Creating a laser focus criteria for your multifamily investment - P5

Once more we we continue our quest through creating a laser focus criteria for your multifamily investment (Part 1 here, Part 2 here, Part 3 here, Part 4 here) let's recap the criteria items we have already covered:

• Area - Metro/City/Neighborhood/etc. (Covered in Part 2)
• Asset class - A/B/C/D (Covered in Part 2)
• Area class- A/B/C/D (Covered in Part 3)
• Size: in units (Covered in Part 3)
• Budget: in USD (Covered in Part 4)
• Expected cap rate: percentage (Covered in Part 4)
• Expected COCR (Cash On Cash Return): percentage
• Expected Annualized Returns: percentage
• Stabilized vs Value Add preference
• KP availability

Let's try to knock off the rest the list...

Expected COCR

COCR stands for Cash On Cash Returns. Before taxes cash flow divided by the amount of cash you invested in the deal.

If you had no debt on the property (bought it fully in cash) then the COCR would be the percentage the NOI is of the total purchase price.

Example:

Purchase Price = $1,000,000

NOI = $100,000 annually

Debt Service: $0

COCR = $100,000 / $1,000,000 = 10% 

However, if you did leveraged the property the COCR is calculated against the cash investment (usually, the down payment).

Example:

Purchase Price = $1,000,000

Mortgage (75% LTV) = $750,000

Down Payment: $250,000

NOI = $100,000 annually

Debt Service: $60,000

Before Tax cash flow: $100,000 - $60,000 = $40,000

COCR = $40,000 / $250,000 = 16%

So to recap the formula:

COCR = ( [NOI] - [Debt Service] ) / (Cash Invested during purchase)

Expected Annualized Returns

Annualized returns are total return on your investment from the cash flow proceeds and from the sale of the property.

Example:

Purchase Price = $1,000,000

NOI = $100,000 annually

Debt Service: $0

Sale price after 1 year: $1,150,000 (a capital gain of $150K)

Annualized return = ($100,000 + $150,000) / $1,000,000 = 25%

Stabilized vs Value Add preference

When you talk to your broker he will try to evaluate your tolerance for risk/work. A value add opportunity will include a higher risk with a promise of higher reward. 

Example to a value add opportunity would be a property with low occupancy rate. If you are willing to do the work, invest to upgrade units, turn the property demographics or condition around and bring occupancy back up you will get the reward in terms of the value of the property (remember, increasing NOI = increase in value).

Stabilized property would be a property that can show a 90% occupancy or above for 90 days or more. 

Why is it important?

Some lenders won't lend on an stabilized property and value add opportunity might require some more creative financing or a higher up-front investment. 

KP Availability

I was wondering if I should include this one but decided to do so anyways. KP stand for Key Principal. When dealing with larger properties the lenders require the buyers to have certain amount of experience and vet value. There are experienced individuals out there that will join a deal (common especially in syndicated deals) just for the sake of the lender seeing their name and experience on the paperwork.

These individuals will usually get compensated with some equity of the deal w/o putting any money into the deal. It might sound weird to you now however the kind of loans you can get with a KP on board will be more than worth the equity you'd have to give up.

There. we finally covered all the items you should know when talking to a commercial multifamily broker.

If you have any questions on any of the list items, please ask in the comments or shoot me a private message and I'll be happy to answer.