Tag: real estate investing software

New REIA v18 Releases for the New Year – Mac and Windows

With the new year comes the release of REIA version 18 for Mac. This release has all the same features, calculations and reports that are found in the Windows release. Like all of our Mac  products, it will run under Mac Excel/Office 2011 only. We continue to wait for Microsoft to make fixes and improvements to Excel 2016 so that our software will run correctly in that version. REIA v18 on the Mac runs on Excel 2011, Excel 2016 and Excel/Office 365.

Also available for immediate download is a maintenance update for REIA v18 Windows. This update fixes minor issues in the Cover Sheet and Cash Flow / Resale Assumptions reports. Customers who own a license of the software can download the latest build 1.07 from either the Welcome worksheet of their product or via their customer account at realdata.com

Keep track of all latest releases on our builds page.

 

New Podcast: Investing in Income-Producing Real Estate

I had the privilege recently of recording a video podcast with REICLub, where we discussed investing in income-producing real estate: deciding what kind of property you should buy, how to begin the analysis process, understanding the income stream, estimating value or worth, dealing with long-term projections, recognizing common pitfalls, investing with partners.

I invite you to view it here:

http://www.REIClub.com/FrankGallinelli

—Frank Gallinelli

New Edition of Frank Gallinelli’s “What Every Real Estate Investor Needs to Know..”

book1 ed3Frank Gallinelli’s popular book, “What Every Real Estate Investor Needs to Know about Cash Flow…” is now available in a new third edition. Frank has added detailed case studies while maintaining the essentials that have made his book a staple among investors. The new cases show how to evaluate an apartment building, a mixed-use, and a triple-net leased property — not just running the numbers, but also looking beyond the surface data to see how you might discern what’s really going on with a potential investment.

See the new edition at Amazon here.

McGraw-Hill first published Frank’s book in 2003 and has since sold over 100,000 copies. For more than a decade it has been a top title in the real estate section at Amazon.

For those seeking reviews from readers, look to the 100+ reviews of the second edition at Amazon, which collectively rate the book at 4.6 out of 5 stars.

And finally, a visual clue: Second edition has a blue cover, new third edition has a green cover.

 

 

New Short-Term Analysis Mode in REIA Pro

Today we are releasing build 1.07 for Windows and build 1.13 for Macintosh of our REIA Professional product to add a third “short term” analysis mode.  This is a free update for all those who have a license for REIA Pro v17.

Select the mode on the General Settings worksheet:

By making this selection, the software reveals a set of worksheets that are specific to a 24 month analysis.  In a typical short-term scenario, you plan to purchase a property, do some renovations, and then resell within two years.

With the addition of this feature, we can now say that REIA Pro has all the features that REIA Express has, plus many more.  See a feature comparison of the two REIA Products for more information.

The Cash-on-Cash Conundrum – a Postscript

A while back, I posted a two-part series called “The Cash-on-Cash Conundrum.” In the first installment I explained the calculation and underlying logic of CoC, and in the second I discussed some of the pitfalls of overreliance on this particular measure.

big pile of dollars

I try to keep my ear to the ground by reading and sometimes contributing to investor forums, where I continue to see a good deal of discussion on the question of what is or what should be the metric of choice for real estate investors. My unofficial and unscientific gauge of the general sentiment is that most investors agree that cash flow is king. Although I would be reluctant to crown any single measure as the absolute be-all and end-all for property analysis, I agree that cash flow is indeed a critical measure of the health of an investment property.

So what’s the big deal? What concerns me is that I see a kind of tunnel vision on this topic. I frequently hear some variation of these two statements bundled together: “Cash-on-cash return is the only reliable metric and the only one I really need,” and “IRR and Discounted Cash Flow analysis are bogus – they’re a waste of time because you just can’t predict the future.” To put it simply, these folks are saying that they trust CoC because it looks at the here and now, and they distrust IRR/DCF because it tries to look into the future.

