sublease Target date for signing the purchase contract or lease agreement Expiration date of the LOI, usually between 5-10 business days after being presented to the seller or landlord Brokers Name of any commercial real estate brokers involved in the transaction Disclosure of which party each broker represents Sales commission or leasing fee paid to each broker if the transaction closes Disclaimers Notice that the LOI is non-binding Pre-conditions to signing a purchase contract or lease, such as approval by shareholders in a partnership or city permit approval How to Write an LOI An LOI is normally 2-3 pages in length with a typical structure consisting of: Introductory paragraph describing the purpose of the LOI, such as interest in purchase the property or leasing available space. Parties to the proposed transaction including the entities involved, legal name and home state, and type of entity such as an LLC to reduce the risk of the wrong information being used in the final purchase contract or lease agreement. Key deal points such as property description, offer terms, disclosure of any commercial real estate brokers involved in the transaction and which party they represent, and any other key terms and conditions specific to the proposed transaction. Closing paragraph including whether or not certain parts of the LOI are binding, a non-disclosure agreement or confidentiality clause, remedies for breaching the binding provisions of the LOI, and a request that the party receiving the LOI sign and return a copy prior to the expiration date of the LOI. Final Thoughts on LOIs A LOI is quick and easy to draw up and present, doesn’t require … Read more

What Is The Difference Between A, B And C Properties? The commercial real estate industry uses a lot of lingo. This can seem daunting for first-time investors looking to make sense of different property types. One of the ways to distinguish amongst property types, for instance, is by a property’s “class” rating. Generally speaking, properties are classified as either Class A, Class B, or Class C properties. This is true across all real estate asset classes, regardless of whether you’re referring to office buildings, retail centers, apartment buildings, or industrial and warehouse facilities. With our expertise in transforming distressed commercial buildings into valuable assets, we are experts in determining the value of Class A, B, and C properties for your investment portfolio. Here is Appelmans’ guide to the ABCs to property types and when you should invest in each. What is a Class A property? Although there is no universally-accepted definition of a Class A (or Class B or Class C) properties, most in the industry consider Class A buildings to be newer with higher-quality finishes, amenities and accessibility. Class A properties tend to be located, and oftentimes have their own brand or lifestyle associated with them. Class A properties tend to be extremely desirable, investment-grade properties with the highest quality construction and workmanship, materials and systems. They often contain unique architectural features, utilize the highest quality finishes, and utilize first rate maintenance and management. Class A properties are also distinguishable by the tenants they attract. Most Class A properties will be occupied by prestigious, credit-worthy tenants that are willing to pay above average rental rates on longer term leases. Class A properties are frequently bought and sold by national and international investors, including institutional investors such as life insurance companies and pension funds, who are willing to pay a premium for quality assets. Example of a Class A property An example of a Class A property would be a newly-renovated office building located in downtown Tampa, Florida, such as the Wells Fargo Center. The property is located close to the waterfront with great views, in a premier location that makes it easy to attract best-in-class tenants. The property is considered highly sustainable (LEED Gold-certified) and has been designed with resiliency in mind. The property also contains robust technology to provide building-level cooling systems to provide the highest level of comfort for the office workers inside. The office building also offers robust amenities, such as a ground-floor café, restaurant, coworking space, bicycle storage, on-site showers and a full service fitness center, and valet service for the parking garage. Benefits of a Class A property There are several benefits to owning or investing in a Class A property. The most obvious benefit is the ability to attract high-quality, credit-worthy tenants that are willing to pay higher rents. The desirability of Class A buildings means that they provide more liquidity than Class B or Class C properties. In other words, there is enough consistent interest in purchasing Class A properties that an investor can expect to have an easier time selling the property than if they were trying to sell a Class B or Class C property in the same market. For all of these reasons, Class A properties are considered to be one of the “safest” additions to an investor’s portfolio (but conversely, offer somewhat lower returns in exchange for this lower risk profile). In fact, a recent study by the MIT Center for Real Estate finds that over the course of a market cycle, Class A properties located in secondary markets (e.g., Atlanta, Miami, Dallas, Houston, Phoenix, Denver, San Diego, Seattle, Minneapolis) outperform Class B properties in primary markets (New York, Los Angeles, Chicago, San Francisco, Boston, and Washington, D.C.). This, the study found, was true when evaluating both office buildings and multifamily properties. What is a Class B property? A Class B property tends to offer more utilitarian space with fewer amenities than one would find in a Class A building. It will typically have ordinary architecture design and structural features, with average interior finishes, systems, and