Top 10 Takeaways - Podcast 4 with Frank Gallinelli

BP Podcast 004: Commercial Real Estate Investing with Frank Gallinelli

Hosts @Joshua Dorkin and @Brandon Turner and Guest @Frank Gallinelli

1. YOU CAN’T CONTROL THE VALUE OF SMALL RESIDENTIAL PROPERTIES. For one units, two units, up to 4 unit multiplexes, value is based on comparable sales. This value determined by forces that are outside your control. You’re looking at general economic forces that cause house values to rise and fall, which means you don’t really have one of the big advantages in owning real estate as a long term investment – you don’t have the ability to create value yourself.

2. YOU CAN CONTROL THE VALUE OF COMMERCIAL AND LARGE RESIDENTIAL PROPERTIES. For 5 or more unit multiplexes and commercial properties, value is based on income stream. You are going to value these properties the same way as the bank does (CMV = NOI/Cap Rate), and you can increase value by increasing income and decreasing expenses. When you add income, value increases at an exponential rate.

3.TAKE A STANDARD APPROACH TO CALCULATING THE CURRENT MARKET VALUE (CMV). For large residential and commercial properties, CMV = NOI / Cap Rate. If you don’t follow the same set of definitions as everybody else, you won’t be able to communicate with lenders or other investors.

4. EQUITY PARTNERS CAN HELP YOU AQUIRE DEALS. Would you rather have 100% of a negative cash flow or would you rather have 50% of a positive cash flow?’ Because if you’re financing it too much and getting poor terms and having enormous debt service, you’re minimizing your chances of having a positive cash flow. As a side benefit, you might learn something from one of those equity partners because you’ll be bringing in another person who may in fact have more experience than you do.

5. SHORT LEASES ARE A POTENTIAL ADVANTAGE. Because you have lots of turnover, you have an opportunity to raise rents.

6. A LOW VACANCY RATE COULD BE A SIGNAL TO BUY. Low vacancy rates are usually due to below market rents. If you buy this property and raise rents, you can quickly increase the value of this property. Don’t accept the argument from somebody selling you the property that you should pay for what it could be. You want to buy that property based on current income stream but you know in the back of your mind that that zero vacancy rate, when everybody else in the market place may be experiencing a 4% vacancy rate, you can go right in there and with short turnovers, especially on residential leases, you can raise that value.

7.DON’T OVERPAY ON PROPERTY TAX. You can’t shop for property taxes, that’s for sure. But you can keep an eye on every time you get a reassessment. I looked at the NOI of my property, I looked at what I knew was the prevailing cap rate – this was a commercial property. I went to the assessor and I said, ‘NOI divided by CAP doesn’t equal what I’ve got on my assessment for CMV.’ He says, ‘Yes you’re right. We’re going to lower your assessment.

8. DO IT YOURSELF PROPERTY MANAGEMENT PROBABLY WONT INCREASE VALUE. The value of a large residential or commercial property is based on the NOI. One way to decrease your expenses is to do your own property management. However, a typical professional property management fee would probably be a couple percent of the gross operating income, so there would be some difference but I don’t think it would be enormous. Second, even if you are trying to boost the value of your property by doing your own property management, many appraisers might simply plug in a default number for the value of property management in their calculation of NOI.

9. MIXED USED PROPERTIES REQUIRE MORE WORK AND PROVIDE MORE OPPORTUNITY. You are hands on and you’re dealing with tenants that are turning over frequently so you expect a higher return because there’s more risk, more uncertainty. Residential tenants don’t keep business hours. If the toilet clogs up at three o’clock in the morning you’re going to get a call. You’ve got to be willing be willing to roll up your sleeves and be 24/7.

10. TRIPLE NET LEASE PROPERTIES REQUIRE LESS WORK AND PROVIDE LESS OPPORTUNITY. The commercial tenant will often pay all of certain operating expenses. The tenant will reimburse you for the property taxes, the property insurance, any utilities involved such as water that might be getting billed to you the landlord. They would do all their own maintenance and repairs. They would do everything. You work less and have less risk so your anticipated return on investment is lower.

* Bonus Takeaway - TRIPLE NET LEASES DO HAVE SOME RISK. If you are locked in to a five or ten or twenty year deal and suddenly you find yourself in a tremendously hot market, you won't be able to participate in rapidly rising rents. Another issue of course is when you have a vacancy it could take you a good deal longer to rent out a property than it would if you were renting a forty unit apartment building.

* Bonus Takeaway - BECOME AN EXPERT IN YOUR LOCAL AREA. When a new house pops up on the market you automatically know that value. When it comes to commercial property in particular, essentially every building is for sale, whether it’s for sale or not. You can spot an aberration more easily when you’re dealing in a restricted area. You not only become an expert but you become a known entity.

* Bonus Takeaway - LEARN THE TERMINOLOGY - Every profession has its secret handshakes and real estate investing is no different. I urge people in the strongest possible terms to know the vocabulary of this business, to know what this terminology means. Not only is it necessary in order for you to make a sensible analysis of a property, it’s also necessary for you to have any reasonable credibility.