Tag: real estate investors

Video post: Understanding Net Operating Income, Part 1

One topic that seems to generate a lot of interest and questions among investors I speak with is the subject of net operating income. Those who are new to real estate investing and even those with some experience are often unclear as to exactly what it is, what it means, and how to use it.

To shed some light on this topic, I’m going to try something new here – new for me at least – a video blog post. I’ll try to answer those questions by giving you a basic roadmap of how Net Operating Income is calculated, and how it’s used in real investment situations. So —  here we go with Part 1 of 2. Click the image below.

net operating income

 

Part 2 is now available here.

 

Copyright 2021,  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.

 

“The Top 10 Real Estate Finance Books Every Investor Should Read.”

investment book

I was honored to find that one of my books was featured at the top of a recent article on Motley Fool: “The Top 10 Real Estate Finance Books Every Investor Should Read.” The book, “What Every Real Estate Investor Needs to Know About Cash Flow,” was originally published in 2004, is now in its third edition, and is alive and still doing well —  a surprise certainly to me, and probably to the publisher as well.

I often get asked what accounts for the book’s long-term appeal, and I think there may be two reasons: First, I avoided “topical” or trendy content, preferring to stick with core concepts and math-based metrics don’t change with time. And second because I really dislike the get-rich quick hype that seems to characterize so many real estate books, and so I shunned that, too.

I don’t think they’ll ever make a movie out of it, but I’m satisfied if it has helped some readers make informed and unemotional investment decisions.

You can find the article here.

Now earn a digital certificate with my video course, “Introduction to Real Estate Investment Analysis”

Professional education is a great thing. And being able to broadcast news of your success makes it even more valuable.

That’s why I’m announcing a new benefit to students who enroll in my course, Introduction to Real Estate Investment Analysis. I’m now awarding a digital Certificate of Achievement and badge to students who successfully complete the course.

Here are some questions you probably want to ask:

What does it cost? For my students: nothing. RealData is picking up the cost of issuing and hosting the certificate.

What do you mean by “digital certificate?” Your certificate will be hosted by Accredible.com, an industry-leading credentialing platform. As you’ll see below, it’s designed so you can share it easily.

Does that mean I don’t get a physical certificate to hang on my office wall? No, you also get a pdf version you can print.

What’s so special about this digitally hosted certificate?  So glad you asked. Here are a few things you couldn’t do with a traditional certificate:

  • You receive a unique url for your Certificate, so you can share it with employers, clients, industry groups, just about anyone.
  • You can share it on any of your social media networks with just a click on a toolbar.

 Your personal certificate page includes a dashboard, as shown at the left. From there you can…

  • Add it to your LinkedIn profile
  • Add it to your email signature
  • Get the code to embed it in your website
  • Email it to anyone
  • Download it as a PDF
  • Download a badge image, which you can attach to your email signature, put on business cards, etc.
  • Add “evidence” to your certificate to increase your credibility — examples of your work, videos about yourself, links to projects you’ve been involved with – and even more

How do I obtain my certificate?Within a few days after you complete the work to earn your certificate, we’ll send you an email with instructions to access it. If you believe you’ve completed the requirements but haven’t heard from us, please contact us at mailto:education@realdata.com

Terms of Use: Please review our common-sense Terms of Use

I believe our online video course provides a solid educational opportunity for those who want to learn about real estate investment and development. I hope this digital certificate will recognize your efforts and will benefit you for devoting the time and effort to pursue that education. I look forward to contacting you when you complete your coursework!

Frank Gallinelli

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 Lease Renewal Assumptions feature for REIA Professional

Making assumptions and entering data about commercial lease revenue — especially rollovers — was often a tedious undertaking. Until now.

Enter our latest game changer: REIA Professional’s Lease Rollover Assumptions

What is it?

Our new Lease Rollover Assumptions feature (LRA) is a way for you to store sets of parameters about different commercial lease rollover scenarios, parameters which you can use over and over when entering tenant information in REIA Professional. What is the probability that a current tenant will renew? How long do you think the space will be vacant if a tenant chooses not to renew?

Build your assumptions sets, add your tenants, and apply the LRAs. Done.

You rely on our products to crunch the numbers quickly and accurately so you can make the best and most profitable commercial investment decisions. LRA brings you a whole new level of power and speed.

