Metrics for Success in Real Estate Investing Metric - a standard for measuring or evaluating something You Get What You Measure Thomas Winfield May 14, 2016

This is not a solicitation or offer Nothing in this presentation is meant to be Legal, Tax or Financial advice Consult your Lawyer for legal advice Consult your Tax Advisor for Tax advice Consult your Financial Advisor for Financial advice

Discussion Points Economy Market What’s it Worth to Ya’ Case Study Outline Economy Market What’s it Worth to Ya’ Acquisition Metrics Ownership Metrics Disposition Metrics

Case- Searching for a Good Deal Investor Can Qualify for a Purchase of $500,000 Invest $2000/Unit to Bring up to Pro Forma Rents Non-Owner Occupied Sale/Trade After 5 Years No Accounting for Income Taxes No Accounting for Cost at Sell of Property Objective 5% Return on Initial Equity 10% Internal Rate of Return

Example Properties Property A Property B Property C Location Long Beach Desert Hot Springs Palmdale Price $500,000 No. Units 4 8 5 Building Size (SF) 2080 4000 3912 Lot Size (SF) 6220 8816 7462 Year Built 1985 1980 1983 Gross Scheduled Income $40,320 $48,600 $50,100 Net Operating Income (NOI) $21,870 $24,300 $31,262 Pro Forma GSI $44,400 $60,000 $57,600

Economy Interest Rates Jobs Inflation

Economy-Interest Rates Loaning Money to the US Government is the Safest Investment in the World The 10 year Treasury Note is a Good Benchmark for Intermediate Term Investments

Economy- Jobs

Economy-Inflation Rate

Economy-Where Else Should I Invest?

Market/Submarket You can Fix the Property, You Can’t Fix the Neighborhood

Real Estate Market Cycle Is the Market Recovering or Expanding? Rents Increasing Vacancy Rates Decreasing Each Market has it’s Own Real Estate Cycle

Market/Submarket--Income Long Beach Desert Hot Springs Palmdale California US Income Per Capita $26,866 $14,757 $18,695 $29,634 $28,051 Median Household Income $52,900 $32,883 $54,277 $61,632 $53,046

Market Evaluation Ranking Property A Property B Property C Location Long Beach Desert Hot Springs Palmdale Market Rank 1 3 2 Price $500,000 No. Units 4 8 5 Building Size (SF) 2080 4000 3912 Lot Size (SF) 6220 8816 7462 Gross Scheduled Income $40,320 $48,600 $50,100

What is an Investment Worth? Investment value (to a particular investor) is different from market (appraisal) value. Real estate decisions are made with an investment motive: expecting cash flows from the investment The Present Value of the Projected Future Cash Flow The Quality of the Cash Flow The Risk Premium Associate with the Asset

Time Value of Money The time value of money (TVM) is the idea that money available at the present time is worth more than the same amount in the future due to its potential earning capacity.

Time Value of Money– Future Value If I give you $100 today, how much will you give me a year from now? Compute Future Value: Assume $100 invested for (period of) 1 Year at 5% interest FV=$100*(1.05)= $105

Time Value of Money – Present Value If you give me $105 in a year, how much should I give you now? Compute Present Value: Assume $105 discounted for 1 Year at 5% interest PV = FV/(1+i)**n PV=$105/(1.05)= $100

Things to Check Before You Buy Acquisition Metrics Things to Check Before You Buy

Annual Property Operating Data (APOD) APOD: Form outlining the Income and Expenses associated with a property. This allows an investor to perform basic calculations. Gross Scheduled Income (Sum of rents when all units are rented) - Vacancy Rate (cost/percent of units not currently rented) =Effective Rental Income - Expenses (Sum of all expenses other than income taxes) = Net Operating Income (NOI) -Debt Service (Payments on the borrowed money) = Cash Flow Before Taxes

Gross Rent Multiplier Ease of Calculation Easy to Verify Definition: A gross rent multiplier is a rough measure of the value of an investment property that is obtained by dividing the property's sale price by its gross annual rental income. Ease of Calculation Easy to Verify Does not include Vacancies Does not include Expenses Property Long Beach Desert Hot Springs Palmdale Gross Rent $40,320 $48,600 $50,100 Property GRM 12.4 10.3 9.9 Market Median 12.9 7.1 10.7 Price Based on Market GRM $520,128 $345,060 $536,070

Size Metrics Long Beach Desert Hot Springs Palmdale Number of Units 4 8 5 Price/Unit $125,000 $62,500 $100,000 Average Unit Size 520 783 500 Price/SF $240 $125 $128 Median Price/SF $248 $89 $114 Rent/SF $19.38 $12.15 $12.80 Median Rent/SF $18.24 $10.00 $12.07