floor plans. The systems will be in adequate condition and the property will be structurally sound, but not overwhelmingly impressive. Generally speaking, the older the property is, the more likely it will the designated as a Class B property. However, there are examples of older buildings that maintain a Class A designation. The maintenance, management, and tenants in a Class B property are considered good (but not necessarily great). Class B properties may also be less appealing to tenants, in general, as the buildings may be deficient in a number of respects, such as ceiling heights and building or facility condition. Tenants that leased space in a class B building tend to be be less established, have lower credit, or may be unable or unwilling to sign a long-term lease. Therefore, while Class B buildings tend to attract broad interest among a wide range of users, the rents these tenants are willing to pay tends to be less than a Class A property can command. Class B properties are often considered more of a speculative investment than their Class A counterparts. Class B properties will occasionally attract attention among national investors, but most investors tend to be local to the marketplace. Example of a Class B property An example of a Class B property would be a 20-year-old office building located in an urban location that has fair to good visual appeal. The office property may be located in an acceptable neighborhood but it is not likely to be the highest rent location. The building may provide ample on-site parking, have functional HVAC systems, and acceptable management. However, the building lacks the robust amenities found in today’s newly-build Class A office buildings. For example, the lobby may not have been renovated in many years and they look “dated”. Many of the suites in a Class B building have floorplans that need to be reconfigured to meet the needs of today’s workplace … Read more

Commercial Real Estate Jargon Explained It’s tough enough being a commercial real estate investor without knowing all of the jargon and industry language you need to learn quickly. Don’t know the difference between asking rent and actual rent? Can’t figure out CapEx or DSCR? We’ve broken it down for you with our commercial real estate glossary. Here are some important terms and concepts to get you started. Absorption Absorption is a measure of the health of the market in which a building is located, measured in square footage. Net absorption is measured by subtracting the total commercial space that is occupied during a given timeframe (usually quarterly) as compared to the total occupied space in the prior timeframe. It takes into account new construction. Positive net absorption signals a healthy real estate market. In the recession of 2008, more commercial real estate square footage came to market than was being leased, leading to negative net absorption. This happened because in 2005, a lot of new buildings were planned. But because they take a couple of years to build, many of them came online in ’08, right when the economy collapsed. Tenants were purging space from the existing buildings while newly constructed buildings were being delivered. That was a double whammy and resulted in negative absorption. Asking Rent, Actual Rent Asking rent is fiction, actual rent is fact. Every landlord will list their asking prices. The most well-known listing service or database is called Costar. It has a virtual monopoly of databases in the United States for office space leasing. Every office building will list its asking prices in this database. But the actual rents are not disclosed, only rumored. As a rule of thumb, actual rents may run 5 percent to 10 percent below asking rents when you factor in concessions and the like, including free rent (see rent abatement, below). Sometimes the so-called “face rate” will equal the asking rent. But when you factor in free rent and extra tenant-improvement dollars and similar concessions, the actual rent is usually lower than the asking rent. That said, asking rents remain a valid barometer because they provide a relative index. CapEx, or Capital Expenditures, and Reserves CapEx refers to the capital improvements to a building. They are distinguished from tenant improvements (see below). A capital expenditure is part of the landlord’s basis for his entire investment in a project. When a landlord performs radical renovations of lobbies — we call them “lobby-ectomies“ — or improvements to offices (“office-ectomies”), they can cost millions. A lobby renovation can cost anywhere from $1 million to as much as $5 million. In most cases, CapEx cannot be passed through to the tenant under the operating expense clause in a lease, unless that particular capital improvement reduces the energy or the operations expense for running the building. In that case, it is legally allowed to be passed through to the tenants as an operating expense under the operating expense clause, with the expense attributable to normal operations as opposed to a one-time capital item. Operating expenses include normal and recurring maintenance. Every month or every year, you have certain minimum expenses. The utility expense for electricity is an operating expense because it’s a recurring expense for the normal operations of the building. The renovation of a lobby is something you don’t do every year; it’s a one-time capital investment. Operating expense can be a tax write off in the year incurred. CapEx, such as an investment in the lobby, is considered a capital improvement and is depreciated according to a depreciation schedule. Under the most recent tax laws, certain parts of a building may qualify for accelerated depreciation. There is a gray area about when a particular expense is a repair or when it is a capital improvement. Take an air conditioning system. If you replace the system’s chiller — this big, massive machine that runs a whole building — it’s a capital expenditure. But