You’re Invited: Value Hound Academy’s Webcast Interview with RealData Founder, Frank Gallinelli

I want to invite you to a webcast interview that will be broadcast Wednesday Sept. 14, 2011 at 11AM PST (2 PM EST).

The folks at Value Hound Academy asked me to discuss my insights into analyzing real estate deals:
—  how to be a “financial detective” when examining a seller’s representations
—  the biggest mistakes investors make when analyzing deals
—  critical items folks overlook in renovation projects
—  and lots more

Crunching numbers is critical to your success as a real estate investor, so do sign up to hear this webcast.  It’s free.  http://www.valuehoundacademy.com/public/337.cfm

New videos

We have just added some new videos to our home page, realdata.com Each video presents a brief overview of one of our main software products: Real Estate Investment Analysis Pro Edition, Commercial / Industrial Development, and On Schedule.

Hope you’ll take a look and let us know what you think.

The Flavor of the Month: Apartment Investing

It comes as no surprise to those of us who are a bit long in the tooth: The recent economic environment has been bad for almost everything, but it’s good for multi-family investment property.

When credit flows freely, almost anyone who can buy a house will buy a house. (Whether they can pay for it after the closing is of course another matter.) On the other hand, when credit tightens or dries up almost completely, then the subprime prospects are frozen out of the housing market, along with a sizeable group of perfectly responsible borrowers who now find they can’t clear the considerably elevated qualification standards. It doesn’t take tremendous insight to realize that most of these people are now candidates for apartment space. Remember Econ 101?  Supply, demand, etc.

If you read the financial press (or follow our tweets) then you’ve seen ample evidence lately that apartment properties are hot. The Wall Street Journal  cites a Marcus and Millichap report stating the the values of apartment buildings rose 16% in 2010 after falling 27% between 2006 and 2009. In that same article, WSJ says that the supply of new apartment buildings is at a two-decade low. There’s that supply and demand thing again.

Reuters  recently reported that apartment vacancies showed a steep drop in the first quarter of 2011. At the same time, Investor’s Business Daily noted that even the smallest buildings — those with four units or less — were in high demand. An advantage here for the small investor is that this kind of property can usually qualify for Fannie- or Freddie-backed financing, and perhaps on even more favorable terms if the investors lives in one of the units.

After a long period when it seemed like investors were in duck-and-cover mode, it’s good to see this resurgance of activity.

(self-serving footnote: If you’re doing an apartment deal, be sure to run the numbers first, Either the Express or Professional Edition of Real Estate Investment Analysis will do a great job with apartment buildings. If you’re raising capital from equity partners, then use the Pro Ediiton — it will give you presentations for individual partners.)

Social Media is Everywhere — Now RealData is in the Game

Finally!  RealData’s on Facebook. Our goal is to make this a hub for networking with our customers and colleagues, and with readers of my books — and for them to network with each other. Find us at facebook.com/realdata You can also follow me — Frank Gallinelli — on LinkedIn at linkedin.com/in/frankgallinelli and Twitter at twitter.com/fgallinelli

Facebook will be the place where you’ll find most of our educational articles and videos  (note the tabs on the left of our Facebook page). In coming weeks and months, you’ll also find free admission to webinars, special promo codes, ebooks, other educational materials, and more. But only on our Facebook page, so please be sure to check in often.

Allow me to start the conversation with a question: What resources or content would you like to see on Facebook — things that will help you become a more successful real estate investor?

New Mac-Compatible Releases of RealData Software

We’ve supported the Macintosh with Excel-based products since the Mac first came out in 1984.  (In fact, way back then we received an award as one of “100 Most Important Companies on the Macintosh.”)

But a few years ago, Microsoft threw us a real curve when they dropped VBA macro functionality from Excel 2008 for the Mac.  As you may know, it’s those complex and sophisticated macros (which you can’t see) that make our software really powerful and easy to use. So our Mac users had to settle for Excel 2004 to run our software

Thankfully, Microsoft has seen the light and restored VBA in their new Excel 2011; and we wasted not a moment getting to work re-writing our products to make good use of the new Excel. It was no small task, but  now all of our products are truly Mac-compatible.

