Frequently Asked Questions (FAQs) about Real Estate Investing
  1. Commercial & Multifamily
  2. Syndications

Commercial & Multifamily

Financial Terms

CAP (Capitalization Rate):Percent of cash return in the first year if the property were purchased for cash. The ratio of NOI to purchase price.

NOI (Net Operating Income):Income after vacancy and expenses and before debt service.

Rent Ratio:(monthly rent / purchase price or market value). Should be 1.0% or more for acceptable cash on cash return with 75-80% loan. Mostly used for rental homes.

Gross Rent Multiplier:(purchase price or asking price / gross rents received from an investment). Mostly used for multifamily (apartment) properties.

Depreciation:Commercial is 39 years linear depreciation, residential (to include multifamily) is 27.5 years. This assumes all physical assets will predictably depreciate to a value of zero after this time, and the losses from this offset income on a tax basis. Depreciation is one of the main benefits of investment real estate ownership.

Cash on Cash Return:Percent of cash out of an investment in a year relative to the amount of cash invested. It does not consider time value of money. It is a very commonly used metric however, seldom used professionally.

Internal Rate of Return (IRR):The annual rate of return that one receives on an investment for all of the capital and cash flows based on the net present value for each when deployed. It is the discount rate such that the sum of today’s investment and future cash flows have a net value of zero. It expresses in the form of an interest rate the value of a given investment in today’s terms. It is the most accurate and one of the most widely used ways of calculating and comparing multiple investments by professionals.

Average Annual Return

The annual rate of return that one receives on an investment for all of the capital and cash flows invested. It does not factor in the net present value of all monies that go into and out of the investment.

How does the Average Annual Return compare to IRR?

The IRR typically is slightly lower than the Average Annual Return because the profits at the end upon sale have a lower net present value than monies that are spent at the beginning of an investment.

Debt Service:Amount of the principal plus interest loan payment per month or annual. The cash flow that services the debt.

Lease Terms

NNN:A type of lease in which the tenant is responsible for the taxes, insurance and maintenance of the building that the tenant leases. Often there is some landlord responsibility (i.e roof and foundation, parking lot, hvac etc)

Absolute NNN:Similar to above however, the tenant receives and pays all bills directly, bypassing the landlord as an intermediary. This is generally the most favorable lease for a landlord.

Gross Lease:Taxes, insurance, and maintenance are the responsibility of the landlord. The tenant is still responsible for their utilities.

  • Modified Gross:Similar to above but with a slight modification – the modification is determined through the negotiations between Tenant and Landlord.

Full Service Lease:Tenant’s rent includes all the same components of a Gross Lease but the Landlord is also responsible for paying the utilities used by Tenant.

Retail Location Terms

Traffic Count: The number of cars that drive by a given street, highway or freeway of a property. Traffic counts are important when evaluating the value of a location in certain types of commercial real estate such as retail, office, and multifamily.

End Cap:The end space in a retail center. Often this space fetches some of the highest rents in a given shopping center on a $/SF basis. They generally attract regional or smaller national tenants.

Pad Space: The free standing buildings in a shopping center. These spaces tend to achieve high rents like end caps but tend to be more popular with QSRs (Quick Service Restaurant a.k.a Fast Food) due to their ability to accommodate a drive-thru. These were once popular with Banks as well.

Anchor Tenant: The tenant with the largest geographic draw in a given shopping center. Also often the largest tenant in terms of space taken. Anchor tenants can make or break a shopping center. They are generally national credit tenant and can service a very large radius of residents depending on the immediate trade area demographics and population density.

Shadow Anchor: A retail shopping center or strip center that is next to an Anchor Tenant but on a separate parcel. Therefore the center benefits from the Anchor tenant’s regional draw but is independent from the shopping center which has the anchor tenant.

Hard Corner: A location that is at an intersection or on a corner. The parcel has frontages on two roads. Due to increased traffic counts hard corners are very desirable in retail real estate.

Signalized Intersection: An amenity to a hard corner location. This would make a hard corner location even more desirable. Generally signalized intersections have high traffic counts – hence the need for the signal and cause cars to stop and look around during a red light which is also perceived as a benefit to retail tenants especially those in end cap or pad locations

How do I select the best metros to invest in?

  1. Filter for the following parameters:
    • Highest CAP rates
    • Highest potential for actual vs. virtual returns
    • Potential for appreciation and rent appreciation
      • Population growth & inward migration
      • Employment growth
      • Cost of living
      • Political support of business and development

How do I select the best team to help me achieve my investment goals?

  • Track record
  • Integrity
  • Experience
  • Expertise
  • Ability to qualify for loans
  • Access to deal flow
  • Ability to negotiate
  • Ability to manage investment

What are the different asset classes within commercial/multifamily real estate?

  1. Office
    • Single Tenant
    • Multi Tenant
  2. Retail
    • Power Center
    • Regional Shopping Center
    • Neighborhood Retail Center
    • Strip Centers
  3. Industrial
    • Single and multi-tenant
    • Manufacturing
    • R&D
    • Warehouse / distribution
  4. Land
    • Landbanking
    • Entitlement
    • Development
  5. Multifamily
    • Garden
    • High-Rise
    • Specialized
      • Student
      • Subsidized
      • Disability
  6. Medical
    • Clinic
    • Hospital
  7. Elder Care
    • Independent Living
    • Assisted Living
    • Nursing Care
  8. Hospitality
    • Flagged / Non-Flagged
    • Motel
    • Hotel

How do their market cycles vary?

Typically single family assets lead the market cycle, and tend to be most closely aligned with the current economic cycle. When the economy dips, single family prices tend to dip immediately as well. Non-multifamily commercial assets move slower, and tend to lag compared to economic changes. In addition, commercial tenants tend to be of higher credit, longer term, and be less likely to move or default on a lease. Many commercial asset classes tend to be more stable than single family.

