Commercial and Investment Real Estate Opportunities Types of Properties Diversity of Clients ® Dearborn Real Estate Education, 2002

Primary Classifications of Commercial Properties Office Retail Industrial Apartments Other Commercial Properties ® Dearborn Real Estate Education, 2002

Commercial Property As an Investment Almost every type of commercial property can be an investment! ® Dearborn Real Estate Education, 2002

Investment Customers Users Space Driven Developers Build-to-Suit Pure Investors Profit Driven ® Dearborn Real Estate Education, 2002

Commercial and Investment Real Estate Opportunities Residential Real Estate – One Client – One House – One Time ® Dearborn Real Estate Education, 2002 Commercial and Investment Real Estate – Many Types of Properties –Several Kinds of Customers –Unlimited Opportunities –Redundant BusinessToo!

“Taxpayer” Small Multiuse Buildings Typically, a store or office on the ground floor with two to six apartments above. ® Dearborn Real Estate Education, 2002

Advantages of Purchasing a Small Multiuse Building Which type of customer would buy a small multiuse building? ® Dearborn Real Estate Education, 2002

Net Operating Income (NOI) Gross Operating Income Less Owner’s Operating Expenses Equals Net Operating Income ® Dearborn Real Estate Education, 2002

Case Study: Main Street Multiuse Building ® Dearborn Real Estate Education, 2002

The Advantages of Purchase Often the cost to buy is equal to or less than the cost to rent. Purchase price is affordable. Tax benefits of ownership, i.e., depreciation ® Dearborn Real Estate Education, 2002

Often the Cost to Buy Is Equal to or Less Than the Cost to Rent. Store rent (from problem) $15 PSF X 1,000 SF = $15,000 annual rent Rental income (apartments)$12,000 Owner’s Operating Expenses 10,000 “Profit”$ 2,000 Effective new rent$13,000 ® Dearborn Real Estate Education, 2002

Affordable Purchase Price Financing the Main Street Building Building Price$160,000 Down Payment – 32,000 Mortgage$128, Year Term, 7.5% Interest Rate Annual Debt Service$ 14,239 ® Dearborn Real Estate Education, 2002

Cost to “Carry” the Main Street Building Debt Service (per year)$14,239 Operating Expenses 10,000 Total Expenses$24,239 ® Dearborn Real Estate Education, 2002

New Store Rent ® Dearborn Real Estate Education, 2002 Cost to “carry” the building$24,239 Less income from apartments–12,000 Effective New Store Rent$12,239 A savings of $2,761 over the original rent ($15,000) due as a tenant.

Tax Advantages of Ownership ® Dearborn Real Estate Education, 2002 Depreciation or Cost Recovery Required by IRS Code Buildings depreciate, but land does not Depreciation Time Commercial Buildings over 39 years Apartment Buildings over 27.5 years

Tax Advantage of Ownership ® Dearborn Real Estate Education, 2002 Purchase Price$160,000 Less Land Value – 20,000 Depreciable Building Value $140,000 Building value divided by 39 years equals the annual tax depreciation. $140,000 divided by 39 = 3,590 Tax Benefit

Buy vs. Rent User-investor saves $2,761 in rent Gains tax advantage of $3,590 ® Dearborn Real Estate Education, 2002 Real estate agents should discuss the advantages of purchasing with their clients.

The Concept of Vacancy Vacancy is defined as a portion of, or entire space without, tenancy, measured for a period of time. ® Dearborn Real Estate Education, 2002

Neighborhood Strip Center ® Dearborn Real Estate Education, 2002

Considerations of a User Customer The cost to buy may be equal to or less than the cost to rent. Tax advantages of ownership. However, “Purchase price is affordable” may no longer be true. ® Dearborn Real Estate Education, 2002

Considerations of an Investor Client ® Dearborn Real Estate Education, 2002 Quality of Tenants Turnover Concerns Rate of Return on the Investment

Case Study: Neighborhood Strip Center ® Dearborn Real Estate Education, 2002

Step 2: Adjusting for Vacancy ® Dearborn Real Estate Education, 2002 Adjusting for vacancy requires a reality examination. Vacancy is usually calculated as a percentage of the Potential Rental Income (PRI).