if you’re just replacing part of the system, that may be considered a repair, which can be a tax deduction for that year. Let’s discuss reserves for CapEx. Any prudent developer looking at buying a new building or projecting the future cash flow of an existing building they own should be allocating a recurring reserve annually for capital expenditures, almost like it is a recurring expense, though it’s technically not that. The reserve is usually expressed in cents per square foot. Here at Appelman Properties’, we have historically used 15 cents per square foot. Then we used 20 cents per square foot. Now we’re using 25 or 30 cents per square foot because over time these things get increasingly more expensive. Those amounts should be set aside in a fund to cover the eventuality that they may be needed. Developers don’t always do that. But some lenders — such as lenders that issue Commercial Mortgage Backed Securities, or CMBS ­— actually require developers each year to post reserves to a lockbox account or a cash collateral account from which they cannot withdraw funds unless they are for a capital expenditure. Each month and each year, money is deposited from cash flow into that account. CMBS lenders also require tenant-improvement reserves, because in the course of managing an office building, there are always going to be tenant improvements. A lender will negotiate reserves for tenant improvements, separate and apart from CapEx reserves. Debt Service Coverage Ratio (DSCR) DSCR is the net operating income (NOI) divided by the debt service. It’s the most important metric in the commercial real estate business, a measure of a project’s financial productivity. It’s the key metric that a lender wants to see. Net operating income refers to all the revenue derived from a property — whether it be an office building, a retail shopping center or an industrial building — minus operating expenses. Revenues include all of the office rents from all of the spaces in a building, plus all of the revenue for ancillary services. … Read more

The 5-3-2 Model for Fix-and-Flip Investors The 5-3-2 Model Explained The 5-3-2 Model is very simple: 5 – Buy and rehab 5 homes 3 – Sell 3 homes through traditional means 2 – Carry back the note on the other 2 homes That is, for every 5 properties that you purchase, sell 3 and “be the bank” for 2. When you sell the 3 homes, it provides you with the ongoing cash flow for your business. For the other 2 homes, ideally, you want to pick out the best properties to carry back the loans on. If you do it correctly, you should have nothing invested in those two properties because you would’ve received all the money back through down payments and the profits from the other 3 properties you’ve sold. Benefits of the 5-3-2 Model The benefits of following the 5-3-2 Model are two-fold: First, you receive ongoing, passive capital to continue building your business. You will continue to receive the profits from selling the 3 properties, as well as the ongoing interest payments from the other 2 properties. Also, since you are carrying the note, rather than being the landlord of the property, you are able to transfer the taxes, insurance, and repair responsibilities to that buyer. Therefore, the investment is completely passive, and also, technically, an infinite return. Secondly, you’ve created residual value that operates like an annuity or retirement plan. Self-employed people, which include real estate investors, tend to forget the value of long-term retirement strategies. Instead, they tend to live deal to deal, rolling the dice, or money, into the next deal. Following this strategy allows you to get the best of both worlds: the instant gratification of realizing the fix-and-flip profits, as well as the long-term, residual income that can be a “safety net” for when the unexpected occurs, like unforeseen personal issues (health, family, etc.) or the market taking it’s next turn for the worse. Please make sure to subscribe and follow our channels for resources in up-to-date strategies for your real estate investing journey.

WHAT IS CAP RATE COMPRESSION? Cap rates can be an incredibly valuable tool for investors looking to establish a property’s value. The cap rate, expressed as a percentage, is calculated by dividing the property’s net operating income by its purchase price. The resulting percentage generally ranges anywhere from 3 percent to 15 percent or more. Cap rates have an inverse relationship to property value. The lower the cap rate, the more valuable the property—and vice versa. Therefore, it is often said that a cap rate is the yield an investor is getting on the purchase price. The lower the cap rate, the higher the yield. Another way to think about cap rates is that they are the inverse of an equity multiple. For example, a five-cap is said to be a 20 multiple on income. What is cap rate compression? Cap rate compression is when the cap rates for any specific property or property type come down. At the building level, cap rate compression can occur after a property has been markedly improved, physically or operationally, or has a significant improvement in the tenancy. For example, if Apple, Google or the federal government signs a long-term lease for a Class A office building, it will likely trade at a lower cap rate than if it were leased to multiple office tenants with less impressive credit. Investors are willing to pay more for these properties given the perceived stability of the tenant. Cap rate compression can also occur among all buildings of a certain property type within a specific geography. For example, when Amazon announced its “HQ2” in Crystal City, Virginia, investor interest in the area skyrocketed. Investors, buoyed by Amazon’s long-term investment in the region, started purchasing other office and multifamily buildings with rapid speed. The significant uptick in investor interest caused cap rate compression within the marketplace. There’s been similar