All Forum Posts by: Frank Gallinelli

There is no silver bullet (if there were, I guess everyone would be rich) but there are steps you can take to help you make an informed decision.

What I recommend is to do at least a 5-year (and preferably a 10-year) pro forma projection of scheduled income, vacancy and credit loss allowance, and operating expenses. Then do an internal rate of return analysis testing how the property would perform if you sold it in any one of those future years. When I analyze a property I look to see what kind of IRR other investors are achieving and of course compare that to the subject property. Most important, of course, is that the projected return must be high enough to justify the risk and the effort involved to earn that return. If you can get 4.5% on a T-Bill you're not going to take a risk and jump through hoops for just a few points more.

With the pro forma, btw, I generally do a best-case and worst-case scenario. Real life has a tendency to land somewhere in between.

Just a quick note. You said, "Do we need to setup a corp. of some sort..." Never own your investment property as a C-corporation because that will expose you to double taxation. In other words, the corporation will be liable for taxes on any profits, and then when you try to pass the money on to yourselves personally you too will pay taxes.

You should hold title as a pass-through entity such as a subchapter-S corporation, or as a Limited Liability Company (LLC). The latter is the preferred choice now of most investors. In any case, no bank will give a small investor a mortgage unless you provide a personal guarantee, so your choice of form of ownership should have little or no bearing on your financing.

I believe most appraisers will use gross income multiplier only for 2-4 family houses. For commercial and for larger multi-unit residential they will use income capitalization (NOI / prevailing cap rate).

I'm afraid I'm going to start sounding like a nag around here, but appreciation that is (or isn't) occurring in your single-family home market has almost nothing to do with the value of your 8-unit apartment building.

That value of that property is going to be based on its Net Operating Income and on the prevailing capitalization rate for similar investment properties in that market. You need to get as good a handle as possible on its actual and potential income, as well as its actual operating expenses (to the extent that you can uncover them) so you'll know what your NOI is.

The fact that home-price appreciation is irrelevant to the value of your property is actually a good thing. You have no control over single-family home appreciation, but you can create value in a true income property by enhancing its income stream. What you can do depends on your particular market, but consider a few f'rinstances: Improve building security, improve outside lighting, give common areas a facelift, upgrade appliances, give away wireless internet service to all the tenants, etc. If you're not already at the top of your market with rents, you can usually find something that will return more than it costs, increase your income stream and hence create value.

Frank Gallinelli

Hello Everyone -

I'm brand new to your forum. I just discovered it and it looks to be one of the few really good ones. I've seen some excellent questions and thoughtful answers in my one day of poking around here.

I'm not brand new to real estate investment, however, having been involved with income properties and real estate education for about 35 years.

Among the more pertinent parts of my CV: I'm the founder and president of RealData, Inc. a software company I started in 1981 to provide analysis models for real estate investors and developers. I write many of the educational articles that appear on our company's website, readata.com. I encourage you to take a look (they're in the "Learn" section) -- there's no fee or sign-up required.

I am also the author of two books published by McGraw Hill. The most well known of these is "What Every Real Estate Investor Needs to Know About Cash Flow." It's not a motivational book, but rather one that's designed to teach you how to interpret pro formas and how to do and understand key calculations that are essential for success in real estate investing.

And for fun I teach once each year at Columbia in their Master of Science in Real Estate Development program.

I've been in the real estate software business long enough to have learned that there's no point in trying to sell people analysis software if they don't have a good grasp of the financial concepts that underly real estate investments. So, I'm on a mission and hope that I can contribute something to the storehouse of knowledge here.

Best regards,

Frank Gallinelli
RealData, Inc.

Glenn is quite right. The value of a commercial income property is a function of it's Net Operating Income, not comps. You first need to research what is the prevailing cap rate in your area for properties like the one you're considering, and apply that cap rate to the NOI.

Next, build a pro-forma that demonstrates why your offer makes sense, given the property's income stream and the cap rate that other investors are using when they purchase this kind of property.

Finally, be sure your offer to purchase include a reasonable opportunity for you to perform your due diligence. You want to verify the leases and, to the extent possible, verify the operating expenses. Many (probably most) commercial property owners hold title as a LLC or limited partnership and I wouldn't hesitate to ask to see the partnership tax return.

Frank Gallinelli

Cash-on-Cash Return is also called the Equity Dividend Rate.

Although you could base it on the cash flow projection for any future year, investors generally look at this only in regard to the first year's before-tax cash flow. That's because it doesn't take into account the time value of money, so the longer the time between investment and return, the less meaningful the result. It has been popular because it allows a quick-and-easy single year comparison to other uses of your investment capital, such as a T-bill.

Truth be told, CCR is not a particularly good measurement of your investment's performance. You're better off with a discounted cash flow analysis, where you can take into account all of the expected future cash flows (including the resale), along with their timing.