All Forum Posts by: Frank Gallinelli

@Andrew Broadbent Are you including the rent value of the unit you'll be occupying?

If the property is 4 units or less, then capitalizing the income is usually not the method of choice for estimating value. Many appraisers will use a market-driven gross-rent multiplier, or a straight comparable-sales approach.

Think about the fair-market rent value of the apartment you occupy, then ask yourself: Will it cost me more or less to live here as an owner than it woud as a tenant? (Remember to be realistic as to your costs as an owner.) Build a pro forma of potential cash flows and resale going out a couple of years, again plugging in the market rent for your apartment. Can you ultimately see yourself making a profit when you sell?

My first investment property was an owner-occupied 3-family forty years ago. It was under-rented, so the increase in revenue over time worked out well, and being the on-site landlord was a great education.

J Scott With zero invested, I don't think you can compute a meaningful IRR; and the NPV (which will equal the PV since the initial investment will be zero), won't necessarily be positive -- and if it is, your objective then is to decide if it's great enough to justify the risk.

@Will Barnard We're kind of saying the same thing, except you're saying it plainly and I'm my usual stuffy, academic self. My point was that the only thing you can really look at -- since IRR is not an option -- is whether or not you have adequate positive cash flow and positive proceeds from selling (just keeping in mind that you should discount to account for the timing.

@Ned Carey You're absolutely right about the importance of DCR -- a point I try to drive home both to investors and to my students whenever I get a chance. And speaking of chances, you don't usually have much of a chance of seeing a 1.20 or greater DCR when you try to finance 100% of a property purchase.

@J Scott Actually, I stopped short of saying IRR because that too is a rate of return measure and it won't work with zero investment. What I'm suggesting is simply to discount all the cash flows, including sale proceeds, to see if the present value of the future income stream is in fact worth anything at all -- in dollars, not rate of return. That's not much of a metric, but it will at least give you the opportunity to reflect on an existential question, something like: "Do I really want to risk my home with a big HELOC to buy a property that I'll have to manage for the next five years, so that I can end up with X dollars (where maybe X, in today's dollars, is not a very impressive number and maybe even negative)?"

@Morgan Smith You cannot calculate a rate of return on a property where you make no investment. ROR implies return on invested capital; and since that is zero, the calculation equals infinity.

What I would recommend is that you build a cash flow and resale pro forma going out through a reasonable holding period, i.e., 5 - 10 years. Be sure you do the resale portion -- that will give you a final cash flow, which is the expected cash proceeds from the sale of the property (after paying off the mortgage and costs of sale).

Then do a discounted cash flow analysis on this string of cash flows. If the result is positive (in other words, greater than your zero investment) that means your getting something out of this property. Ask yourself, is it enough to justify the time, effort and potential risk?

John Mireles Commercial lending has been in turmoil since the financial meltdown; I'm hearing that things are getting better, but the new normal is still difficult to deal with. My suggestion, if you haven't done so already, is to start by putting together detailed financial presentation about the property's current and projected performance; then bring that to a commercial mortgage broker, someone who can probably save you a lot of time by focusing on lenders who are a reasonably good match for your loan.

@Eric Thomson I believe @Jon Holdman has given you precisely the right take on this financing. Somewhere in the neighborhood of 65% loan-to-value, 15-20 year amortization, five-year balloon. And you'll certainly need to meet a debt coverage ratio somewhere north of 1.25 (most likely, as Jon suggests, closer to 1.5), and that's unlikely to happen if you do in fact finance anything like 80-90%.

I also agree with his suggestion to consider bringing in an equity partner. I've seen plenty of instances over the past five years where it was a choice between bringing in investors or walking away from the deal. Keep in mind that the more total equity there is in the deal, the more likely it is to secure favorable terms on the financing.

Just to be cautious, you should check to see if the terms can change if you no longer occupy.

Best of luck with your investment. I started out in an owner-occupied multi-family (several decades ago, I must admit), so I think it can be a great way to learn how to select and manage a property.

@Ryan_Halverson Looks like you're being thorough and careful in your analysis. I would suggest you include an allowance for vacancy and credit loss. Also, confirm that these financing terms are available to an investor, not just to an owner-occupant.

@Karen M. Thanks for the kind words about the pod cast. I haven't listened to it yet, and I'm hoping Josh and Brandon edited out all my foot-in-mouth moments.

Are you pre-leasing the properties as you develop? One approach, of course, would be to capitalize the NOI based on your first-year of stabilized operation, and that would be reasonably credible with leases in place.

Also, if there is rental rate, absorption, and vacancy history for similar properties, that data would be helpful in building pro-forma forecasts of future performance on your new properties.

Somewhere in my mass of stuff here is a short ebook I wrote about the front-door and back-door approaches to analyzing a new income-property project. I'll let you know when I unearth it.

@George Paiva You're quite right. I always tell my students not to get too exercised when they see a lousy IRR in the first year or two. It simply is the result of compressing all the costs of acquisition and of disposition into a short time frame, which takes all the steam out of your IRR. Better to look, as you say, at 5, 7 and 10-year projections.

I also suggest running best-case, worst-case and somewhere-in-between projections. In real estate, as in life, things seldom go as well as we hope or as bad as we fear. By running a range of projections, you can develop a sense of the limits; then ask yourself, can I live with results somewhere within these limits?