Not only will you have the advantage of Excel’s new interface and features, but you’ll now be able to use the latest versions of RealData software on your Mac — even REIA Express, Version 2 and the RealData Real Estate Calculator — and you’ll see all of our programs run at speeds that are orders of magnitude faster than they ran with Excel 2004.

(A sidebar note: Because these programs are not simply spreadsheets, Windows versions won’t work properly on the Mac and vice-versa. That’s why we created these new releases specifically for the Mac.)

We’re glad to be back offering the latest and best of our software for our loyal Mac customers.

Help Us to Help Toys for Tots

The bad economy — and particularly the unemployment crisis — have taken a real toll on many American families. During the holidays, it’s especially tough on families with children. Recently I was delivering a toy to a local charity, thinking about the smile that I hoped would come over that child’s face, and wishing I could multiply that smile many times over. Grandpas have a tendency to get like that.

My plan is very modest, and won’t cure the world’s financial ills, but I hope you will help: I will take 50% of the proceeds of our December 7, 8, and 9 RealData software sales and send that money to the charity run by the U.S. Marines, “Toys for Tots.”

So, if you were thinking about buying one of our programs next week or next month or next quarter, I urge you to do it instead during these three days — December 7-9. You’ll get the powerful software you need, and we’ll send “Toys for Tots” half of what you paid us. You’ll be helping yourself make better investment decisions with our software, but perhaps equally important I believe you’ll help us do something good for a  worthy cause — and maybe together we can put smiles on a lot of kids’ faces.

Thank you, and wishing you peace during this holiday season and beyond,

Frank Gallinelli

President, RealData, Inc.
www.realdata.com

MIRR — How It Works

From our experience, it appears that Internal Rate of Return (IRR) is the metric of choice for many, if not most, real estate investors. However, you may be aware that there are a few issues with IRR that can cause you some vexation: If you expect a negative cash flow at some point in the future, then the IRR computation may simply fail to come up with a unique result; and with your positive cash flows, IRR may be a bit too optimistic about the rate at which you can reinvest them.

For these reasons, a variation on IRR, called Modified Internal Rate of Return (MIRR), can be very important. When you see how it works, then you’ll also see that it gives you the opportunity to deal with IRR’s shortcomings.

Our support folks have had a number of calls from users of our Real Estate Investment Analysis software asking for guidance in using and understanding MIRR. How does it work, and how do I choose the “safe” and “reinvestment” rates that it asks for?

Let’s start with some definitions:

safe rate The interest rate obtainable from relatively risk-free investments, such as U.S. Government Treasury Bonds.” source: The Complete Real Estate Encyclopedia by Denise L. Evans, JD & O. William Evans, JD; 2007, McGraw-Hill (btw, this is an excellent reference book)

reinvestment rate When analyzing the value of an income producing property, it is the rate an investor is assumed to be able to earn on intermediate cash flows. …” Ibid

There is an alternative name sometimes used for the safe rate — “finance rate” — and the rather opaque definition given in the Excel help for MIRR doesn’t seem particularly helpful: “…the interest rate you pay on the money used in the cash flows.” Frankly, I’m not sure I understand what that is supposed to mean, but I believe if you focus on the term “safe rate,” you will be able to follow this discussion easily. The reinvestment rate also sports an alias — “risk rate” — which seems clear enough, but I believe again that you will find it easier to stick with the more common term, “reinvestment.”

Let’s begin with the safe rate and pose the question, “Why and when does the safe rate come into play?” The answer has to do with negative cash flows. Usually, you expect an investment to put cash into your pocket (positive cash flow), but sometimes it pulls money out of your pocket instead (negative cash flow). In real life, you can’t leave a negative cash flow sitting there and just move on to the next year. The property has to pay its bills, so you as the investor have to pick up the tab. In other words, you have to make an additional cash investment in the property. Herein lies the key.