How it works

First, create a set of assumptions on the new LRA worksheet.  Enter values for months vacant, rollover probability, new and market rent, etc.

lra4

Then apply those assumptions to a tenant just by selecting the option on the Commercial Income worksheet:

lra5

How to get it

If you already own a license of REIA Professional version 18, then you just need to download the latest build from your customer account at realdata.com

If you have a previous version, consider upgrading.  Upgrade costs can be found here.

Learn More

We have a knowledgebase article which walks you through the setup and configuration of the LRA feature.

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

Real Estate Expense Recoveries—What are they, how do they work? (part 3)

In Part 2 of our discussion of real estate expense recoveries, we looked at several different methods that property owners use to recover some of their operating costs from tenants:

  • Simple pass-throughs — These typically work well in single-tenant properties, or in properties with no common area. The expenses chosen for reimbursement are billed to the single tenant; or if there are multiple tenants, then the charge is divided according to each tenant’s share of the total space.
  • Expense-stop pass-throughs — Some pass-through arrangements require the tenants to pay a just portion of the recoverable expenses. The landlord pays up to a certain amount, called an “expense stop,” and the rest is passed through to the tenants. The “stop” can be a dollar amount defined in the lease, or it can be a “base-year stop,” where the landlord pays whatever amount comes due in the first year of the lease and the tenants pay any increase in subsequent years.
  • CAM — In larger properties, where there is common space for the benefit of all tenants as well as for the public, the landlord my collect CAM (Common Area Maintenance) charges—expenses related to the maintenance of these common areas.

We left off at sticking point, however, regarding larger properties. If there is a significant amount common area, then the landlord will surely be thinking about the fact that this space accrues to the benefit of the tenants but doesn’t earn anything for the landlord. There must be a way to remedy this apparent inequity.

 

The Load Factor

Enter the “load factor.”

Fotolia_42618982_XSload factor

Recall two definitions near the end of the previous article:

usable square feet (usf): The amount of space physically occupied by a tenant.

rentable square feet (rsf): The amount of space on which the tenant pays rent.

The load factor represents a percentage of the common area, which is then added onto a tenant’s usable square footage to determine the tenant’s rentable square footage.

Let’s say a shopping center has a total area of 100,000 square feet. 90,000 is the usable area, occupied by tenants, and 10,000 is common area.

Load Factor = total area / usable area

Load Factor = 100,000 / 90,000

Load Factor = 1.11

What this means is that each tenant’s usable square footage will be multiplied by 1.11—in other words, bumped up by 11%—to determine its rentable square footage, the amount on which it pays rent.

Say for example that you operate a 2,000 square foot boutique in this 100,000 center, and have contracted to pay $40 per rentable square foot.

2,000 usable sf x 1.11 load factor = 2,220 rentable sf

2,220 rsf x $40 = $88,800 per year rent

Unlike what you did in the earlier pass-through models, you’re not paying an additional charge on top of your base rent here. Your base rental rate remains the same, but now it is applied to a greater number of square feet—the space you actually occupy plus a proportional share of the common area. This combination of your private space plus a pro-rata portion of the common space is what we now call your rentable square feet.

You and the other tenants are paying rent for your proportional shares of the common area from which you all benefit, and the landlord is receiving rent for all the space in the property. Cosmic equilibrium is restored.

 

 

Is It More Income or Less Expense?

Regardless of the name we give it—reimbursement, recovery, or pass-through—the end result is the same. The bottom line of our Annual Property Operating Data (APOD) form, Net Operating Income, is increased. The final issue to confront is how do we account for this additional money when we assemble a presentation or analysis?

more lessOne way that I see often, and which I believe to be incorrect, is to treat the reimbursement as if it were a negative expense—in other words, to show the expense reduced by the amount reimbursed. For example, if the actual property tax bill were $10,000 and the amount reimbursed were $9,000, then by this method the property tax expense would be shown as $1,000. Why do I say this is incorrect?

The purpose of an APOD, or of any income-and-expense statement, is to convey information that is both accurate and useful. The taxes for this property are $10,000. If you were a broker or property owner and handed me a report that showed taxes of $1,000, I would…

a) suspect you were trying to con me

b) doubt all of the rest of the numbers on your report

c) be denied essential information I need to evaluate the property (e.g., the true cost of property taxes and the lease terms regarding expense reimbursement)

d) find another broker or owner to work with

e) all of the above

The correct answer, of course, is “e.” You’ve missed a key ingredient of successful business discourse: clarity. You should convey your analysis of a property in terms that are unambiguous, accurate, and relevant to your audience.