On the surface, that argument might seem reasonable enough. Cash-on-Cash return is the property’s expected first-year cash flow before taxes, divided by the amount of cash invested to make the purchase; it’s quick and easy to calculate, and it does indeed focus on a more-or-less tangible present. A strong CoC unarguably provides a good sign that your investment is off on the right foot.

Is that the end of the story – or should it be? I think this narrow focus can cause an investor to miss some vital issues.

By adopting the “can’t predict the future” argument, aren’t you ignoring what investing is all about? You don’t have a crystal ball, but still — isn’t investing about the future, and isn’t the ability to make sensible choices in an uncertain environment a key trait of the successful investor?

I find it difficult to accept the argument that I should make a decision to buy or not to buy an investment property based on its first-year cash flow alone and without regard to projections of future performance. Ironically, there is a hidden message in this point of view: If the first year performance data is sufficient, then apparently I should believe that such data will be representative of how well the property will perform all the time. In other words, it really is OK to predict the future, so long as I believe the future will always be like the present.

I would argue that it is in fact less speculative to make the kind of projections that you typically see in a Discounted Cash Flow analysis, where you look at the anticipated cash flow over a period of time and use those projections to estimate an Internal Rate of Return over the entire holding period.

With any given property, there may be items that you can forecast with a reasonable degree of confidence. For example, on the revenue side you may have commercial leases that specify the rent for five years, ten, or even more. You may even be able to anticipate a potential loss of revenue at a point in the future when a commercial lease expires and you need to deal with rollover vacancy, tenant improvements, and leasing commissions.

You could be looking at a double- or triple-net property where you are insulated from many or most of the uncertainties about future operating expenses like taxes, insurance and maintenance.

Or, with residential property, you may have a history of occupancy percentage and rent increases that permit a credible forecast of future revenue.

Then there is the more basic question, why are you analyzing this property at all? Why are you running the numbers and making this CoC calculation? Are you trying to establish a current market value, as a commercial appraiser might? Or are you trying to make a more personal decision, i.e., will this particular property possibly meet your investment goals? And what are those goals?

Seems like I just took a nice simple metric and wove it into a more complicated story. Sorry, but in your heart of hearts you know if investing really were that simple, then everyone with a pulse would be a huge success. At the same time, it doesn’t have to be so complicated either, so long as you approach it in a reasonable and orderly way.

That orderly approach begins with deciding what you are looking to get out of this investment. Maybe you want to hold it for a few years to get strong cash flow and then sell it, hopefully for a profit. Perhaps you intend to hold it long term, less concerned with immediate cash flow (so long it as it positive), and then sell the property much later to fund your children’s college costs or your own retirement. In either case, if your plan is to buy and hold then there is one thing you can’t ignore: the future.

This approach continues with projection of the revenue, expenses, potential resale, and rate-of-return metrics, running out to your intended investment horizon. Perhaps key here is the realization that you shouldn’t really expect to nail your projections with a single try. Consider several variations upon future performance: best-case, worst-case and somewhere in-between scenarios to give yourself a sense of the range of possible outcomes.

All this brings us back to the duel between the Cash-on-Cash metric and DCF/IRR. I believe if you rely only on the former, then you are not just saying, “You can’t predict the future.” You’re saying, “If the first year looks good, then that’s all I need to know.” This is, quite literally, a short-sighted investment strategy. The takeaway here is that there should be no duel between metrics at all; that prudent investors can use Cash-on-Cash to get an initial reading of the property’s immediate performance, but they should then extend their analysis to encompass the entire lifecycle of the investment. To quote the folks at NASA (who, after all, really are rocket scientists), “It takes more than one kind of telescope to see the light.”

—-Frank Gallinelli

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Your time and your investment capital are too valuable to risk on a do-it-yourself investment spreadsheet. For more than 30 years, RealData has provided the best and most reliable real estate investment software to help you make intelligent investment decisions and to create presentations you can confidently show to lenders, clients, and equity partners. Learn more at www.realdata.com.

