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Welcome back to my new podcast series. In my first interview I answered some questions about how I got started as an investor, and I hope my experience provided some ideas for you if you’re just looking to get started yourself.
And in the second, I talked about my first commercial investment, which is where I really found my way in leveraging technology, and which led to the birth of RealData software.
In this third interview I discuss how my experiences with the software company evolved into a passion for investor education.
Below is a snippet of the video version of this podcast. You can watch the entire video on youtube, or visit our complete youtube video library (lots of good stuff there for investors). You can also listen to the audio version of my podcasts on Spotify, Apple, or on most anyplace you usually get your podcasts.
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.
Welcome back to my new podcast series. In my first interview I answered some questions about how I got started as an investor, and I hope my experience provided some ideas for you if you’re just looking to get started yourself.
Now I want to take you on the next few steps in my journey and talk about how I came to learn about analyzing income-property investments.
In this interview I tell you about my first commercial investment, which is where I really found my way in leveraging technology, and which led to the birth of RealData software.
Below is a snippet of the video version of this podcast. You can watch the entire video on youtube, or visit our complete youtube video library (lots of good stuff there for investors). You can also listen to the audio version of my podcasts on Spotify, Apple, or on most anyplace you usually get your podcasts.
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.
You probably all know me as a “numbers guy” who focuses on metrics and analysis of potential real estate investments.
But I hear lot of people who sound frustrated or discouraged by a very basic question: Just how do I get started?
So I’m going to step back from my spreadsheets for a bit and try to address that question — and I’ll do it in this first of a series of podcasts where I’ll talk about the not-so-exotic way I began. Spoiler alert: I’ll discuss something I did back then that I didn’t know had a name, something called BRRRR.
The video below is a snippet from the first podcast. You can listen to the whole thing on Spotify, Apple, or on most anyplace you usually get your podcasts.
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.
We usually think of Return on Equity (ROE) as a straightforward investment measure. That’s understandable, because the traditional method of calculating ROE is pretty clear cut: Take your cash flow after taxes and divide it by your initial cash investment.
This in fact is just a hop-and-a-step away from another popular measure, Cash-on-Cash Return (aka Equity Dividend Rate). The only difference is that Cash-on-Cash uses the cash flow before taxes.
Whichever of the two appeals to you more – and we’ll stick with ROE for simplicity here – the measurement will give you a quick sense of how your cash flow measures up to its cost.
There is a non-traditional approach, however, that we use in our Real Estate Investment Analysis software – an approach that can tell you something quite different about your income-property investment. This not-so-standard method differs in its definition of “equity.” Instead of looking at the actual dollars invested, you look instead at potential equity at a particular point in time. That equity is not what you invested, but rather the difference between what you believe the property is worth at that time and what you still owe in mortgage financing. So, if you look at the equity after one year (or two or three), you’ll be taking into account the growth or decline in the property’s value as well as the amortization of your mortgage.
Our non-standard formula now looks like this:
This measurement becomes interesting if you apply it in a multi-year projection. Let’s assume that you make projections about a property’s performance over a number of years and that you include in those projections the potential resale value and mortgage balances for each year (as we do in our REIA software). Whether or not you actually sell the property in any particular year, you accept the idea that your equity at a given time is the difference between what your property is worth and what you owe on your mortgages. By this reasoning, your return on equity measures not how your cash flow performs in relation to how much you originally invested, but rather how it performs in relation to how much you currently have “tied up” in this property.
What difference does it make? Consider this situation; you project that your property’s cash flow and resale value will increase each year but when you calculate the ROE you find the following:
You observe that your ROE starts going down at some point even though the value of the property and the Cash Flow After Taxes continue to go up. Is this a mistake? No, it can occur if the equity grows at a rate that is faster than the growth in cash flow. With our non-standard definition, your equity can grow when the value of the property increases or the mortgage balance decreases – or both. Mortgage amortization typically accelerates over time, so that alone can accelerate the growth in your potential equity. ROE is a simple ratio, so if the equity grows faster than the cash flow, then the Return on Equity will decline over time.
