Principals 10

The difference is on the degree that you can personally influence the ultimate success of your investment. With SFHs, you must rely on the general market conditions over which you have little influence.

Frank Gallinelli on SFHs

1) Look for real appreciation (not nominal, higher NOI, lower Cap Rates) a) When demand for a specific property, location or both grows faster than the supply of competing properties b) Note: areas differ in their rate of appreciation 2) Inflation of Real Estate Values (appreciation) a) general increase in prices b) newspaper "price increases" generally overall sales tredns, not i. Investment property gains ii. returns adjusted for leverage iii. Value created in investment properties not yet sold 3) Cash Flows from Operations a. Don't overlook that you earn current cash flow from just holding properties (unique vs. many other assets and makes holding RE easier) 4) Equity Gains amplified by Leverage (supercharged) 5) Cash Flow Returns amplified by Leverage 6) Mortgage Payoff 7) Increases in NOI from Inflation! a. very big deal b. Revenue increases disproportionally with inflation when compared to i. Expenses ii. Debt Service 8) Increases in Cashflow from Refinancing a. Refinance: To Obtain a new loan to replace your existing loan i. can be with current or new lender b. Strategy #1 Re-amortizing your existing loan balance c. Strategy #2: Re-amortize your existing loan balance and lower your interest rate i. Lower interset rates can be achieved through: -Overall market conditions -Increases in your overall credit score (for your 2cnd+ loan, this helps with bank) -Decreases in your LTV (as your loan amortizes) 9) Refinance to extract equity 1. Access newly formed equity 2. Reclaiming capital improvement expenditures a. Using second mtg to match cashflow with asset usage 3. Putting extracted equity back to work in new projects 10) Buying at Below Market Prices 1. Unusually Motivated Sellers (use financial models to uncover this) a. Financial distress b. "Accidental" landlord (i.e. inherited property) 2. The "grass is greener" sellers - disposing of assets to pursue 'better; opportunities. Moving out of town 3. Stage of life sellers - Looking to eliminate risk. Not interested in all the "fuss" 4. Out-of-Touch Sellers - Often literally "out of town sellers" 5. Undercapitalized Sellers - Not in the financial position to undertake needed renovations 11) Selling at Above Current Market Prices 1. Unusually motivated buyers a. 1031 Exchange participants (rather pay a small premium than pay a huge tax bill to govt.) b. Neighbors who value the land more than typical investors 12) Creating value through smarter management (check out IREM for classes for property mgmt and maximizing their performance) 1. Improve Revenue a. Eliminating delinquencies b. Keeping up with real rental increases 2. Cut Operating Costs a. Renegotiating contracts (insurance, garbage, lawn maintenance, etc) 3. Reduce Maintenance and Repairs a. Seek out low-maintenance tenants b. Make your repair clauses stronger c. collect higher deposits d. Preventative maintenance 13) Creating Value Through Renovation 1. Deep clean the property 2. Add Pizzazz with color schemes, decorating patterns and fixtures 3. Create usable space (e.g., zinobia got 60% increase through adding bathroom and washer dryers in units and using the saved spaces for the extra rooms) 4. Create a view 5. Capitalize on Owner Nearsightedness 6. Eliminate a negative view 7. Enhance the unit's natural light 8. Repair building systems a. plumbing, electrical, HVAC, windows, appliances, doors, locks, landscaping, storage areas, roof, etc. 9. BEWARE of OVER IMPROVEMENT! - Don't spend money if the improvement doesn't carry a positive NPV!

Gary Eldred Recommendations

Everything but beginning balance and accrued interest as these are in the debt service and loan advance yr 1. Plus financing fees yr 1

How to apply financing to DCF analysis?

Beginning Loan Balance + Loan Advances (e.g., initial loan proceeds) + Accrued Interest - Annual debt service - Loan repayment at sale = Ending Loan Balance Assumes payments are all end of period this interest series on the beginning balance

How to track loan balance over time?

Cash you get from loan post fees Loan amount - Financing Fees

Net loan proceeds

1. Challenging and seldom financially rewarding from a rental income standpoint (you're betting on appreciation) 2. When property's value is a function of its income stream you have the opportunity to create value by enhancing the income stream (active mgmt, controlling costs, etc.) a. As investments, SFHs don' work this way b. By and large, changes in NOI have little or no impact on the value of your single family home

SF Home Investments Conclusion

1. Familiarity a. most people understand it b. Maintenance seems straight forward 2. Financing widely available and easy to obtain 3. Large volume of transactions a. Many investments b. Relatively less competition from investors and institutional funds 4. Less transient families (may stay for years) apt ~50% turnover, 1.5y avg lease, SFH 2-3, 6-8yrs

SF Homes Advantages

Levered cashflows are different for every owner 1. Helps us understand ROE 2. Depends on possibilities regarding our specific financing arrangements

Why look at levered cashflows?