cap rate compression in the Tampa Bay, Florida office market. Investors who once focused on properties in Los Angeles, San Francisco and New York City have watched a growing number of workers relocated to Florida in the aftermath of COVID. Now, those investors are reallocating large swaths of their portfolios to Florida-based office buildings given the uptick in demand. As competition for Florida office buildings has increased, cap rates have correspondingly compressed. Office cap rate compression While cap rate compression impacts all real estate asset classes, it has specific impacts on the office sector. The biggest distinction between office cap rate compression and other product types pertains to credit. For example, when someone is contemplating the purchase of a 300-unit apartment building, few buyers are going to dig into the credit of all 300 tenants renting units in that building. It will be assumed that the tenants met some preliminary screening criteria as part of the broader application process and therefore, have at least some minimum credit score. In contrast, those looking to purchase an office building will generally look to see at least three years’ worth of an office tenant’s trailing financials, balance sheets and cash flow statements. They will also ask to see any projections that the office tenants have relative to their future income and expenses. Prospective buyers might even look for news stories or undertake other investigative measures to understand the stability of an office tenant. Investors spend significantly more time evaluating the credit of office tenants than they do the tenants of residential buildings. The stringent due diligence on office tenants’ creditworthiness is because office tenants tend to be on long-term leases. Depending on the size of the property, the building may be leased to one or just a few office tenants. If one of those tenants stops making their rent payments, or worse, goes bankrupt, then the landlord could experience a significant disruption in their cash flow. An investor who has purchased a property at the height of the market, in a tight cap rate environment, will likely need that income to remain solvent. Conversely, the creditworthiness of office tenants can impact a building’s cap rate. Tenants that are S&P or otherwise formally rated are considered the “safest” tenants and therefore, landlords can usually command prices for these properties. A building with highly-rated tenants, especially if those tenants are on long-term leases, will generally trade for lower cap rates than a building leased to tenants with more questionable credit. Each prospective buyer evaluates tenants’ creditworthiness differently, and therefore, will make their own judgments about the tenants’ stability. This due diligence process is part art, part science. As such, two different buyers could come to different valuations (and therefore, different cap rates) based upon their assessment of the tenants’ creditworthiness – something that is decidedly unique in the office sector compared to multifamily investments. Is cap rate compression good or bad? Whether cap rate compression is good or bad depends on a person’s perspective and role in a commercial real estate deal. Sponsors with existing real estate will generally find cap rate compression to be a good thing as it makes their buildings and assets more valuable. Cap rate compression can also lead to higher rents over time. For example, someone who purchases a property at the top of the market for a low cap rate may feel more pressure to fully stabilize a property and increase rents than if they had purchased the same building at a lower price and higher cap rate. Those who pay top dollar for a property naturally want to grow their yield as much as possible. Conversely, from a tenant’s perspective, cap rate compression might be viewed as a bad thing if it results in higher rents. Unless tenants have other options, they may be forced to pay more for their leases than they would in a higher cap rate environment. Ultimately, the extent to which cap rate compression has an impact on the local rents will depend on total supply and demand. If there is excess supply in a marketplace, cap rate compression will not have … Read more

What is IRR in Real Estate? When investing in an income-producing asset, it’s important to know how much money you will make as well as when you will receive it. Checking the performance of stocks and bonds can be easily done by logging into a brokerage account for updates. However, identifying current and future real estate returns is much more difficult because the same property does not change hands every day. Of the various financial analysis metrics available to real estate investors, IRR is one of the most often used calculations. IRR in real estate incorporates key investment criteria to help identify property that meets the specific goals of each individual investor. What is IRR? Internal rate of return (IRR) is a financial metric used to measure the profitability of an investment over a specific period of time and is expressed as a percentage. For example, if you have an annual IRR of 12%, that means you have 12% more of something than you did 12 months earlier. The IRR calculation combines profit and time into one formula: Profit is how much cash the investment generates over the holding period compared to the amount of capital invested Time value of money (TVM) estimates what the current value is of money received in the future Opportunity cost by comparing the IRR of one investment to other alternatives A good way to think about IRR is that it is the discount rate – or interest rate – that makes the net present value (NPV) of the cash flows you receive equal to zero. By weighting the periodic cash flows, IRR helps you to make a fair comparison to alternative investments with cash flows that occur at different points in time. That’s because a dollar actually received