If you don’t treat the reimbursement as a negative expense, then how should you handle it?

You should treat it as revenue, the same as rent.

  • It is rent. The amount may be based on a calculation involving one or more operating expenses, but it is still money paid by a tenant to a landlord under a lease agreement. If it walks like a duck, etc.
  • Many lease agreements will in fact describe the reimbursement as additional rent.
  • You can then apply a vacancy allowance to the total of base rent plus recoveries to account for the loss of both from a vacant unit. The top portion of your APOD might look like this:

(One side note on the interplay of vacancy on expense recoveries: Some leases will contain a gross-up clause. In such a lease, if there is less than full occupancy (which is defined in the lease, and is often pegged at 90 or 95%), then the landlord may take certain variable expenses that would be directly affected by the level of occupancy, such as janitorial cost, and “gross them up” to the amount they would be at full occupancy.)

In these three articles I’ve given you the abridged version of simple, single-tenant pass-throughs; pro-rated multi-tenant pass-throughs; expense stops; base-year stops; CAM charges; load factors; and even presentation issues. But there is no limit to the creativity of landlords and tenants in their pursuit of successful dealmaking. If you’ve been part of novel expense-recovery design, please share it with us.

—-Frank Gallinelli

Want to learn more? Visit learn.realdata.com

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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. Find out more at www.realdata.com.

Copyright 2016,  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.

Real Estate Expense Recoveries—What are they, how do they work? (part 2)

Expense recoveries (aka reimbursements or pass-throughs) serve as a customary ingredient in leases for non-residential property. In part 1 of this article, I discussed some of the typical ways such an arrangement might play out.


The Simple Pass-Through

Fotolia_84790892_XS_split_costsIn a single-tenant property the tenant may be expected to pay all or a portion of certain operating expenses, such as property taxes and insurance, in addition to its base rent. If the tenant is obliged to pay just a portion of the expense, that amount is the excess over what is called an “expense stop.” Let’s say the property taxes are $12,000 and the lease requires the tenant to pay the excess over an expense stop of $4,000. The tenant would have to pay $8,000.

property tax expense — expense stop = expense reimbursement

$12,000 — $4,000 = $8,000 expense reimbursement

If this were a multi-tenant property, the recoverable amount would typically be pro-rated among the tenants—that is, it would be divided up according to the square footage of each tenant’s space in relation to the whole.


Base-Year Expense Stop

A variation on the expense-stop theme is the “base year expense stop.” In this scenario, the parties agree that the landlord will pay the full amount of the recoverable expenses for the first year, and in future years the tenant will pay any increase over that base.

An arrangement like this certainly seems straightforward enough, but prospective tenants sometimes view it with a jaundiced eye. What if the landlord tries to maneuver the timing of base year expenses in order to minimize them? Then the excess in subsequent years would be artificially inflated. If that’s a concern, then perhaps the tenant would prefer a pre-defined expense stop, as in the earlier example.

Keep in mind that the tenant does not pay these expenses directly to the original source of the bill. The landlord pays the tab and passes the appropriate charge through to the tenant, hence the term “expense recovery” or “reimbursement.”


Common Area Maintenance

furniture in small spaceNot every property will fit into a nice, neat, divisible mold. Take, for example, an office building or a larger shopping center. Properties like these may include areas such as lobbies, hallways, elevators, escalators, rest rooms, and parking lots—areas provided for the benefit of all the tenants, as well as for the public served by those tenants (i.e., their customers or clients). In addition, there may be services that the landlord provides for everyone’s benefit, such as security, trash removal, and janitorial. How does the property owner pass these costs through to tenants?

One approach is to bundle up the cost of common services into an item called CAM— Common Area Maintenance charges— and to pass that charge through based on square footage, just as one might pass through a property’s tax expense. Let’s take a tenant who occupies 2,000 square feet out of a total of 10,000; and let’s also say that we have identified $1,000 in total CAM charges for a given time period.

pro rata share of space x CAM charge
= expense reimbursement

20% x $1,000 = expense reimbursement

= $200 expense reimbursement

This method may be fine in situations where the CAM charges are based mainly on services, but the property owner might be less than satisfied with this approach if the property has a significant amount of physical area devoted to common use. Why?


