I found out today that New Mexico is not LAST in everything.  We are first is DWIs as well as the first state to adopt a Real Estate Recovery Fund…which has now been adopted by most states.  So…yes…we do have pride in being first….or maybe we have pride in being last?

Anyway…

Quick thought….

A while back I was reading  a book by Nassim Nicholas Taleb called The Black Swan.  Great book by the way.  Anyway…I remember Mr. Taleb talking about banks and how over the years…the banks have gotten bigger all over the world (smaller banks being absorbed by the big ones).  What was more interesting was how he stated that all the banks are tightly connected in a dangerous way.  More specifically, how if one big banks goes down how it impacts all the other banks.

Now…we all saw this when big banks started failing in the United States….but have we really been impacted by failing banks in other parts of the world?  I am sure we have in one form or another…but what is happening in Dubai brings Mr. Taleb’s words back to life.  If…by some chance the ordeal with Dubai explodes.  Will we see another big bank fall?  Which we all know is possible.  If another big bank falls…what will be the impact to us Americans?  ….to the world?

I am sure I am showing my ignorance…but in the big picture of things….I do know this is a dangerous situation.  Chances are someone will save the day ….for now….but I am sure we have not heard the last of this situation.

Read more here on the situation in Dubai:

Dubai Scrounges for Cash as New Deadline Looms

Until next time…..rob

What will this green one do?

The real estate investment arena is filled with its own language and often features terms from property law, banking concepts and feudal times. As a continued segment to help you navigate the real estate investment lingo, we will be periodically posting commonly used real estate investment terms and definitions provided by many sources including www.investorwords.com and www.creonline.com.

This posting will focus on terms you will encounter regarding the financials of your property.

5 C’s of Credit
The five C’s of credit are the important factors a borrower must have to obtain credit. They include conditions of the economy and borrower, collateral to secure the debt, capital, capacity (cash flow to pay the obligation) and character. As the economy changes, lenders focus on different c’s.

Absorption Rate
The absorption rate is the rate by which properties are leased or sold in an area.

Amortization Schedule
The amortization schedule is the schedule of payments to complete a loan.

Assignments of Rent
Assignments of rents are written documents or contracts that transfer the owner’s ability to collect rent to the lender upon default of the mortgage.

Basis Points
Basis points are generally used to note changes between yields on fixed income securities. They equal one hundredth of a percentage point.

Current Production Rate
The current production rate is the highest interest rate allowed on current GNMA mortgage-backed securities, which is generally half a point below the current mortgage rate.

Debt Service Coverage Ratio (DCR)
Debt service refers to the measurement of a property’s ability to generate enough revenue to cover the cost of the mortgage payments. To calculate debt service, divide net operating income by total debt service.

Liquidity Risk
Liquidity risk refers to risk generating from the inability to sell an asset. When secondary markets are insufficient, liquidation of the asset can be minimal or limited. Real estate is generally considered a highly liquid asset with a high liquidity risk.

Negative Amortization
Negative amortization is a gradual increase in the mortgage debt that stems from the monthly payment being insufficient to cover interest. This results in the balance due growing.

Retrocession
Retrocession refers either to the voluntary act of returning property that was previously ceded to its original holders. It can also refer to purchasing reinsurance by a reinsurance company, which limits the risk a reinsurance company can face.

Right of First Offer
A right of first offer is a contractual right that requires the seller to provide the opportunity to purchase the asset to the first offer holder before entertaining any other offers. A first right holder provides consideration to the seller (i.e. funds to hold the option). The first offer contract does not dictate the terms of the transaction, but does require the seller to first negotiate with the first offer holder.

Second Lien Debt
A second lien debt refers to the place in line a secured party sits to receive compensation in the event of bankruptcy or default. Second lien holders follow first lien holders, which means if the first lien holder exhausts the available funds, the second lien holder will not be entitled to compensation.

Net Income....what net income?

Defining Income

The best way to maximize your investments is to understand what constitutes true income. This means that you need to examine both the gross income (all incoming dollars before expenses) and net income (the money you have left after paying expenses). Knowing what you actually earn can help you determine what expenses could be lessened to help increase your net income.

Understanding The Balance Sheet—Tips from the IRS
When you prepare your tax filings, you need to include all gross income from rent. The IRS defines rental income as any payment you receive for use or occupation of the property. The IRS will allow you to deduct expenses in the same year you pay them.

In preparing your filings, you need to report income for the year you actually or constructively receive it. This includes advance rents (any amount received before the period it is due), security deposits (only if you plan to keep the money because the tenant fails to properly hold up the lease), and expenses paid by the tenant (if the tenant pays any expenses).