Copyright 2014,  Frank Gallinelli and RealData® Inc. All Rights Reserved

The information presented in this article represents the opinions of the author and does not necessarily reflect the opinions of RealData® Inc. The material contained in articles that appear on realdata.com is not intended to provide legal, tax or other professional advice or to substitute for proper professional advice and/or due diligence. We urge you to consult an attorney, CPA or other appropriate professional before taking any action in regard to matters discussed in any article or posting. The posting of any article and of any link back to the author and/or the author’s company does not constitute an endorsement or recommendation of the author’s products or services.

Crowdfunding Real Estate Investments

Pooling of resources, passing the hat — call it what you will, but collaborative underwriting has probably been around for a couple of centuries. Never one to leave well enough alone, the internet has again risen to the role of game-changer, extending a global reach to individuals and companies looking for backers.

You have probably heard of the crowdfunder Kickstarter, which is a popular donation-based site, aimed primarily at creative projects. Backers who donate to such projects don’t become shareholders or expect any financial return. They may be more akin to patrons than to investors.

But investment-based crowdfunding sites have also emerged. I can’t say that I knew much about them, but I recently attended the annual Yale Alumni Real Estate Association’s National Conference where one of the sessions was devoted to this subject, with presentations by two of the top players in this field: Daniel Miller of Fundrise and Rodrigo Nino of Prodigy Network.

Although this method of funding real estate projects may be just a blip on the radar at present, it does appear that more and more real estate crowdfunding sites like these are cropping up and deals actually are getting funded. So just what is this all about and how is it supposed to work? I’ve tried to take what I learned at the Yale conference and have expanded on it a bit; and so, the following are a few observations from an interested outsider.

For the Project Developer Seeking Financing

Among the top arguments for crowdfunding a real estate project are these:

  • It offers an opportunity to get a project financed more quickly and easily than it would through more conventional channels.
  • By eliminating some of the middlemen usually involved, it can lower transaction costs.

The arguments seem credible, since most bank and institutional financing has become a test of endurance. Some crowdfunding sites offer both debt and equity investments, and most are quite specific as to the types of properties with which they deal. The process may not be entirely a walk in the park, because the typical site screens developers by taking them through a rigorous application and evaluation process.

For the Investor

One attraction for investors is that they typically don’t have to pony up a huge commitment to participate in a single project. Hence, they could spread smaller chunks of cash among several properties or even several developers, thus spreading their risk.

There would appear to be a few murky areas, however. Successful commercial real estate investors generally apply a laser focus on their due diligence. In a crowdfunded scenario one should expect that the developer will be doing that, carefully vetting the property and supplying detailed financial information and projections to the potential investor; but how much detail will they provide and can the investor independently verify that information? With the proliferation of crowdfunding sites, will there be consistency among them in the amount and quality of data they provide? A prudent investor must be certain at least to take a very careful look at the track record of the developer.

Investing through crowdfunding may have particular appeal to inexperienced investors. They should be particularly cautious, understanding that there is not likely to be any liquidity, that their cash could be tied up for a considerable time, and of course that there is no guarantee of an acceptable return or of recovering the initial investment. Sometimes deals simply fail.

How is Crowdfunding Even Possible?

It should come as no surprise that there are plenty of regulations that govern these investment offerings. It appears that most of the crowdfunding sites have been operating under SEC Regulation D, which limits general solicitation and restricts participation to “accredited investors.” These generally include investors with a net worth of at least $1 million (not including the value of their home) and income of $200,000 for the past two years, or $300,000 together with spouse.

One site, which at present seems to be unique, is Fundrise. They have been able to use an obscure SEC Regulation A that allows non-accredited investors to participate in community-based deals with investments as little as $100. There is apparently plenty of hoop-jumping for them to deal with, since this regulation also involves state approvals as well as a limit on capital that can be raised in a 12-month period.

In 2012, Congress passed the JOBS Act (Jumpstart Our Business Startups)  and in September 2013, Title II of that act became effective. Title II allows general solicitation, but only to accredited investors.