Debt Service Coverage Ratio The DSCR or debt service coverage ratio is the relationship of a property's annual net operating income (NOI) to its annual mortgage debt service (principal and interest payments). DSCR= NOI/Annual Debt Service

How Much Can I Borrow? Compute Annual Payment base on DSCR Compute Max Loan using Present Value formula with the computed Annual Debt Service Long Beach Desert Hot Springs Palmdale NOI $24,998 $24,300 $31,262 Debt Service $24,157 DSCR 1.03 1.01 1.29 Amount Needed $325,000 Max Amt Borrow $310,345 $301,776 $386,348

Cap Rate Definition The capitalization rate is the rate of return on a real estate investment property based on the income that the property is expected to generate. Used to estimate the investor's potential return on his or her investment. If I paid cash for the property, then the cap rate would be the return on my investment

Historical Cap Rates for Property Class Class A- Built within the past 10 years or so; good quality renters with good jobs; very little maintenance / repair issues 5% to 7% Class B- Built within the past 20 years or so; tenants mix of white and blue collar and has some deferred maintenance / repairs. 7% to 9% Class C- Built within past 30 years or so; tenants mix of mainly blue collar workers & subsidized housing and has maintenance / repairs. 10% to 12% Class D- Built 30 years plus, usually found in bad areas filled with bad tenants. If properties are in a Class B or Class C area, you may reposition to higher Cap Rate. 12% Plus

Cap Rate Measures Risk The Greater the Cap Rate, the Lower the Price Cap Rate is a measure of risk

Comparing Cap Rates to Risk Free Investments The Risk Premium is the difference between the Treasury Rate and the Cap Rate

Which Property Has the Best Cap Rate Long Beach Desert Hot Springs Palmdale Entry Cap Rate 5.0% 4.9% 6.2% Pro Forma Cap Rate 5.5% 7.2% 6.9% Market Median 5.9% 7.8% 7.6% Price Based on Market Median $423,695 $311,538 $411,342

Band of Investment (Derived Cap Rate) The Band of Investment is a yield capitalization method that is used to build a capitalization rate using two components; financing and equity. The formula is: Cap Rate = F + E. (F)inancing = Mortgage (Loan) Constant x percent financed (E)quity = Desired Return x percent down

Calculate Property Value Based on BOI Method Desired Return of 5% Down Payment of 25% Loan Rate of 5% Amount Borrowed $375,000 Loan/Mortgage Constant = Annual Payment/Loan Amount = $24,157/$375,000 =.064 F=Loan Constant*Percent Borrowed =.064*.75=.048 = 4.8% E=Desired Returned*Percent Down payment =.05*.25=.0125=1.2% Derived Cap Rate =F+E =4.8% + 1.2% =6% If I want a certain return, how much should the cap rate be? Long Beach Desert Hots Springs Palmdale NOI $24,998 $24,320 $31,262 Derived Cap Rate 6% Value $416,634 $405,333 $521,033

Break Even Analysis Breakeven Occupancy Ratio is the Ratio of all expenses to Scheduled income Indication of What is needed to make a profit Long Beach Desert Hot Springs Palmdale Operating Expenses $14,112 $21,870 $16,834 Debt Service $24,157 Gross Scheduled Income $40,320 $48,600 $50,100 Breakeven Ratio Initial 95% 82% Pro Forma Breakeven 89% 75% 77%

Operating Expense Ratio The operating expense ratio formula measures how much of a property’s potential rental income is consumed by expenses needed to operate the property. Operating Expense Ratio = Operating Expenses Gross Scheduled Income Long Beach Desert Hot Springs Palmdale Operating Expenses $14,112 $21,870 $16,834 Gross Scheduled Income $40,320 $48,600 $50,100 Operating Expense Ratio 35% 45% 34%

Year 1 Cash Flow Comparison Long Beach Desert Hot Springs Palmdale GROSS SCHEDULED INCOME $40,320 $48,600 $50,100 Less: Vacancy & Cr. Losses $1,210 $2,430 $2,004 EFFECTIVE RENTAL INCOME $39,110 $46,170 $48,096 Less: Total Operating Expenses $14,112 $21,870 $16,834 NET OPERATING INCOME $24,998 $24,300 $31,262 Less: Annual Debt Service $24,157 CASH FLOW BEFORE TAXES $841 $143 $7,105

Return on Invested Capital (ROIC) Down Payment Invested Capital Loan Fees Closing Cost Rehab Cost Etc. Return on Invested Capital (ROIC) = Year 1 Cash Flow Total Invested Capital Long Beach Desert Hot Springs Palmdale Invested Capital $148,000 $159,750 $153,750 Year 1 Cash Flow $841 $143 $7,105 ROIC 0.5% 0.1% 4.6%

Return on Equity (CF/Equity) Equity is Down Payment plus Debt Reduction Long Beach Desert Hot Springs Palmdale Year 1 Cash Flow $841 $143 $7,105 Equity $130,533 ROE 0.6% 0.1% 5.4%

Ownership Metrics What Metrics are Useful During Property Ownership?