today is worth more than the promise of a dollar received several years from now, due to factors such as inflation, unknown future events, and general investment risk. As a real estate investor, you have a required rate of return on the capital being deployed in order for the investment to make sense. Everything else being equal, the investment that generates an IRR greater than or equal to your required rate of return will be worthwhile taking a closer look at. Examples of calculating IRR Let’s assume you invest $100,000 in a property with a holding period of five years. If you choose the wrong investment and have no cash flows and no profit or loss at the time of sale, your IRR is 0%. However, the three more likely potential outcomes are: #1: Annual cash flow and no profit from sale Initial investment $100,000 Annual cash flow $12,000 Initial investment of $100,000 recovered at the end of the five-year holding period IRR is 12%, which is another way of saying that the investment generated an annualized profit of 12% #2: No annual cash flows but a profit from sale Initial investment $100,000 No cash flows over the holding period Initial investment of $100,000 recovered plus a $25,000 profit from sale for a total of $125,000 IRR is 4.56% because a profit was generated when the property was sold at the end of five years – note that the IRR is lower than Outcomes #1 and #3, due to the NPV and TVM concepts #3: Annual cash flow and profit from sale Initial investment $100,000 Annual cash flow $12,000 Initial investment of $100,000 recovered plus a $25,000 profit from sale for a total of $125,000 IRR is 15.66% because cash flows were received and a profit was made when the property was sold at the end of five years Assuming your required rate of return is 6%, the only outcome that is worth considering is the last one with an IRR of 15.66%. Key assumptions that affect IRR Note that in order to calculate the potential IRR of a real estate investment you’ll need to make four assumptions: Amount of periodic cash flows Timing of periodic cash flows Date property will be sold Sales price of property Minor changes in these four assumptions can have a significant impact on your IRR, such as receiving cash flows monthly or annually. For example, if you invest $100,000 and receive $1,000 the first month, you now have $101,000. That’s 1% more than your original investment, and a monthly IRR of 1%. Assuming your investment grows by 1% each month, in the second month you would have made $102,010 ($101,000 x 1.01), and by the end of 12 months you would have made a total of $12,682.50 from your original investment. The annual IRR of 12.68% ($112,682.50 / $100,000) – 1 = 0.1268 or 12.68%. On the other hand, if you received a single annual distribution of $12,000 from your $100,000 investment, your annual IRR would be just 12%. What is a Good IRR? IRR is a comprehensive way of thinking about the potential profitability of a real estate investment. When you think about what a good IRR is, it’s important to take a detailed look at the prospective investment and understand that an IRR isn’t always what it appears to be. For example, a project may boast a big top-level IRR, but the net IRR to you as an investor is lower because of asset management fees taken by the developer or sponsor before distributions are made. On the other hand, an IRR may be understated due to the industry standard of calculating investment returns on an annual basis, when distributions are actually made monthly or quarterly. Core Plus, Core, and Value Add investments will also yield different IRRs due to the anticipated income stability and the level of risk: Core Plus investments will generate a lower but very predictable IRR similar to the regular payment schedule of a bond or stock dividend, with little upside or downside Core properties will return slightly higher IRRs due to gradually increasing cash flows and an upside gain when the property is sold Value Add projects may provide higher IRRs, although … Read more

What Is 70 Rule In House Flipping What Is The 70% Rule In House Flipping And How Can It Help Me Decide How Much To Pay For A Distressed Property? What’s the key to flipping houses successfully? Buying homes at a low enough price so that when you sell them you make a large profit. Overspending on the front end of a home purchase will make it much more difficult to earn those big dollars. But how do you determine when a home’s sales price is right? The 70% rule can help. It’s important to remember, though, that this rule is just a general guideline and won’t replace the long hours of research you’ll still need to do to make sure you’re not overpaying for a home you want to flip. What Is The 70% Rule In House Flipping? Home flippers have a simple plan for earning money: They buy a home cheap, fix it up, and then sell it at a higher price. The goal for flippers is to buy low and then sell high to boost their profits. The 70% rule can help flippers when they’re scouring real estate listings. Basically, it says that investors should pay no more than 70% of the after-repair value of a property minus the cost of the repairs necessary to renovate the home. What does this mean? The after-repair value, or ARV, of a property is the amount that a home could sell for after flippers renovate it. When buying a home to flip, investors need to estimate how much they think the property could sell for after it’s been renovated. They can then multiply that amount by 70% and subtract it from the estimated cost of renovating the property. The resulting figure is the highest price that flippers should consider paying for that property. The key here, though, is to realize that the 70% rule is just a general rule of thumb. Before buying any home, you need to study market conditions, work with real estate professionals to get a more accurate resale estimate and meet with contractors to determine how much repairs will cost and which renovations are needed.