Usable vs. Rentable

Perhaps the answer lies in that we mean by “space.” Let’s pause for two definitions:

usable square feet (usf): The amount of space physically occupied by a tenant.

rentable square feet (rsf): The amount of space on which the tenant pays rent.

The common area represents space from which the tenants benefit, but that space is not part of their private, usable square footage. The common space is being used for lobbies and hallways and rest rooms, so it’s not available to lease out and earn rental income. This would not appear to be an ideal business plan for the landlord. Should the landlord absorb the loss? Is there an alternative?

The answer, and more, in our final installment about expense reimbursements.

—-Frank Gallinelli

Want to learn more? Visit learn.realdata.com

####

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. Find out more at www.realdata.com.

Copyright 2016,  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.

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.

 

 

Real Estate Expense Recoveries—What are they, how do they work? (part 1)

If you’ve gotten involved as a landlord or tenant with non-residential real estate, such as retail or office buildings, then you have probably encountered a phenomenon that may go by any of several names: expense recoveries, expense reimbursements, pass-throughs, or common area maintenance (CAM) charges. What exactly is this phenomenon and how does it work?

The typical commercial lease will specify a base rent, sometimes as a dollar amount per month or year, but more often as an annual number of dollars per rentable square foot of space occupied by the tenant. Many leases also call for additional rent over the base amount in the form of expense reimbursements.

How it Works—The Math

Vector modern flat business background. Eps 10Let’s take a simple example. Say that you own a single-tenant property with 10,000 rentable square feet. The lease specifies a base rent of $30 per square foot. It also says that the tenant is obligated to reimburse you, the landlord, for all property taxes in excess of $4,000 per year. The $4,000 cut-off is called an expense stop.

In the first year of the lease, the total property tax bill is $12,000. How much will the tenant pay during the first year? Start with the base rent:

area x rate = base rent

10,000 square feet x $30 per sf = $300,000 base rent

Now calculate the reimbursement:

property tax expense — expense stop = expense reimbursement

$12,000 — $4,000 = $8,000 expense reimbursement

So the tenant is going to pay a total of $308,000 in the first year.

What happens if the space is divided among multiple tenants? While the leases for these tenants could be structured in any way to which the parties agree, the most common arrangement would be to allocate the reimbursements according to each tenant’s pro-rata share of the total rentable square footage.

Let’s say now that instead of occupying the entire rentable area, the tenant we’ve been discussing takes up only 2,000 square feet and the remainder is rented to other businesses. The calculation of the base rent works just as it did before (area x rate = base rent), but the reimbursement involves an additional factor, the tenant’s pro rata share. Since the tenant occupies 2,000 of the 10,000 square feet total, its share is 20%

pro rata share x (property tax expense — expense stop)
= expense reimbursement

20% x ($12,000 — $4,000) = expense reimbursement

20% x $8,000 = $1,600 expense reimbursement

As before, we add that to the tenant’s base rent

2,000 square feet x $30 per sf = $60,000 base rent

to get a total of $61,600.

In this example, we have been passing through just one expense, but the landlord and tenant can agree to pass through as many or as few as they like. Property tax is probably the most common, and a lease that has just that single reimbursement is called a net lease. If the lease passes through both taxes and insurance, it is called a net-net lease. And if it adds tenant responsibility for repairs and maintenance into the deal, it is called a triple-net lease.

 


How it Works—The Practical Issues

All this is nice in theory, but how does it work in practice? Does the property owner let the tenant pay the bills?

doodle building earthquakeHardly ever. If you as a property owner pass property taxes or insurance cost–or any other expense for which you are responsible–on to a tenant, what you should do is pay those expenses directly yourself and send your tenant a bill for the reimbursable amount. A moment’s reflection will make the reason for this immediately obvious. Do you really want to rely on a third party to pay your tax or insurance bill on time? What if they don’t? You’re probably already picturing the nightmare scenario, where the insurance bill was left unpaid by the tenant, and then a catastrophic uninsured loss occurred. Or the tax bill was ignored, and you end up with a lien against your property and a black mark on your credit. If it’s your bill, pay it yourself and then collect from the tenant.

More…

Now that we’ve nailed down the basic mechanics of expense reimbursements, we want to go a bit further. There are some variations we should look at, like base-year reimbursements and CAM charges; there are some accounting and presentation issues worth considering; and there is the fundamental question as to why commercial landlords and tenants follow this pass-through practice at all. Come back for Part 2 to find out more.

—-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 2015,  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.