Unlevered cashflows are the same for every owner 1. Helps us understand ROA 2. Forms basis for comparison of different properties

Why look at unlevered cash flows?

Leverage can create higher returns with lower capital commitments

Why use leverage?

How much equity is required to purchase the investment? Equity = Total project cost - Loan Amount

Equity Analysis Ratio

1) Achieve enough NOI 2) to pay for financing 3) Which is sufficient to pay for the acquisition and development 4) Which is adequate to... back to 1)

Balancing the REI Finance Triangle

Prior year ending balance

Beginning balance yr 1+

100% entrepreneur financed -> 11% 50% LTV bank finance @ 6% -> 16% Add 45% Investor @ 14% -> 34%

Capital stack impact on returns example

(Annual) NOI - Annual Debt Service

Cash throw-off

Cash Throw-Off / Equity Similar to ROE with debt service netted out of the numerator

Cash-on-Cash Return

1. Familiarity a. most people understand it b. Maintenance needs are very straight forward i. You only have to worry about the inside of your unit! 2. Financing widely available and easy to obtain 3. Large volume of transactions a. Many investments b. Relatively less competition from investors and institutional funds 4. Healthy tenant pool a. almost exact apartment substitute 5. Much smaller fixed cost-to-unit ratio vs. SFH 6. Value can somewhat be increased through NOI a. Prices still largely driven by factors outside of your control 7. Much greater degree of uniformity a. Even if value tied to comps, you have a good idea about the price 8. Less equity required to purchase

Condo Advantages

1. Despite drawbacks, condos tend to be a good product for first-time investors 2. May accumulate several condos early in career 3. Allows for investment diversity, builds experience, increases credentials for obtaining loans 4. As soon as possible, invest in multi-family (duplex, four-plex, 8-unit building, etc.)

Condo Conclusions

1. HOA fees eat into your profits (15-30% of rent, part is mgmt co) 2. You don't control the building a. Little control over nuisance neighbors, crime, etc. b. HOW limits your flexibility due to rules (e.g., no pets) c. Exterior upkeep completely out of your control i. Nothing you can do it if looks shabby except complain 3. Potential for special assessments ($5k - $40k) - required when asked for, no deferment, no other options.

Condo Disadvantages

Loan amount not net loan proceeds!

Debt service basis

1. Lack of density (lots of fixed costs to spread over a single unit) a. High land to unit ratio b. High exterior surfaces to unit ratio (less efficient heating, more epxensive ratio c. High windows to unit ratio 2. Highly idiosyncratic market (every home is different) e.g., Zillow closed down flip unit b/c they couldn't value them well enough 3. Smaller renter pool a. Qualified to purchase their own home (maybe bad credit, downpayment, temporarily in the city) 4. BIGGEST DISADVANTAGE: Value is not a function of ability to produce rent a. based on economic factors which you generally don't have control b. Comparable sales vs. cashflow c. Interest rates and lending environment (90-95% LTV vs. investors paying commercial and 75% LTV) d. Owner occupant is not a renter not investor: tastes and preferences drive prices up beyond what makes sense from a cashflow stand point

SF Homes Disadvantages

Cash Throw-Off Equity Analysis ratio Cash-On Cash Return

Simple ratios

11% ROA property $1 invested $0.11 annual income - $0.06 Annual Interest Paid to Bank = $0.05 -$0.03 investor interest = profit on each dollar raised from investor(s)

The Money-Making Machine for Financed & Investor Funded Properties

11% ROA property $1 invested $0.11 annual income - $0.06 Annual Interest Paid to Bank = $0.05 profit on each dollar borrowed from the bank!

The Money-Making Machine for Financed Properties

1.5-3% of loan amount 1. Loan origination (1-2%) 2. Loan discounts / points 3. Appraisal fee 4. Credit report fee 5. Lender's inspection fee 6. Attorney or closing agents fees 7. Recording fees

Typical loan costs / fees

IRRs on other comparable properties -Should be the rate you could reasonably expect to achieve by investing the same amount of money in a similar investment posing comparable risk

Where do discount rates for NPV analysis come from?