Determine Gross Operating Income ® Dearborn Real Estate Education, 2002

Step 3: Calculating the Total Operating Expenses ® Dearborn Real Estate Education, 2002

Step 4: Calculating NOI Net Operating Income Gross Operating Income minus Operating Expenses equals Net Operating Income ® Dearborn Real Estate Education, 2002

Repair and Maintenance Contingency Expenses Contingency expenses are best thought of as irregular, unexpected or emergency events. There is an important distinction between normal regular expenses and contingency repair and maintenance expenses. ® Dearborn Real Estate Education, 2002

Repair and Maintenance ® Dearborn Real Estate Education, 2002 Guidelines Age of the building Condition of the property Under the lease terms, what are the landlord’s responsibilities? Calculation Percentage of PRI or Percentage of GOI or Fixed Dollar Figure

Repair and Maintenance Problem ® Dearborn Real Estate Education, 2002

Effect of Repair and Maintenance on Expenses ® Dearborn Real Estate Education, 2002 Operating Expenses Taxes$20,000 Insurance 2,500 Repair & 3,750 Maintenance Total$26,250 Revised NOI Income$67,500 Expenses–26,250 NOI$41,250

Market Value © Dearborn Real Estate Education, 2002

Market Conditions Affecting Price Supply and Demand Location, location, location! Available Financing Insurance Value © Dearborn Real Estate Education, 2002

Commercial Values Retail – Location – Traffic Industrial – Cost of Labor – Transportation Investment – Upside Potential © Dearborn Real Estate Education, 2002

Highest and Best Use The best use of a property will create the highest financial return on the investment. © Dearborn Real Estate Education, 2002

Triple Net Lease (NNN) Tenant pays all © Dearborn Real Estate Education, 2002

Floor Area Ratio (FAR) a.k.a Land Coverage Ratio The ratio of the bulk area of a building to the land on which it is situated. © Dearborn Real Estate Education, 2002

Highest and Best Use Problem A © Dearborn Real Estate Education, 2002

Conversion Costs Variance–Legal Costs Construction Costs Down Time © Dearborn Real Estate Education, 2002

Highest and Best Use Problem B © Dearborn Real Estate Education, 2002

Comparing NOI Current Tenant GOI$75,000 TOE 15,000 NOI $60,000 Proposed Tenant GOI $60,000 TOE (NNN) 0 NOI $60,000 © Dearborn Real Estate Education, 2002

Good Deal for Owner? Rent Increases No Conversion Expenses No Down Time Bigger Building Sale versus Land Lease © Dearborn Real Estate Education, 2002

Capitalization Rate (CAP Rate) The CAP rate can be looked at as a desired “profit percentage” for an investor. © Dearborn Real Estate Education, 2002

CAP Rate Formulas Solve for Market Value NOI$50,000 CAP Rate 10% Market Value? Solve for CAP Rate NOI $60,000 Offer$500,000 CAP Rate? © Dearborn Real Estate Education, 2002

CAP Rate Problems A property is priced at $750,000 and has a NOI of $67,000. What is the CAP rate being offered? An investor wants to sell her building. She advises you that she has an NOI of $48,000 and will offer the property at an 11% CAP. At what price do you market the building? © Dearborn Real Estate Education, 2002

Retail Terms © Dearborn Real Estate Education, 2002

Anchor Tenants Do not sell anchors! Large department stores or supermarkets Do their own advertising © Dearborn Real Estate Education, 2002

CAM Charges Common Area Maintenance © Dearborn Real Estate Education, 2002

GLA Gross Leasable Area © Dearborn Real Estate Education, 2002

Tax Escalation Clause a.k.a Real Estate Taxes over Base a.k.a Tax Stops © Dearborn Real Estate Education, 2002

Annual Property Operating Data (APOD) © Dearborn Real Estate Education, 2002

Case Study: Mountain View Mini Mall © Dearborn Real Estate Education, 2002

Base Rent Roll Calculation $167,000Total $32,000$162,000Real estate $36,000$182,000Stationery $54,000$183,000Video store $22,500$151,500Dry cleaner $22,500$151,500Restaurant Annual Rent Base RentSquare FeetStore © Dearborn Real Estate Education, 2002

Step 2 Analyze all other income and adjustments to income. Solve for Gross Operating Income. © Dearborn Real Estate Education, 2002

Vacancy and Credit Losses In this problem, 5% is used for vacancy contingency. Potential Rental Income$177,000 Multiplied by 5%X.05 Vacancy & Credit Losses $8,850 © Dearborn Real Estate Education, 2002