Title III of the JOBS Act is called the “Crowdfunding Exemption.” Expected to work its way through the SEC rule-making process sometime later this year, it would allow non-accredited investors to participate in equity offerings. The proponents of investment crowdfunding see this as the real game-changer.

Conclusion

Crowdfunding could revolutionize how real estate investments are financed, but not everyone is convinced that it is the Next Big Thing. A recent BusinessWire article cites a number of concerns, including one that this writer has seen elsewhere:  “Will crowdfunding expose innocent, small-time investors to fraudsters and scam artists?”

Both real estate crowdfunding itself and the regulatory environment that will govern it are in their infancy, so how this will all play out must be a matter of conjecture for now. On the one hand, the real estate industry — to put it as politely as possible — has a long history of being resistant to change. On the other, technology in the 21st century has had a habit of sweeping away things that we confidently viewed as permanent cultural fixtures. To be convinced, I need only to rummage in my basement to dig out my old rotary-dial wall phone and my case of incandescent lightbulbs.

Time will tell the story.

—- Frank Gallinelli

Read more in the recent press about real estate crowdfunding:

Crowdfunding’s Latest Invasion: Real Estate

How Crowdfunding Could Reshape Real Estate Investing

The Big Five in Real Estate Crowdfunding

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Your time and your investment capital are too valuable to risk on a do-it-yourself investment spreadsheet. For more than 30 years, RealData has provided the best and most reliable real estate investment software to help you make intelligent investment decisions and to create presentations you can confidently show to lenders, clients, and equity partners. Learn more at www.realdata.com.

Copyright 2014,  Frank Gallinelli and RealData® Inc. All Rights Reserved

The information presented in this article represents the opinions of the author and does not necessarily reflect the opinions of RealData® Inc. The material contained in articles that appear on realdata.com is not intended to provide legal, tax or other professional advice or to substitute for proper professional advice and/or due diligence. We urge you to consult an attorney, CPA or other appropriate professional before taking any action in regard to matters discussed in any article or posting. The posting of any article and of any link back to the author and/or the author’s company does not constitute an endorsement or recommendation of the author’s products or services.

NPV, PI, IRR, FMRR, MIRR, CpA — Stirring the Alphabet Soup of Real Estate Investing, Part 2

IRR – Internal Rate of Return

Internal Rate of Return (IRR) seems to befuddle many investors, but if you understand Discounted Cash Flow and Net Present Value, then you already understand IRR. That’s because it is really the same process, but one where you are solving for a different unknown.

In DCF, you believe you know what the future cash flows will be, and you believe you know the rate at which those cash flows should be discounted. Your mission is to figure the Present Value of the cash flows.

With IRR, you still believe you know what the future cash flows will be, but now you know the Present Value and want to find the discount rate. How is it that you know the Present Value? This is a deal happening in the real world. The PV is the amount of cash you are paying for those future cash flows.

When you solve for the IRR, you are looking for the discount rate that accurately describes the relationship between those future cash flows and the money you put on the table on Day One.

When you’ve found the discount rate that makes the PVs of the future cash flow equal to your initial investment, you’ve found the IRR. You can express this another way: When you’ve found the discount rate that makes the NPV equal zero, you’ve found the IRR.

Admittedly, the math to find the IRR is ugly, but if you’re reading this then you probably have a computer (or a highly sensitive gold filling that also picks up the BBC on the Internet); there are plenty of tools, including Microsoft Excel and our own RealData software that will do the job for you.