Real estate finance and investment education

A number of colleges and universities have been using my books as well as my company’s Real Estate Investment Analysis software for instructional purposes in their classes on real estate finance and investment (as have I at Columbia).

The “Express Edition” of the software dovetails nicely with my books, but some instructors recently asked for inclusion of a few of the features from its big brother, the Pro Edition. Happy to accommodate.

And so… we released a new version of REIA Express which does just that.

If you teach real estate finance or investment, note that we have an academic version of the software available for classroom use. Your students can use that to work through many of the problems and case studies in the books.

If you would like to find out more about academic use of this software, please contact me via our online contact form.

Five More Rules of Thumb for Real Estate Investors

In a previous article – Six Rules of Thumb for Every Real Estate Investor – I offered some guidance that might reasonably be held dear by every income-property investor. Woe to him or to her who doesn’t take a property’s vital signs, such as Debt Coverage Ratio, Loan-to-Value, or Cap Rate, to heart before making an investment decision.

Hidden below these very objective measures, however, is a sub-stratum of more subjective issues to consider when you invest. It would be a stretch to suggest that these considerations apply to every investor or to every situation. Your mileage may vary. Still, these are issues that should be worthy of your attention whenever you invest in real estate.

Small Property or Large?

By “small” and “large” I am referring to the number of rental units, not to the physical size of the property. I often hear from people who are investing in real estate for the first time and are choosing to buy a single-family home to use as a rental property. I suspect that these folks have not taken a pencil to paper (or even better, used one of RealData’s investment analysis programs) to see if they could reasonably expect to enjoy a positive cash flow from that property.

Although it’s possible to get a good cash flow from a one-family house, it is certainly not something you should take for granted. Whether you’re purchasing a single-family house or a 40-unit apartment building, that structure is going to sit on a single piece of land; and typically, the land cost-per-unit is likely to be higher – perhaps much higher – with a single-family house.

The more you pay per unit for the land, the more rental revenue per unit you will need to generate to cover your costs. In short, generating a positive cash flow in this scenario could prove to be a challenge. The deck may be stacked against you, so run your cash flow projections before you buy. Add up the cost of your mortgage payment, property taxes, insurance, maintenance and miscellaneous expenses. Will your rent be greater than the total of these costs?

Another perilous characteristic of the single-family as a rental property concerns vacancy. Simply put, if you lose one tenant, then 100% of your property is vacant. Consider again that 40-unit apartment building: Lose one tenant there and you lose just 2.5% of your revenue.

Finally, there is the issue of what drives value. A single-family house’s value is customarily based on market data, i.e., comparable sales, while the so-called commercial property (generally defined as one having more than four rental units), is valued based on its ability to produce income. This difference is important to you as an investor because you have the opportunity to create value by enhancing the commercial property’s income stream, an opportunity you will not have with that single-family.

All this is fine and makes good sense, but you may just not be built for starting off your investment career on a large scale. If thatss the case, then consider a multi-family house – ideally one with more than four units, but even smaller if you must – as your starter investment. Learn from that, then move on to bigger things.

Residential or Commercial?

I used the term “commercial” above to refer to properties with more than four units. Such properties are commercial in the sense that they are bought and sold for their ability to produce income. In more common parlance, however, the term “commercial” is often used to describe real estate that is occupied for business purposes and not as dwellings for families or individuals.

In a separate full-length article, I discuss in some detail the pros and cons of investing in each property type, but for our discussion here let’s just consider a few key points. If you’re a first-time investor, the most basic issue is that of comfort level. It is very likely that you have a good deal of personal familiarity with residential property. Chances are that you already know something about residential rent, leases, security deposits, utility bills, and the like. If you have never had similar experience with commercial property – renting your own office or retail space, for example – then you may feel more comfortable dealing with a property type that is more familiar to you.

There are plenty of potential advantages to owning commercial property, such as longer-term leases with built-in escalations, and tenant responsibility for certain operating expenses. Once you have expanded your comfort zone by owning and operating investment property, commercial real estate can be a very good long-term strategy.

