Section 16: Investment Real Estate Flashcards
“Wholesaler”
A wholesaler doesn’t own investment properties; rather, he finds deals and resells them (assigns them) to other investors for a fee.
During periods of inflation, $10,000 today will be worth less tomorrow. This is an example of what type of risk?
Buying power
Blain is a wholesale investor. Which of the following strategies will interest him most?
The wholesaler doesn’t own investment properties; rather, he finds deals and resells them (assigns them) to other investors for a fee.
What is a major advantage of real estate investment over other types of investment?
Ability to leverage
Types of Risk
-
Business:
This is the difference between what the investor thought the investment would create in profit and loss and what actually occurred. -
Financial:
This is the ability of the investment to cover operating expenses through operations, borrowing, and equity. -
Buying power:
This risk is caused by inflation. If an investor owns a rental property with fixed rents for a long period of time, this risk is present because the income is fixed, yet its buying power is diminished due to inflation. -
Interest rate:
When interest rates rise, the value of an investment goes down. -
Liquidity:
Loss may occur if the investment has to be sold immediately. - Safety: This is the risk of losing earnings and/or capital, and includes market risk and risk of default.
What is a gross lease?
The landlord pays all expenses related to the property, such as taxes, insurance, and maintenance, which are then included in the tenant’s lump monthly lease payment. CAM charges are included in these payments-no need to calculate them separately.
What is a net lease?
the tenant separately pays some or all of the property expenses
What is a triple net lease?
NNN lease, one of these “Ns” stands for maintenance. (It may be more helpful to use the acronym TIM, which means “taxes, insurance, maintenance.”) In these leases, the tenant pays all expenses related to the property in addition to the rent, in one monthly (or yearly) payment. Triple net leases don’t require CAM to be calculated separately-those
charges are included.
Formula for Gross Rent Multiplier
Property Price / Gross Rental Income = GRM
What is a capitalization rate?
Cap Rate = Property’s Price / annual income
capitalization rate is the estimated rate of return, written as a percentage, that a property should produce on an investment.
Operating Expense Ratio formula
Operating Expenses / Effective Gross Income
Net Income Ratio
Net operating income / effective gross income
Break-Even Ratio formula
(operating expenses + debt service) / effective gross income
Debt coverage ratio
used to determine an income-producing property’s ability to cover its
monthly mortgage payments.
= net operating income / annual debt service
annual debt service = all interest and principal paid for all loans on a property for one year.
Calculating Net Operating Income
Effective gross income - Operating expenses
A property is generating $100,000 in income and has expenses of $25,000. The investor pays $3,000
toward mortgage principal each year and $32,000 toward interest, plus another $4,000 in income taxes. What is the before-tax cash flow?
To arrive at before-tax cash flow, subtract from income ($100,000) expenses ($25,000) and debt
service ($3,000 + $32,000 = $35,000). So $25,000 + $35,000 = $60,000. Then $100,000 - $60,000 =
$40,000. Income taxes of $4,000 are not subtracted.
If a property has a potential gross income of $50,000, a vacancy and collection loss of 10%, and taxes
are another 10%, what’s the effective gross income?
$45,000
To solve this, use this equation: potential gross income - vacancy and credit losses = effective gross
income. Plugging in the numbers, that’s $50,000 - $5,000 (which is 10% of the PGI) = $45,000.
Disregard the tax information, because taxes are not part of this calculation.
A comparison of before-tax cash flow to cash invested is known as
Cash-on-cash return
Cash-on-cash return is a ratio or percentage of the before-tax cash flow divided by the cash invested.
Before tax cash flow equation
Income - non-tax expenses = before-tax cash flow
Cash-on-cash return
The ratio of annual before-tax cash flow to the amount of cash invested.
If an investor put down $350,000 on a property and has a before-tax cash flow of $9,000, the cash flow would be 2.6%.
Potential Gross Income
all the income a property would make if it were leased at full capacity and at the current market rate for
rents.
Potential gross income = total yearly rental income + total yearly income from other sources
Effective Gross Income
Effective gross income is the amount remaining from the potential gross income after deducting for vacancies and credit loss, which is expressed as a percentage of the potential gross income.
Potential gross income - vacancy and credit losses
Net operating income
The effective gross income minus operating expenses.
= effective gross income - operating expenses
You know a property’s effective gross income and its operating expenses. How would you calculate
the net operating income?
Subtract operating expenses from effective gross income.