Step 3 Expenses Only the Owner’s Operating Expenses Reminder: All figures are annual. © Dearborn Real Estate Education, 2002

Step 4: Solve for NOI Net Operating Income (NOI) Gross Operating Income$168,150 Less: Operating Expenses– 81,000 Net Operating Income $87,150 © Dearborn Real Estate Education, 2002

What Is My Building Worth? Step 5: Calculating Market Value NOI ÷ CAP Rate = Value $87,150 ÷.12 (12%) = $726,250 © Dearborn Real Estate Education, 2002

The Value of Investments © Dearborn Real Estate Education, 2002

Key Investment Terms Rate of Return Leverage Initial Investment Cash Flow Before Taxes (CFBT) Equity Cash on Cash Return Internal Rate of Return (IRR) © Dearborn Real Estate Education, 2002

Leveraged Purchase Cash on Cash Return CFBT = NOI – Annual Debt Service Cash on Cash = CFBT ÷ Initial Investment © Dearborn Real Estate Education, 2002

Investment Strategies Stability Potential Flipping Upside Potential Holder © Dearborn Real Estate Education, 2002

What Is the Property Worth? © Dearborn Real Estate Education, 2002

Components of Value Current year analysis Five-year forecast Owner’s perspective Buyer’s perspective © Dearborn Real Estate Education, 2002

Case Study Office Building © Dearborn Real Estate Education, 2002

Determine Current Rent Roll and Potential Rental Income © Dearborn Real Estate Education, 2002

Complete the Income portion of the APOD. © Dearborn Real Estate Education, 2002

Operating Expenses © Dearborn Real Estate Education, 2002

Net Operating Income © Dearborn Real Estate Education, 2002

Cash Flow Before Taxes (CFBT) © Dearborn Real Estate Education, 2002

Cash on Cash Return Cash on Cash = CFBT ÷ Initial Investment $15,294 (CFBT) ÷ $125,000 (II) = % is the Cash on Cash Return © Dearborn Real Estate Education, 2002

All Cash Purchase Capitalization Rate Formula: NOI ÷ Value (Purchase Price) = CAP Rate $60,936 ÷ $500,000 = % CAP Rate © Dearborn Real Estate Education, 2002

Spreadsheets Cash Flow Forecasts © Dearborn Real Estate Education, 2002

The Upside 44,84441,64233,52428,02215,294CFBT 90,48687,28479,16673,64460,936NOI Year 5Year 4Year 3Year 2Current Year © Dearborn Real Estate Education, 2002

Cash on Cash Returns.1224 (12%)$125,000$15, (36%)$125,000$44, (33%)$125,000$41, (27%)$125,000$33, (22%)$125,000$28,0222 Cash on Cash Return Initial Investment CFBTYear © Dearborn Real Estate Education, 2002

Market Value Does the potential buyer care about the present owner’s return on his/her investment? © Dearborn Real Estate Education, 2002

Potential Market Value 12% CAP 10% CAP 90,48687,28479,16673,66460,936NOI Year 5Year 4Year 3Year 2Current Year © Dearborn Real Estate Education, 2002

Potential Market Value 754,050727,367659,717613,867507,800 12% CAP 904,860872,840791,660736,640609,360 10% CAP 90,48687,28479,16673,66460,936 NOI Year 5Year 4Year 3Year 2Current Year © Dearborn Real Estate Education, 2002

What Is My Property Worth? © Dearborn Real Estate Education, 2002

Considerations Regarding Value What the current owner paid is irrelevant. Test the assumptions used in the forecast. How much upside potential will a buyer pay for? © Dearborn Real Estate Education, 2002

Methods of Valuation Income Approach Comparable Sales Method Cost Approach © Dearborn Real Estate Education, 2002

The Buyer’s Perspective Challenges Incorrectly Stated Facts Questionable Assumptions Business Style © Dearborn Real Estate Education, 2002

Applied to the last problem Basement Rent? Vacancy Rate 7%? Repairs and Maintenance 5%? Off Site Management 5% © Dearborn Real Estate Education, 2002

Compare the Market Values None of the “facts” changed. What did change were the assumptions. © Dearborn Real Estate Education, 2002

Commercial Agents Validate the facts and evaluate the assumptions. © Dearborn Real Estate Education, 2002

To make a deal Negotiate the assumptions first Then the price © Dearborn Real Estate Education, 2002

Future Business Develop relationships with commercial and investment customers for life. © Dearborn Real Estate Education, 2002