All Forum Posts by: Frank Gallinelli

John Thedford You need all of your expected periodic cash flows -- typically your "Year 0" cash investment (which of course is cash out), then each future year's expected cash flow -- Year 1, Year 2, etc. Your final year would include both the cash flow from operating the property that year, plus the cash proceeds from selling it.

You then look for the IRR for that series of cash flows. You can't calculate it directly; if you're trying to do it manually you have to use a technique called "binary search" or "successive approximations." As a practical matter you would never try to do it manually because Excel has a built-in IRR function.

I may be showing my age here, but do you remember a tv commercial for beer back in the '70s where Yankees owner George Steinbrenner is arguing with some guys about whether Miller Lite is "Less filling" vs "Tastes Great?" Manager Billy Martin pipes in with, "I feel very strongly both ways."

As do I about your question here. I agree completely that all of the items you list are important when analyzing an income-property investment. I also agree that the analysis is all about cash flow and cap rate (and also IRR, but not cash-on-cash -- I'll explain in a sec)

A complete analysis of a potential income-property investment should include not only its current performance, but also a reasonable projection of its future performance througout the expected holding period. Those projections are going to be tied closely to what you believe about things like employment and market trends, population growth, etc. If you see strength in those areas, then you may project higher absorption and increasing rental rates. If you see weakness, then of course you would assume the opposite.

So your projections about future cash flow, cap rates, and overall IRR will in fact be driven by the larger economic and market issues. Those issues are important to the extent you believe they will impact future performance and overall rate of return. So you see -- I really do feel very strongly both ways.

One sidebar: The reason I'm not a big fan of cash-on-cash return as a metric is that it looks at a property's performance at a point in time. If you expect to hold a property for any length of time, then IRR -- which is sensitive to both the magnitude and the timing of future cash flows -- can tell you more about its expected performance.

@Paul Tyrell I agree with @Will Bernard on this. You may have a bit more than 270k all-in (don't forget to count your out-of-pocket for debt service, taxes, insurance while you were re-habbing), but if you can sell for 399k then you'll have a very handsome profit indeed. While I don't have all your numbers, on the surface it looks like it probably would not be nearly as profitable if held as a rental property, so selling seems like your best course.

And since it could be more attractive to an owner-occupant than to an investor, you might want to consider leaving that one unit vacant for a bit while you look for a buyer.

@William Bannister This area is so complex that you shouldn't take any action without reviewing it with a CPA and/or estate attorney. I'm neither, but having investigated this same topic recently, I can at least give you a couple of clues.

I believe the federal gift tax and estate tax are now unified, so gifts during your lifetime do eat into your estate tax allowance. A possible additional "gotcha" however is your state's estate tax. The limit there may be less than the federal, and gifts during your lifetime may or may not eat into the state allowance. Every state is different, so even if you have no federal estate tax you could have one with your state.

Another consideration when gifting an interest in real estate is the question of basis. My understanding is that a gift of such interest carries its current basis, but if that interest is inherited then the recipient has a basis that is "stepped up" to the value at the time inherited -- a benefit to the heir.

I haven't really given you any usable answers, but i hope I've suggested some questions you should investigate with your accountant or lawyer.

@Brittney Taylor Forgive me for piling on, but @Kyle J. and @Joshua Dorkin have given you excellent -- and critically important -- advice. Start by learning all you can about one area of real estate investing. Do that by seeking out the advice of people here on BP and taking advantage of the resources on the site. There is a huge number of extraordinarily generous people here who have experience and who are happy to share their knowledge. Investors helping investors, no hidden agendas.

Josh is right: Put a padlock on your wallet while you're getting up to speed. Instead of spending all your cash on "gurus," get your education here and put that money toward your first deal instead.

I go along with the conventional definition, i.e., non-residential income-producing property as well as residential having greater than four units. As far as questions 2-4 -- do you, have you, would you? -- (apologies to Dr. Seuss ;) ) -- yes, yes, and yes.

Now let me ask a follow-up question, one that usually provokes a lively discussion with my r.e. investment grad students: What kind of commercial property suits you best, and why?

Hey @Kyle_Zaylor -- Thanks for the kind words about my book. I always wanted to rich and famous, but happy to settle for just famous ;)

And btw, I also recommend the Brueggeman and Fisher book to my students -- pretty much the classic r.e. finance text

--Frank

@Vlad_Selsky Sounds to me like you've thought this through. You may not be as fortunate with future tenants, so that might be another reason to hold your 60k back in reserve rather than use it to improve your cash flow. That would still leave open the option to use it toward another property in the future, or to use some of it in the short term to offset your negative cash flows directly.

@Vlad_Selsky All else being equal equal, your cash flow swing of 3,492 is largely the result of lower debt service because of the smaller mortgage when you use some of your own funds instead of 100% financing.

I am usually skeptical of no-money-down deals because the financing terms are typically less favorable compared to conventional financing. However, in your case there is no penalty, so that's not really an issue. The other typical concern with no-money-down is the likelihood of negative cash flows. If one is unable or unwilling to absorb those, then improving the cash flow by reducing the financing is advisable.

Keep in mind that everything has a cost; so if you are improving your cash flow by investing 60k of your own cash, then you are making that cash illiquid and you are losing the opportunity to invest it elsewhere. 60k is enough for the downpayment on another 200K+ property, which should return significantly more than what you're realizing by reducing your mortgage on the first property.

...and by the way, just because you can't get an IRR, that doesn't mean you shouldn't still do a cash flow and resale projection. You can still get a sense of how the property will perform year-to-year and whether it looks like the proceeds from the eventual resale will justify holding the property with what may be a minimal cash flow.