IRR is the measurement of choice for many investors because it take into account both the timing and the magnitude of your cash flows. Consider this example:

You still have that $300,000 to invest, and you can invest it in the property you saw in the first example, yielding these cash flows and IRR:

Year 0 Initial Investment:
(300,000)
Year 1 Cash Flow:
10,000
Year 2 Cash Flow:
20,000
Year 3 Cash Flow:
25,000
Year 4 Cash Flow:
30,000
Year 5 Cash Flow:
385,000
(includes the proceeds of sale)
IRR = 10.32%

Or you can acquire this property:

Year 0 Initial Investment:
(300,000)
Year 1 Cash Flow:
80,000
Year 2 Cash Flow:
50,000
Year 3 Cash Flow:
30,000
Year 4 Cash Flow:
10,000
Year 5 Cash Flow:
300,000
(includes the proceeds of sale)
IRR = 12.97%

If you add up the cash inflows and outflows for both properties, you will find that each has $300,000 going out in Year 0, and a total of $470,000 coming in over the next five years. However, the second property shows a significantly higher IRR. Both properties have the same total number of dollars going out and coming in over five years, but the second property shows a greater return on investment. Why?

Because IRR is indeed sensitive to both the timing and amount of cash flow. The first property has a big payday, but you have to wait five years to get the money. In the meantime, annual cash flows are relatively modest.

In the sale year the second property returns combined cash from operation and resale that is only as much as you originally invested to acquire the property. However, the intervening cash flows are much larger, especially the earlier ones. The early cash flows are especially valuable because you don’t have to wait long to receive them and therefore you don’t have to discount their values so greatly.

But Wait…

This sounds terrific; we’ve found the perfect way to measure our investment’s return. But wait – on closer inspection, IRR has a few warts. Sometimes its results are imperfect, sometimes even misleading. In the third installment of this series, we will look at the problems with IRR and at some potential solutions. We’ll examine FMRR and Modified IRR, and how they provide us with a means of dealing with the shortcomings.

—Frank Gallinelli

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Your time and your investment capital are too valuable to risk on a do-it-yourself investment spreadsheet. For more than 30 years, RealData has provided the best and most reliable real estate investment software to help you make intelligent investment decisions and to create presentations you can confidently show to lenders, clients, and equity partners. Learn more at www.realdata.com.

Copyright 2008, 2014,  Frank Gallinelli and RealData® Inc. All Rights Reserved

The information presented in this article represents the opinions of the author and does not necessarily reflect the opinions of RealData® Inc. The material contained in articles that appear on realdata.com is not intended to provide legal, tax or other professional advice or to substitute for proper professional advice and/or due diligence. We urge you to consult an attorney, CPA or other appropriate professional before taking any action in regard to matters discussed in any article or posting. The posting of any article and of any link back to the author and/or the author’s company does not constitute an endorsement or recommendation of the author’s products or services.

NPV, PI, IRR, FMRR, MIRR, CpA – Stirring the Alphabet Soup of Real Estate Investing, Part 1

NPV, PI, IRR, FMRR, MIRR, CpA–It may seem like a witch’s brew of random letters, but truly, it’s just real estate investing. You can handle it. Any or all of these measures can be useful to you, if you understand what they mean and when to use them.

NPV – Net Present Value

NPV, or Net Present Value, is connected to what all good real estate investors and appraisers do, namely discounted cash flow analysis (aka DCF, if you’d like some more initials).

Discounted Cash Flow is a pretty straightforward undertaking. You project the cash flows that you think your investment property will achieve over the next 5, 10, even 20 years. Then you pause to remind yourself that money received in the future is less valuable than money received in the present. So, you discount each of those future cash flows by a rate equal to the “opportunity cost” of your capital investment. The opportunity cost is the rate you might have earned on your money if you didn’t spend it to buy this particular property.

Consider this example, where you invest $300,000 in cash to earn the
following cash flows:

Year 1 Cash Flow:
10,000
Year 2 Cash Flow:
20,000
Year 3 Cash Flow:
25,000
Year 4 Cash Flow:
30,000
Year 5 Cash Flow:
385,000
(includes the proceeds of sale)

If you discount each of these cash flows at 10%, then add up their discounted values, you’ll get 303,948:

Year 1, Discounted:
9,091
Year 1, Discounted:
16,529
Year 1, Discounted:
18,783
Year 1, Discounted:
20,490
Year 1, Discounted:
239,055
Total PV of Cash Flows:
303,948

Now you have the Present Value of all the future cash flows. However, you also had a cash flow when you initially purchased the property (call that Day 1 or Year 0) – a cash outflow of $300,000, your initial investment. To get the Net Present Value, you find the difference between the discounted value of the future cash flows (303,948) and what you paid to get those cash flows (300,000).