What does this decline mean to you as an investor? It means you have more and more potentially usable, investable cash tied up in this property and that the return on that cash is declining. Is that a bad thing? Not absolutely – it depends on your alternative uses for the money. If you were to refinance and extract some of that equity, could you purchase another property and earn a greater overall return? If you sold, could you use the funds realized to move up to a larger or better property, one with a better long-term upside?
If the answer to any of these questions is yes, or even maybe, then being tuned into to the message from this alternative method calculating ROE can give you the heads-up you need to maximize your investment dollars.
— Frank Gallinelli
To make this kind of ROE projection – and to analyze all facets of your income-property investment – use our Real Estate Investment Analysis software with its numerous rate-of-return, cash flow and resale metrics
Copyright 2022, Frank Gallinelli and RealData® Inc. All Rights Reserved
I had a question recently about a metric called Yield on Cost, aka Return on Cost and also sometimes called Development Yield. So what is it and when and how might it be useful?
Yield on Cost is very similar to cap rate, which you’re already familiar with, especially if you’ve followed my posts, read my books or taken my online course. It’s a metric commonly used by investors and commercial appraisers, and it’s the ratio of a property’s Net Operating Income to its market value. It looks at an income property at a point in time.
What’s the difference between cap rate and Yield on Cost?
Cap rate measures income in relation to the value of a property. Yield on cost measures income in relation to the total cost of the property.
Another way to think of Yield on Cost is as a forward looking cap rate.
Let’s try to make some sense of this by hanging some numbers on these words.
You decide you’re going to buy a property today with its 50,000 NOI at the market cap of 5% for $1 million. But you see a value-add opportunity here to make improvements and to create value. You’re going to spend money to make money.
Specifically, you’re going to upgrade these apartments and raise the rents. Remember value-add is an opportunistic approach to investing. You’re looking for a better return, and almost by definition, higher return implies greater risk. So you want to try to get a quick read on whether that higher return – in your judgment – is going to be worth the greater risk.
You’re thinking of spending $75,000 on improvements so you can bump up rents by 15%. Let’s see how that looks:
Now you have a new total cost for the property of $1,075,000 – the purchase price plus the improvements — and a NOI that’s 15% higher than before, or $57,500. Let’s use the Yield on Cost formula, which is basically a lot like the cap rate formula:
YOC = stabilized NOI / total cost
YOC = 57,500 / 1,075,000 = 5.35%
I believe you’ll see right away how this is just slightly different from the standard cap rate formula. With YOC you’re using the NOI as it is stabilized after you make your improvements; and you’re using total amount the property cost you rather than what you think it might be worth. Again cost, not value. So now…
Yield on Cost = 57,500 / 1,075,000 or 5.35%
Your yield on cost is higher than the 5% market cap rate, and that’s what you want. You want a so-called spread between the Return on Cost and the market cap rate for your value add scenario. That spread is 0.35%.
The question that only you can answer is, is that spread worth the risk?
One way that might help you decide is to ask: What do you think the property is going to be worth after these improvements? For that you cycle back to the cap rate formula, because that deals with value as function of income. You’ll use the market cap of 5% with your new stabilized NOI
Value = NOI / cap rate
Value = 57,500 / .05
Value = 1,150,000
Its value now, after these improvements, is $1,150,000, which is $75,000 more than your total cost:
Value (1,150,000) minus cost (1,000,000 + 75,000) = 75,000
The math here is probably simpler than the decision itself. That decision rests on your subjective evaluation of the risk involved. How confident are you that you can raise the rents by 15% after spending $75,000 on improvements? In other words — You’ve calculated the potential reward, objectively. Now you must weigh that against the risks, — risks which you measure pretty much subjectively.