Local Market vs. Hot Market

It seems like everyone is telling you that the demand for real estate is running wild in Last Ditch, Wyoming. Should you head, checkbook in hand, straight for the Ditch or stay close to home? Keep in mind an old axiom that applies to all kinds of investing: By the time you or I hear of a great deal, all the money that’s going to be made already has been made by someone else.

I have no doubt that you can find investors who have made a killing in some remote real estate market. You can probably also find someone who has won the Irish Sweepstakes. An important part of your strategy should be to optimize your chances of success, and you will do that best by staying close to home – perhaps very close.

I usually tell new investors that they should choose a location where they know every crack in the sidewalk. Information that you may take for granted can prove to be truly priceless. You probably know how well local businesses are doing, if the city needs to spend money soon on new schools or infrastructure, if a major employer is thinking of moving in or out of town, if a new transportation hub is nearing the final stages of approval, or if the local college is increasing its enrollment. In short, you know the likely trends that will drive demand for residential and commercial space, and you have a sense of where local property taxes are headed. You’re plugged in to your market, and nothing is more valuable to an investor.

Equity Partner vs. Debt Partners

Unless you have the resources to buy property for all cash, you have partners. When you finance an investment property, the bank (or whoever is lending you money) is your “debt partner.” They will very definitely get a piece of the action. In fact, they will expect their piece even if there is no action – no cash flow – at all.

In the current economy and with the state of the financial markets as it has been, we see an increasing number of experienced investors looking for more equity partners and less financing. It may not be as romantic as going entirely on your own, but it can be more successful. Financing has been difficult to obtain of late; the less you ask for in relation to the value of the property, the better your chances of securing it and the better the terms are likely to be. With less financing, you improve your chances of achieving a positive cash flow, even if you have to share it with your partners. Partnering up may be a good strategy for the times.

Professional Management vs. Do-It-Yourself

The question of whether or not to hire a professional property manager is one that you need to answer on a case-by-case basis. There may be no better way to learn how rental property works than to roll up your sleeves and run it, personally, like a business. But as with any business, you need to weigh the risks of on-the-job training.

For example, it may be prudent for you to use an experienced agent to find tenants and to check their references. That can be time-consuming work, and signing up a troublesome tenant can prove costly and consume even more of your time.

On the other hand, getting involved directly in overseeing maintenance, repairs and general management can help you recognize if your property is a good and desirable product in the marketplace. What is the appeal of your property, compared to others that compete for tenants in the same market? Your tenants will probably let you know if you work with them directly.

In addition, I have always believed that most tenants will not respect your property unless you do. You are more likely to sign up and retain responsible tenants if they see that you care about keeping the property in top shape and that you will respond to reasonable requests for maintenance or repair. As in any business, when you are directly involved in setting the tone and the standards, you have best chance of seeing those standards met. Eventually, as you build your real estate empire, you may have too many units for this hands-on approach to be practical; but if you are just starting out, this can be an effective way to develop your set of expectations for whoever will manage in your name in the future.

The Bottom Line?

True confession: These five rules are not really set-in-stone rules at all, but options that every real estate investor needs to weigh on his or her personal balance scale. Unlike a nice metric such as Debt Coverage Ratio, there is not really an unambiguous choice for any of these. You must take into account your own personal skills, experience and resources, your available time, and the nature of the property in which you are investing – and then choose wisely.

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Recovering from the Housing and Financial Crisis

Federal Reserve V.P. and senior policy advisor John Duca has just published an an exceptionally lucid article that discusses the four key “shocks” suffered by the U.S. economy during the financial crisis: As he states quite succinctly, “Home construction plunged, wealth fell, credit standards tightened and financial markets seized up.”

He discusses the relationship between home construction and GDP, housing’s wealth effect, and the availability of credit; and concludes with a balanced assessment of what may lie ahead for both the U.S. and global economies. He cites indicators that point to recovery, but tempers those with a discussion of the downside risks that remain.

There are enough stats and charts here to satisfy number crunchers like me, but the prose is clear and readable enough to stand on its own.

I think this is material that anyone in real estate, construction or mortgage finance should read, so we have posted it on our “Learn” page.