What Are My Expenses?
Rental expenses include a wide variety of payments you make as owner to maintain the property. These can include repairs, vacancies, debt service, insurance, accounting, janitorial services or management.

The common definitions of these expenses are:
1. Repairs refer to any part of the property that you have physically changed either by necessity or cosmetic choice. They can include fixing a broken water heater, repairing broken windows or changing the locks for enhanced security.
2. Vacancies are the expenses incurred by the owner from not having an income from a unit because it is unoccupied by a paying tenant. For example, if an owner has a four-unit apartment building with each unit renting for $500 per month, the owner would receive $2,000 a month if the building were fully occupied. If only three units are occupied, then the owner receives $1,500 per month leaving a $500 per month expense.
3. Debt service refers to the series of interest and principal payments required on an obligation over a set period of time.
4. Insurance refers to the promise made by an insurer of compensation for specific potential future losses in exchange for payment. Insurance is designed to protect the financial well being of the insured.
5. Accounting refers to any payments made to a person or firm to prepare financial statements, create and maintain billing systems or otherwise perform general bookkeeping duties.
6. Management and Janitorial services refer to any payments made to staff to manage or clean the units.

Definitions and IRS tips are provided by investorwords.com and irs.gov.

What am I left with?
The remainder of the income after paying your expenses is your net income. Many real estate experts recommend at least a 75/25 net to gross income ratio. If you are receiving less net income, examine your expenses and programs. Now may be a good time to look at technologies to help cut costs and streamline your income process.

What asset type are you?

When you get started investing in commercial properties, it can be overwhelming to consider all the types of properties out there.  If you’ve only thought about investing in single family homes or apartment buildings in the past, you are just scratching the surface of the vast array of investment properties available for your consideration.

A brief review of the following list of commercial property types can be dizzying.  Where to start?

Types of Commercial Properties

Emily Cressy Real Estate Investor and Coach

• Apartment Buildings
• Mini-Storage/Self-Storage
• Senior Housing
• Raw Land
• Entitled Land, Ready-To-Build
• Office Buildings
• Mobile Home Parks
• Campgrounds/RV Parks
• Car Washes
• Ground Leases (With a business on the land owning the building it occupies – a common model for fast food franchises)
• Hotels
• Golf Courses
• Entertainment Centers (mini golf, go carts, arcades, batting cages, etc)
• Retail Centers
• Strip Malls
• Shopping Malls
• Outlet Malls

As with most things, it’s best to start by looking at your OBJECTIVES and your AREAS OF EXPERTISE before picking a property type to work on.  Just like it’s never wise to follow a hot stock tip, I wouldn’t jump in to a new area of commercial real estate investing without having some expertise on my team, even if I had reason to believe I was onto a hot opportunity.

Look at your Investment Objectives

Different types of real estate investments have different demands and different rewards.

Rewards of investing in real estate:

1. Cashflow
2. Tax Write-Offs
3. Appreciation
4. Pride of Ownership
5. Activity/Hobby – something to keep your brain busy
6. Place For Your Business/Place to Live

There are also these potential costs or trade-offs involved in owning commercial property:

1. Legal exposure/liability
2. Time to manage the property or the property manager
3. Money needed for negative cashflow or capital events
4. Risk of loss from fire, flood, etc.
5. Risk of depreciation
6. Worry/hassle factor
7. Conflict in the family/amongst heirs

Real estate can be a great investment, or it can be horrible.  A lot of that depends on whether you’re prepared to capitalize on the opportunities that are most relevant to you and you are prepared to deal with the costs, risks and possible consequences of your investment.

One good way to mitigate the risks of owning commercial real estate is to get MORE KNOWLEDGE.  If you are putting together a commercial property investment, surround yourself with people who are familiar with the property type, the dynamics of the local marketplace, and the management issues that will be involved.

Some property types, say a 30-year lease to a national chain, are relatively low-risk, no-effort type deals.  These are what’s known as “turn key” investments or “coupon clippers” because they’re easy to just sit back, relax and own.  Once you’ve built up the cash to buy one of these properties, you can confidently own it and cash the check.  My broker used to say buying this type of property was a lot like buying a bond.

Other types of commercial real estate property are really more like businesses than investments, RV parks and campgrounds, mini-storage, and hotels, for example can be highly profitable (and usually sell with great cap rates) but will take a lot of your time, or a full-time staff, to operate properly.

If you’re planning to get into commercial real estate, but aren’t sure where to get started, please contact us for a complimentary evaluation of your position.   We’d be happy to connect you with the resources most appropriate for your current goals and expertise.