How do I evaluate whether a deal is for me or not?

Trust in syndicator As an investor you are a limited partner in a commercial real estate deal. As such, you are fully passive, with all management decisions being made by the syndicator (sponsor). Therefore, trust in a syndicator, and a successful track record, is very important when evaluating a deal

Risk tolerance Commercial deals tend to run the gamut of risk/reward. Low risk investments are typically stabilized assets that have conservative leases and tenants in place close to or at full occupancy. These are usually longer hold periods and are sometimes referred to as “mailbox money”, with a secure dividend check every quarter. Other deals are “value add”, which take on more risk to make substantial improvements to a property, typically increasing both occupancy and rents. Development deals also offer attractive returns at higher risk, and can encompass land entitlement, construction, and operation of a new facility.

Desire for passive investmentsAs a limited partner investors take a passive role in the ownership of real estate commercial investments. Sponsors set up full property management, handle taxes, finances, accounting, and an investor simply receives predetermined profit splits. It also has the advantage of limiting liability to amount invested due to passive nature.

Cash flow vs appreciationLower risk deals tend to have more stabilized values but produce cash flow over long terms that help meet investor cash flow goals. Appreciation and value add deals can generate a large profit but take on more risk to attempt those objectives.

Why are commercial tenants easier to manage than residential?

Long lease terms, NNN leases, economies of scale for multifamily.

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I notice the tax records that you appreciatively provide to me sometimes show appraised values that are higher or lower than the your sale price and of the MLS comparables. Can you explain this?

Texas is one of 11 non-disclosure states, which means that the sales prices do not have to be reported, although many do, which is where we obtain the MLS comparables to support each property value. So each county appraisal district has to guess what each property is worth, and if it was sold, for how much. It becomes a good news/bad news issue.

If the appraised value is less than your purchase price, that is typical, because generally the appraised values trails the actual market value by two to three years and your taxes will be lower, and it will reflect in a little higher cash flow ROI for you.

If the appraised value for the property that you are considering purchasing is higher, it is further supporting evidence that you are buying a good value. The bad news is that your tax may be a little higher, but if you send in a protest letter along with your copy of the sale (closing statement), generally they will reduce the appraised value, and, therefore, the taxes.

What are the advantages of each type of investment product? How do single family homes compare as investments to a duplexes, fourplexes small multi families, apartment buildings or commercial properties?

Single Family Residences (SFR) are relatively easy to understand, liquidate or get cash out from a refi. In order to give good cash flow the rent should be close to 1% per month of the total investment amount, are best if they are not built earlier than the 80’s, and should be in a region with high employment growth and a broad based economy, not “one horse towns” like N. Dakota.

Duplexes, triplexes, and fourplexes can give slightly higher cash flow (if everything else is equal), however, you are putting more “eggs in one address”. They are less liquid and tend to appreciate less than a SFH. Like all investments it is critical that you buy from a reputable experienced source and that you get excellent property management.

Multifamily (Apartment buildings – 5 or more units) properties just amplify the characteristics above, both positively and negatively. It is very difficult to qualify for a loan if you are not currently a mulfifamily owner, however, if you do, or if you invest with an entity that can, you avoid limiting your Fannie/Freddie loan restrictions. To reduce and spread your risks it is recommended that you invest with an excellent, reputable and very experienced syndicator.

Commercial properties on the average have higher returns and higher risks. Their advantages are that you have higher quality tenants, longer term leases, and more predictable income. Also most are NNN (triple net) which means that the taxes, insurance, and maintenance costs are passed on to the tenants. Again, like with multifamily properties, to reduce and spread your risks it is recommended that you invest with an excellent, reputable and very experienced syndicator.

Syndications

How do I select the best metros to invest in?

  • CAP rates.
  • Potential for actual vs. virtual returns.
  • Potential for appreciation and rent appreciation.

How do I select the best team to help me achieve my investment goals?

  • Track record
  • Integrity
  • Experience
  • Expertise
  • Ability to qualify for loans
  • Access to deal flow
  • Ability to negotiate
  • Ability to manage investment

How do their market cycles vary?

Typically single family assets lead the market cycle, and tend to be most closely aligned with the current economic cycle. When the economy dips, single family prices tend to dip immediately as well. Commercial assets move slower, and tend to lag compared to economic changes. In addition, commercial tenants tend to be of higher credit, be more reputable, and less likely to move or default on a lease, so commercial markets tend to be more stable than single family.

How do I evaluate whether a deal is for me or not?

Trust in syndicatorAs an investor you are a limited partner in a commercial real estate deal. As such, you are fully passive, with all management decisions being made by the syndicator (sponsor). Therefore, trust in a syndicator, and a successful track record, is very important when evaluating a deal.

Risk toleranceCommercial deals tend to run the gamut of risk/reward. Low risk investments are typically stabilized assets that have conservative leases and tenants in place close to or at full occupancy. These are usually longer hold periods and are sometimes referred to as “mailbox money”, with a secure dividend check every quarter. Other deals are “value add”, which take on more risk to make substantial improvements to a property, typically increasing both occupancy and rents. Development deals also offer attractive returns at higher risk, and can encompass land entitlement, construction, and operation of a new facility.

Desire for passive investmentsAs a limited partner investors take a passive role in the ownership of real estate commercial investments. Sponsors set up full property management, handle taxes, finances, accounting, and an investor simply receives predetermined profit splits. It also has the advantage of limiting liability to amount invested due to passive nature.

Cash flow vs appreciationLower risk deals tend to have more stabilized values but produce cash flow over long terms that help meet investor cash flow goals. Appreciation and value add deals can generate a large profit but take on more risk to attempt those objectives.