So to wrap things up… Yield on Cost is similar to cap rate except it uses stabilized net operating income after improvements and measures that against total property cost. It does that rather than weighing current NOI against current property value — which is what you’re doing with regular cap rate. Yield on Cost is extremely easy to calculate and it can be useful with value-add investments to get a sense for how improvements to a property will impact your return. It should also give you a sense as to whether the additional return is worth the risk.
Yield on Cost is often used by developers for a quick read on a potential project. Look for more about this metric in a new lesson I will be adding to my course, Introduction to Real Estate Investment Analysis.
In the meantime, if you’d like to watch my discussion of this topic in a video post, you can get that here: https://vimeo.com/635351764
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.
If you’ve taken my video course, read any of my books, listened to some of the podcasts I’ve been on, then you’re very aware that I often rant about how important it is for you to account for just the real operating operating expenses when you evaluate the worth of a property — no more and no fewer.
There is one mistake I see really often, and I want to call it out here in this video blog.
We’re reaching out to our followers who teach real estate investment, development, or finance to let you know that our Real Estate Investment Analysis course is available for the virtual classroom – now with volume academic pricing.
For more than a decade I’ve devoted much of my professional life to investor education, as a writer, Columbia adjunct professor, and through my company RealData. As you may know, a few years ago I created an online video course, Introduction to Real Estate Investment Analysis. It has grown to include a broad range of topics that are key to understanding how income-producing properties work, and how investors, developers, lenders, and others evaluate their financial dynamics.
With so many schools and colleges now needing to provide good content for a virtual learning environment, we’ve re-deployed the course as a resource that instructors can add to their existing curricula. We now offer volume academic pricing at a significant discount, depending on class size.
For an overview, including access to sample lessons, go to the course home page. To see a complete course outline, click here.
If you’re involved in real estate or financial education, then I hope that this can help you provide meaningful content to your remote learners. To get a quote for volume licenses for student use or to discuss this further, please email me at education@realdata.com.
— Frank Gallinelli
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Copyright 2020, 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.
I had the privilege of being invited as a return guest on Keith Weinhold’s real estate investment podcast. Our topic, “The Real Estate Numbers That Matter.” I hope they matter to you, too!
The end of the year compels many people to think about tax planning, which in turn prompts us to highlight a feature of the new tax law that could provide significant benefit to real estate investors. It has to do with what are called “Opportunity Zones.”
These zones are economically distressed, low-income communities, and according to the Wall Street Journal the zones encompass almost 9,000 census tracts with a population of nearly 35 million. A list of the zones can be downloaded from this IRS page.
In a nutshell, the benefit to investors is that they can defer the capital gains on an existing investment until the end of 2026 by rolling those gains into an Opportunity Zone project. In addition, they can avoid capital gains on the new investments in the zone if they hold them for at least 10 years
Like a number of provisions in the Tax Cut and Jobs Act, not all of the details were in place when the law was passed, but the IRS did in fact release regulations about this on October 19, 2018. Apparently there are still some loose ends and the IRS in their FAQ says they will be “…providing further details, including additional legal guidance, on this new tax benefit” over the next few months.
Those who enjoy parsing the tax code can peruse the current version of the regulations. You can find more readable summaries at National Real Estate Investor or here if you have an online subscription to the Wall Street Journal.
A key takeaway from the Journal article is that this tax break appears to have been designed to give investors reasonable flexibility. For example, it cites that “…as long as 70% of a business’s tangible property is in a zone, the business doesn’t lose its ability to qualify for the tax break.” The regulations so far don’t seem to have a lot of hidden trap doors or “gotchas.”
It would appear that this tax break provides an opportunity for investors to free up capital that is sitting dormant in properties they’re reluctant to sell because of what would otherwise be a capital gains tax burden. Now investors should be able to benefit from at least one if not two tax breaks, and at the same time do something positive for their communities.
What do you think? Are you likely to pursue a project in an Opportunity Zone?
— Frank Gallinelli
View a sample lesson from my video course,
“Introduction to Real Estate Investment Analysis”
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Copyright 2018, 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.