News regarding commercial real estate asset types in the blog-o-sphere:

Investing Symposium Alternative Investing» Articles on Investing … – Even with all of this said, investing in something like commercial real estate where you can get your mind and your hands around an actual asset, looks pretty good compared to the alternatives like equity based hedge funds. …

Rethinking Stocks: Put Land in a Real-Estate IRA for Retirement – Other types of income are free of it, including dividends, interest, royalties, annuities, most real-estate rents and gains from sales other than trade-or-business property. The real-estate IRA can also be used to originate mortgage …

Commercial real estate – the next shoe to drop – “Most commercial mortgages that were written over the last 10 years for most product types, except apartments, were done by conduits, and they were done by asset-backed finance securitizations, CDOs, etc. The overwhelming number of …

Watch List (Dec. 7-13): Hotels Experiencing Rapid Weakening … – The Watch List is a powerful one-two-combination of both top-down macro analysis and bottom up micro real estate news, as well as valuable leads about companies expanding and contracting and property and loan investment opportunities. …

Worst Unemployment Rate Since 1974 is Not Creating High Returns … – I remain very focused on unemployment as it is the single most important economic metric affecting the fundamentals of our real estate market. The U.S. lost 533000 jobs in November, the largest one month drop since 1974. …

What to do....or what not to do!

Don’t Buy Your Next Real Estate Investment Without Taking These Steps Into Consideration!

Emily Cressy Real Estate Investor and Coach

Contemplating the purchase of your first (or next!) piece of commercial real estate is exciting.  Many investors start their real estate portfolios by owning single family homes – assets that are generally more time-intensive to care for, and which offer less cash flow as a general rule.  The switch toward buying commercial real estate represents a graduation or a rite of passage… you’re now in the Big Leagues of real estate investors and building a part of your portfolio which will be able to work hard for you, without your needing to put in a lot of time and effort on a regular basis.

However, before you take the dive into the deep end and start to buy commercial real estate, here are a number of important things you’ll want to consider.

1. Where can you find the best deals on the type of property you want to buy?
2. How will you analyze the property to see if it makes sense for your portfolio?
3. How big a property do you want to buy?
4. Where will you come up with the cash to use for a down payment?
5. What part of the country are you buying in, and what is the real estate market like there?  (What part of the market cycle are you in?)
6. How will you handle the financing?
7. What is your holding strategy?
8. How will you manage the property?
9. When do you plan to sell?
10. What is your contingency plan?

The funny thing about buying commercial real estate is that BUYING it is actually the easy part of the process.  Anybody with a good credit score, some money, and a willingness to jump can get into a commercial property.  The harder part about buying commercial real estate is ANALYZING and MANAGING the process correctly so that the building ends up being a blessing in your life that will help you create wealth, not a thorn in your side that will bleed you dry.

So, let’s go over this list in a little more detail, I want to share a few important concepts under each bullet point before you buy commercial real estate yourself.

Where can you find the best deals on the type of property you want to buy?

Inventory is the name of the game here and realtors hold the keys when it comes to this.  True, you can do it yourself (just like the realtors do) and contact owners directly by phone or mail.  This can work well if you’re especially interested in targeting smaller properties that not as many realtors would be interested in representing (say under $1 million, or under 8-units), or are really attached to getting a deal in certain neighborhoods (say close to your house).  Pursuing FSBO owners can be quite an effort in time and money, so this is not where I would start.  Begin by looking at what the realtors have to offer and searching for and negotiating good deals from their stock.

How will you analyze the property to see if it makes sense to add to your real estate portfolio?

Knowing  your buying criteria or “numbers” is really important before you purchase your next piece of property.  Are you looking for a turn-key solution that you can manage with a minimum of time and effort, or are you hoping to find a project where you can roll up your sleeves and add some real value by turning around a problem?  You should have a strategy in mind going in and tell you realtor to bring you properties that meet your needs.

Also, remember to look at the numbers.  Many of us are stuck on just a few “quick check” numbers to help us decide what deals to spend more time on.  Some people just look at cap rates, for example.  However, it is a good idea to slow down and take a global look at the property to snag a good deal.  For example, let’s say the owner is keeping rents down to decrease vacancies and make the property require less management effort.  If this is the case, the cap rate might be lower than average for the area.  That doesn’t mean that there isn’t upside in the deal.

However, be careful about buying on “pro forma” numbers.  Lots of realtors make a big effort to sell you on the properties potential and they show you the “blue sky” numbers, the “we-wish-the-property-was-like-this” numbers.  Pro forma’s are an exercise in creative writing… some are more realistic/accurate than others, but beware.  Negotiate to buy what’s THERE not what COULD BE there…

How big a property do you want to buy?