Yearly Cash Flow Assumptions: Year 1: Repairs made to achieve Pro Forma Rents Increase Rents by 3% yearly Expense are 35% of Gross Scheduled Income Year 1 Year 2 Year 3 Year 4 Year 5 Long Beach $841 $3,371 $4,197 $5,047 $5,924 Desert Hot Springs $143 $11,843 $12,923 $14,035 $15,181 Palmdale $7,105 $10,979 $12,033 $13,119 $14,237

Discounted Cash Flow (DCF) DCF analysis uses future cash flow projections and discounts them to arrive at a present value estimate, which is used to evaluate the potential for investment. You are buying cash flow, not property The higher the risk, the greater the discount rate

Net Present Value (NPV) The Net Present Value (NPV) benefit is a calculation that measures the net benefit of a project in today’s dollar terms, taking into account that over time money today is more valuable than money in the future (discounted time value of money). Decision rule: if NPV > 0, then the project meets desired returns

Net Present Value Based on Cash Flow and Desired 10% Return My Desired Return is 10% Year 5 Returns Include Proceeds from Sale of Property Cost Year 1 Year 2 Year 3 Year 4 Year 5 NPV Long Beach -$148,000 $841 $3,371 $4,197 $5,047 $242,374 $11,497 DHS -$159,750 $143 $11,843 $12,923 $14,035 $346,129 $76,711 Palmdale -$153,750 $7,105 $10,979 $12,033 $13,119 $328,977 $76,412 if NPV > 0, then the project meets desired returns

Internal Rate of Return (IRR) IRR gives an investor the means to compare alternative investments based on their yield. Cost Year 1 Year 2 Year 3 Year 4 Year 5 IRR Leveraged IRR Unleveraged Long Beach -$148,000 $841 $3,371 $4,197 $5,047 $242,374 12% 7% DHS -$159,750 $143 $11,843 $12,923 $14,035 $346,129 20% 11% Palmdale -$153,750 $7,105 $10,979 $12,033 $13,119 $328,977 21%

What Happens When The Property Must Be Sold or Exchanged? Sale or Exchange What Happens When The Property Must Be Sold or Exchanged?

Exit Cap Rate-The Projected Cap Rate at Point of Sale Historical Analysis Economic Trends Class A: 5% to 7% Class B: 7% to 9% Class C: 10% to 12% Class D: 12% Plus How do I know what the Cap Rate should Be?

Calculate Sale Price Calculate Value based on 3% Yearly increase Long Beach Palmdale and DHS Calculate Value based on 3% Yearly increase Calculate Value Based on Exit Cap Rate and NOI Long Beach Desert Hot Springs Palmdale Purchase Price $500,000 NOI $40,518 $39,546 Cap Rate 6% Annual Increase 3% Sale Price $580,808 $675,305 $659,097

Total Return How much Money Will I have Received Compared to How much I Invested? Total Invested Year 1 Year 2 Year 3 Year 4 Year 5 Total Received Return Long Beach -$148,000 $841 $3,371 $4,197 $5,047 $242,374 $255,831 173% DHS -$159,750 $143 $11,843 $12,923 $14,035 $346,129 $385,073 241% Palmdale -$153,750 $7,105 $10,979 $12,033 $13,119 $328,977 $372,214 242%

Long Beach Desert Hot Springs Palmdale Market 1 3 2 GRM 12.4 10.3 10.0 Price/Unit $125,000 $62,500 $100,000 Price/SF $240 $125 $128 Rent/SF $19.38 $12.15 12.80 Cap Rate 5.0% 4.9% 6.2% Value using BOI Cap $416,634 $405,333 $521,033 Amount Financeable $310,345 $301,776 $386,348 Break Even 95% 82% Cash Flow Year 1 $841 $143 $7,105 Cash Flow Year 5 $5,924 $15,181 $14,237 Cash on Cash (ROIC) 0.5% 0.1% 4.6% NPV $11,497 $76,711 $76,412 IRR 12% 20% 21% Total Return 173% 241% 242% Sales Price $580,808 $675,305 $659,097

References http://www.propertymetrics.com/ What Every Real Estate Investor Needs To Know About Cash Flow ...and 36 Other Key Financial Measures– Frank Gallinelli http://www.investopedia.com