NPV = PV of future Cash Flows less Initial Investment
NPV = 303,948 – 300,000 = 3,948

What does that mean to you as an investor? If the NPV is positive, it suggests that the investment may be a good one. That’s because a positive NPV means the property’s rate of return is greater than the rate you identified as your opportunity cost. The more positive it is in relation to the initial investment, the more inclined you’ll be to look favorably on this investment. Your result here is not stellar, but it is at least positive.

If the NPV is negative, the property returns at a rate that is less than your opportunity cost, so you should probably reject this investment and put your money elsewhere.

That’s all fine, to the extent that you’re confident about that discount rate, your opportunity rate. You estimated 10% in the example above. What if you adjust that estimate by one-half of one percent either way?

NPV @ 9.5%
= 10,284
NPV @ 10.0%
= 3,948
NPV @ 10.5%
= (2,244)

How about one full percent?

NPV @ 9.0%
= 16,789
NPV @ 10.0%
= 3,948
NPV @ 11.0%
= (8,238)

Clearly, the NPV here is very sensitive to changes in the discount rate. If you revise your thinking just slightly about the appropriate discount rate, then the conclusion you draw may likewise need to be revised. As little as a half-point difference could change your attitude from luke-warm to hot or cold. The prudent investor will test a range of reasonable discount rates to get a sense of the range of possible results.

While we’re beating up on NPV, let’s also note that it doesn’t do you much good if your goal is to compare alternative investments. To have some kind of meaningful comparison, you need at least to keep the holding period for both properties the same. But what if one property requires that $300,000 cash investment, but the alternative investment requires $400,000?

PI – Profitability Index

Fortunately, NPV has a cousin that can help you with that problem: Profitability Index. While the NPV is the difference between the Present Value of future cash flows and the amount you invested to acquire them, Profitability Index is the ratio. It doesn’t tell you the number of dollars; it tells you how big the return is in proportion to the size of the  investment.

So where the NPV in the example above was equal to 303,948 minus 300,000, the Profitability Index looks like this:

PI = 303,948 / 300,000 = 1.013

If, quite improbably, you expected exactly the same cash flows from the property that required a 400,000 investment, you would expect your Profitability Index to be much worse, and it is.

PI = 303,948 /400,000: = 0.760

A Profitability Index of exactly 1.00 means the same as an NPV of zero. You’re looking at two identical amounts, in one case divided by each other so they give a result of 1.00 and in the other case subtracted one from the other, equaling zero.

An Index greater than 1.00 is a good thing, the investment is expected to be profitable; an Index less than 1.00 is a loser. When you compare two investments, you expect the one with the greater Index to show the greater profit.

There is a good deal more stirring about in our alphabet soup, so join us for the next installment when we look at IRR – Internal Rate of Return.

—Frank Gallinelli

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Your time and your investment capital are too valuable to risk on a do-it-yourself investment spreadsheet. For more than 30 years, RealData has provided the best and most reliable real estate investment software to help you make intelligent investment decisions and to create presentations you can confidently show to lenders, clients, and equity partners. Learn more at www.realdata.com.

Copyright 2008, 2014,  Frank Gallinelli and RealData® Inc. All Rights Reserved

The information presented in this article represents the opinions of the author and does not necessarily reflect the opinions of RealData® Inc. The material contained in articles that appear on realdata.com is not intended to provide legal, tax or other professional advice or to substitute for proper professional advice and/or due diligence. We urge you to consult an attorney, CPA or other appropriate professional before taking any action in regard to matters discussed in any article or posting. The posting of any article and of any link back to the author and/or the author’s company does not constitute an endorsement or recommendation of the author’s products or services.