The size of the property is something to consider on two main fronts:  Money – can you afford to get into a bigger property?  And Time – Can you afford to manage a smaller property?

Generally speaking, bigger properties will cash flow better and are better able to support professional management.  It makes sense to have about 12-18 units in a building before hiring a residential property manager makes good economic sense (although many people do hire management even for their single family homes, it’s just relatively more costly).

Also, you’ll have different levels of competition for different sized properties.  For example, here in Seattle, we have a glut of 4-plexes on the market.  Many investors who own 4-plexes are having trouble selling them because they are very expensive relative to the income they produce, but since they are under 5 units, you have to buy them with a regular house loan instead of a commercial loan.  5-plexes are much easier to buy in our market place.

So, if you were in the market to buy a 4-plex, you could probably negotiate a better deal or some nice owner financing more easily than if you were in the market for a 5-plex.  Talk to your realtor to find out whether there’s a soft spot like this in your marketplace.

Where will you come up with the cash to use for a down payment?

For most investors, this is the question that keeps them up at night when they go to buy commercial real estate.  No cash, no property.  My partners at Grassland Investments and I have solved this problem by syndicating deals and raising private funds for the down payment.  We get 10 or so of our friends and colleagues together and raise $1 million for a down payment on a $5 million dollar property.  It works well as long as the property’s performance can meet these investors goals.  For example, we buy cash flowing properties, and then distribute the monthly income amongst the investors.  We also give the investors a chunk of the back-end profits.  Compensating investors generously makes it a lot easier to find them on your first and subsequent deals.

You can also rely just on yourself or a money partner to come up with the down payment.  Many people get their funds through

• The old-fashioned way: Saving and investing til they have enough
• Doing a 1031 Exchange and using the proceeds from the sale of another rental property to help them move into something bigger
• Taking out a line of credit (or refinancing) on their personal home or another investment property
• Investing cash from another line of business – such as fix-and-flip properties
• Windfall profits from an inheritance, bonus, lawsuit settlement, etc.
• Changing asset classes (taking money out of their stock portfolio and diversifying into real estate).

What part of the country are you buying in, and what is the real estate market like there?  (What part of the market cycle are you in?)

The next thing to decide is where to buy.  In the past, many people have been constrained by the idea that they should invest in their own back yard where they can keep an eye on the property.  If you want to invest in your area, that’s fine, you can do so.  But consider comparing your area (and it’s current market cycle) with other parts of the country that might be better investments.

When I buy commercial real estate, I like to buy in areas that are RISING in value and which have a balance between values and rents so that I can get a positive cash flow.  There are a lot of investment markets, on the coasts, for example, where properties rise in value, but you can’t get positive cash flow unless you put 50% down to buy the property.

There are other areas of the country with great cash flow, like the Midwest, where property values can be very stagnant and appreciation is little to none.

Before you decide where to buy your next commercial property, don’t just consider the parts of town where you live, consider the entire nation.  This is especially true if you’ll be buying a property large enough to support commercial management, anyway.

Financing Your Commercial Property

There are lots of ways to handle financing.   You can

• Get bank financing for 80% of the purchase price and use your own cash for a down payment.
• Get down payment money from a refinance of another building, or a line of credit.
• Raise private money from friends and colleagues for some or all of the purchase price.
• Go to a hard money lender.
• Get owner financing or have the owner take back a second mortgage.
• Assume the mortgage officially.
• Take over the financing subject to.
• Use a contract for deed.
• And you can even buy on a Lease/Option basis.

How you finance the property is only limited by your creativity.  However, remember the golden rule of real estate:

He Who Has The Gold Makes The Rules

If you need help financing the property, be prepared to pay more for it.  If you come in with more of your own cash and/or better credit, you should be able to put a better deal in place and save yourself some money on the purchase price and/or the cost of the financing.

What is your holding strategy?

Before you buy any commercial property, it’s a good idea to know what you plan to do with it.  Is it a “value added” play where you will drastically change management, change the use of the building, or remodel it in order to increase its value?  Or are you stepping into a “turn-key” situation where you’ll have very little to do except cash your checks?

It’s important to know the answer to this situation going in.  Value Added deals can be more profitable, but can tend to demand more effort, money and/or expertise.  Be careful and have a knowledge support team and some extra resources behind you if you’re going in to turn around a problem property.

If it’s your first commercial real estate transaction, get your feet wet in the shallow end of the pool, and look for something that won’t present too big a challenge your first time out.

