this is the 'cap rate' -- the capitalization
that you make from the net income of an investment property... Put simply,
the cap rate is the net operating income divided by the sales price
or value of a property expressed as a percentage. Investors, lenders
and appraisers use the cap rate to estimate the purchase price for different
types of income producing properties. A market cap rate is determined
by evaluating the financial data of similar properties which have recently
sold in a specific market. It provides a more reliable estimate of value
than a market Gross Rent Multiplier since the cap rate calculation utilizes
more of a property's financial detail.
The
GRM calculation only considers a property's selling price and gross
rents. The Cap Rate calculation incorporates a property's selling price,
gross rents, non rental income, vacancy amount and operating expenses
thus providing a more reliable estimate of value.
When
evaluating a potential investment property you want to consider of course
the location (is it a desirable place for renters?), its condition andwhether
it's up to the local city code guidelines (hardwired smoke & fire
alarms can be quite expensive!), and the return on investment... the
return also depends on how $$$ much you are putting down vs. mortgaging.
Carefully consider the expenses (does owner pay for the heat, from one
common furnace?) and estimates for maintenace and vacancies...
If
you are able to obtain a market cap rate, you can then use this information
to estimate what similar income properties should sell for. This will
help you to gauge whether or not the asking price for a particular piece
of property is priced well.
NOI
NOI
Cap
Rate =
-------- Est.
Value = -----------
Value
Cap
Rate
Example:
A property has a NOI of $17,000 and the asking price is $145,000.
17,000
Cap
Rate = ---------- *
100 = 12
145,000
if
cap rates in the area average about 12%, estimated market value is:
17,000
----------
= 142,000
.12
Net
operating income is determined by subtracting vacancy amount and
operating expenses from a property's gross income. Operating expenses
include the following items: advertising, insurance, maintenance, property
taxes, property management, repairs, supplies, utilities, etc. Operating
expenses do not include the following items; Improvements such as a
new roof, personal property such as a lawn mower, mortgage payments,
income and capital gains taxes, loan origination fees, etc.
Vacancy
Rate: Locally, Merchants Bank Commercial Lending division typically
uses 7% for their vacancy rate in evaluating a property value.
If
you have questions about commercial loans, try Kathy Yost
with Merchants (610.253.5117) or Karen Miller with Karen Miller Mortgage
Group (610.250.5920)
commercial
loans: from a lender's perspective, what is considered 'commercial'
and what does it matter?
...this is an important question, since your
mortgage loan terms are directly affected... for an investment property
OVER 4 residential units, this is considered a commercial property.
for a property that has a mix of residences and shop or commercial
office space, this is a mixed use property and therefore you are again
looking at a commercial loan.
Commercial
loans have much stricter terms than conventional loans. in general
you will need about 15-20% down $$$ on the commercial property (this
can vary among banks - some require 25% and some may go as low as
10% down) and your interest rate will be % higher -- prob. a couple
points higher than the current conventional loan rates.
excellent
investment property evaluation tools here, fyi: www.mortgage-investments.com
What
is a 'tax deferred real estate exchange' and why should I care?
A 1031 tax exchange, or like-kind
exchange where a taxpayer can sell his/her property and defer
the federal capital gains tax, state tax and depreciation recapture
taxes.
'Like Kind' is a little misleading; the next property 'B' you purchase
with the proceeds from property 'A' could be any income property
(not personal residence) in the USA -
"for use in a trade or business or for investment."
What's so great about these? It's an excellent way to defer paying
capital gains on property sale gains, and you can snowball this
into a nice big deferred-tax real estate fortune that goes to your
heirs (which don't need to pay capital gains on the value), or results
in your goal-property of a multi-unit on the Jersey shore, or just
a deferred tax paid on your capital gains at the end, when you do
finally 'cash-out' (in this case you do need to pay what is called
a 'recapture' for the deferred gains - however with inflation over
the years the blow may not be as horrible as 'real time'.
So, if A is a 3-unit in allentown - you can purchase B, a 7-unit
motel in venice beach, FL or even a commercial fishing-boat, that
will run deep-sea fishing trips. If the target property is less
than the one sold, that money is called 'BOOT' and
uncle sam will naturally come trotting in to collect his capital
gain (15%) on that amount.
You
need to identify up to 3 'target' properties within 45 days of your
property A sale (but you can still switch those down the road),
and 180 days to settle on target-property 'B'. A Qualified
Intermediary "QI" facilitates the 1031 Exchange by preparing
the necessary documents, and holding the sales proceeds in escrow,
for a deferred exchange.
The
Reverse Exchange is a variation on the typical deferred
exchange. This is when a taxpayer acquires the new investment property
prior to selling the old. This frequently occurs when a taxpayer
constructs a new office building, for example, and is obligated
to purchase the land and pay for construction costs to make it ready
for occupancy prior to selling the old office building. A reverse
exchange is somewhat more complicated than a deferred exchange,
and involves different documentation, accounting, and especially
lender concerns.
The
law is very explicit in limiting the taxpayer's rights to "receive,
pledge, borrow, or otherwise obtain the benefits of" the sales proceeds
from a 1031 Exchange. For this reason, the IRS prohibits a taxpayer
from using his or her attorney, accountant, broker, or real estate
agent as the qualified intermediary - you must use a qualified third
party.
...It
sounds complicated but a good Realtor + QI team can help guide you
through, and get you on your way to saving $$$ up lots of money
in investment properties. A good book to learn more about 1031s
is "Essentials of Real Estate Investments" by David
Sirota.