How will you manage the property?

Property management is of critical importance to the success of an real estate venture.  The bigger the property, the more important it’s management is.  Property management is often the last thing an investor considers when he’s planning to buy a commercial investment.  This is a dangerous approach.  Sharp investors I know find the MANAGEMENT COMPANY FIRST and then look for good deals in the areas the management company services.

Having learned the hard way how quickly a bad property management company can damage a property’s physical structure and value, I now am much more concerned with quality property management, even for small commercial buildings.

The management company must know you, understand the type of property that you are letting them work on, and have good systems in place to ensure fast evictions, fast apartment turn-arounds, on-time bill paying and competent cash management, and have adequate supervision of staff who maintain the property.

With any new property management company it is imperative that you supervise them heavily with surprise inspections and audits to make sure that your property is being well taken care of.  If you ran an airline company, you wouldn’t hire the first guy who said he had a pilot’s license to handle your property.  You wouldn’t hand your stock portfolio over to a manager who said he was great at beating the market, would you?  You’d do your homework and look for proof.  You need to do the same thing here.

If you need help managing your commercial real estate, or understanding whether your current property manager is competent, I STRONGLY recommend the forensic services of Roger Maupin in this regard.  He supervised the removal and replacement of our bad property management company on a 150+ unit complex and saw the financial losses they created by mis-management of our buildings.  Roger is well aware of the cost of a bad management company, and can help you avoid paying through the nose for your manager’s incompetence.

When do you plan to sell?

You should always buy a commercial property with a plan on when to sell it.  You can always change your plan, but having an initial holding-time strategy in place is important.  This can affect your tax strategy, your financing structure, your capital improvement program, and more.  Before you buy, be sure you take this into account.

Is your property purchase meant as a fast-as-possible fix-and-flip?  Is it a 5-year hold as you ride the market cycle up?  Or will you hold it until you die and then pass the building on to your kids?  It’s important to have a sense for this before you get into the property.

What is your contingency plan?

When it rains, it pours.  As I write this in December 2008, many investors are wringing their hands and tearing out their hair as property values continue to sink and foreclosure rates are up across the country.  Others are biding their time, with cash in their pockets and blood in the streets, starting to look for great deals they can snap up when confidence is down.

As the falling real estate market of the last year has taught us, nothing lasts forever, and what goes up must come down.  I think there was also something about “the best laid plans…”

The bottom line is that things don’t always go our way.  The government can change the zoning requiring costly building upgrades.  Businesses providing an economic base for the area can downsize or move.   The economy can soften.

Although we hope that none of this happens to you or your commercial real estate investments,  these things do happen.  The difference between the people who survive these downturns, and make money during them, and those who go belly-up is often the difference between those who planned for problems and those who didn’t.

In my opinion, cash, or access to cash, is one of the best ways to protect yourself against costly changes in the marketplace.

Don’t overleverage yourself to get into properties.

Maintain healthy reserve accounts and budget for capital expenses in every building you own.

Live below your means.  It’s safer to grow a little slower than you think you can, than to let the momentum of your property acquisitions run away from you, and wind up play catch-up.

Leverage is the big risk-factor here, so use it wisely.

If you have bought or are looking to buy a piece of commercial real estate, please stay organized.  Let us know how we can help!  We regularly answer reader’s questions here on our blog, so feel free to write!

More News and Articles…..

Office Depot Shuttering 126 Stores, 6 Distribution Centers, and … – Office Depot is already a client of DJM Realty, Gordon Brothers’ real estate disposition subsidiary — the firm is currently handling the disposition of eight Office Depot store leases unrelated to this announcement. …

Equities, Real Estate, and Deflation | Square Feet Commercial Real … – About Square Feet. Square Feet is a commercial real estate blog providing information, market data, as well as commentary on news and happenings which have an impact on the Silicon Valley commercial real estate market. …

Paper Economy – A US Real Estate Bubble Blog: Commercial Calamity … – Today’s results indicate that the commercial real estate decline has firmly arrived and it is notable with a marked decline for all components with three of the four now showing annual declines resulting in the first year-over-year …

Boston Looking To Provide Seed Money For Commercial Construction … – The fees and taxes they place on real estate development are an important part of paying for the government. And being politicians they are doing all they can to not cut the bloat in the budgets, but to find a way to keep the Golden …

Real Estate Blog – Finally, Some Good News – Seems all we hear or read these days is bad news – The economy is in recession – Real Estate values are in a free fall – Banks are failing – Corporations and cities are looking to the federal government for.