All Forum Posts by: Justin Greenwood

Hi Jon,

I still think Frank Gallinelli's book on understanding cash flow is an important text if you're aiming to learn the basics of evaluating a commercial real estate product. I use the concepts taught in the book daily. I thought the case studies were useful exercises in cementing the ideas that Gallinelli taught in the book. Definitely still worth the money I spent on it.

Take care,

Justin Greenwood

Hello BiggerPockets Community!

I'm finally ready to begin the journey towards financial freedom! I've just moved from Seoul, Korea to the Albany (NY) area and I'm looking to meet a real estate agent who understands the mindset of a real estate investor. I'm hoping to leverage the BiggerPockets community and get a few names of agents I can begin developing a long-term relationship with. If anyone knows a realtor in the Albany area that works with investors (and is hopefully also an investor himself/herself), please let me know!

Thank you in advance,

Justin Greenwood

Thank you for the quick response. I've read, and reread the case study several times hoping to find something I'm missing that will help this make sense to me. I'll go back and review the details again and try to reverse engineer how he came up with those numbers. Perhaps the answer can be found in determining the capital gain, as you suggested.

I really appreciate that you took the time to answer my question. I've actually been losing sleep over this!

Justin Greenwood

Hello Biggerpockets community!

I'm a new investor. I bought Frank Gallinelli's "Mastering Real Estate Investment: Examples, Metrics and Case Studies" to practice analyzing property data to determine if a product was a good investment. In his Apartment Complex case study (Chapter 40), Mr. Gallinelli's numbers for the AFTER-TAX SALE PROCEEDS gave me some problems. First, I will show you the numbers for 2014, 2015, and 2016:

                                                       2014             2015                2016

PROJECTED SELLING PRICE        2,712,000       2,736,000       2,760,000

- Costs of Sale                                  189,840         191,520           193,000

- 1st Mortgage Payoff                 2,050,042        2,002,102       1,955,413

- 2nd Mortgage Payoff                   280,102          259,410           237,552

BEFORE-TAX SALE PROCEEDS       192,016          282,968           373,835

-Total Federal Tax on Sale                (9,905)             (9,344)             (8,819)

AFTER-TAX SALE PROCEEDS          202,921           292,312           382,654

I understand how all these numbers were calculated, with the exception of the "Total Federal Tax on Sale". How can I determine the Total Federal Tax on Sale given these numbers? Is there a standard rate of tax?

Thank you for your time,

Justin Greenwood

Thanks again for the explanation. I fully understand how to make these calculations now, thanks to you! I think you got a different answer from Mr. Gallinelli because you used the original cost of sale from the example to determine the closing costs (.07 X 1,695,600 = 118,692). When I plugged in the adjusted numbers (0.07 X 1,606,368) the result was 112,445. When I finished plugging in all the cash flows into the IRR calculator the result was 16.16%. Not the same as in the book, but close.

Your points about real estate investors focusing primarily on the small cash flows and largely ignoring the large cash flows is a point well taken. I've read over forty books on real estate investing in the past two years and "What Every Real Estate Investor Needs to Know About Cash Flow" is the only one that even mentioned IRR. I wonder why so many of these published real estate "experts" are leaving out this extremely important aspect of due diligence?

Again, I can't thank you enough for taking the time out to explain these numbers to me. I look forward to putting these calculations to good use when I return to the United States this winter.

Sincerely,
Justin Greenwood

If you could help me with one more question....

Mr. Gallinelli follows up with:

"Since you're a prudent investor, however, you won't settle for an analysis with just one pass. You will ask yourself, 'Do I think there is any reason why the market in this location might get stronger or weaker in the coming years?' Then you rerun your projections with exit cap rates that are above and below the rate at which you bought the property. Are you still OK with the results?"

"If you must resell at a 9.5% cap rate:

                                                     Year 1              Year 2               Year 3           Year 4                Year 5

IRR Before Tax -45.20% -7.54% 6.68% 13.02% 16.17%

"If you can resell at an 8.5% cap rate:

                                                     Year 1              Year 2              Year 3            Year 4                Year 5

IRR Before Tax 3.09% 17.12% 20.84% 22.03% 22.33%

How do I go about performing such an analysis? This type of analysis seems to be important given the comment you made regarding the potential for the economy to change.

Thank you again for your time!

Dear Sir,

Thank you VERY much for giving such a clear explanation! I wasn't adding the "BEFORE-TAX SALE PROCEEDS" to the  "CASH FLOW BEFORE TAXES" in the fifth year. Your chart with those figures hit me like a bolt of lightning.

Mr. Gallinelli's advice about considering the time value of money seemed like a very important factor in determining the overall potential for earning a profit on an investment and I really wanted to understand how to figure that out. Your additional suggestion of paying close attention to the economics in your target area is something that I hadn't fully considered, but now that I have, it will absolutely be a part of my analysis.

Again, I really appreciate you helping to explain IRR and why it is important to make such a projection.

To your continued success in real estate investing,
Justin Greenwood

Thank you for responding! Here are the details:

"A local agent has shown you a few properties, but none has exited your interest. However, there is a 16-unit building located near your home in the suburb of New York City that has caught your eye, and your attorney has told you that he has heard that the owner has an interest in selling. You decide to approach the owner directly.

"The owner is indeed willing to discuss a possible sale, and so you begin your due diligence by asking him for a list of the current rents and the expenses for the past year. He provides the following:

4 studio apartments @ $1,000 per month

4 one-bedroom apartments @ $1,250 per month

4 two-bedroom apartments @ $1,500 per month

4 two-bedroom apartments @ $1,800 per month

Property taxes, $40,000 per year

Insurance, $15,000 per year

Water and sewer, $12,500 per year

Electricity for common area lighting, $2,800 per year

"You confirm the rents by examining the leases and you verify independently that the expenses are accurate as quoted.

"You're able to observe that the building is brick, and the exterior appears to be in good condition. There is parking for 16 cars. You have $350,000 in cash available to invest, and your bank has said that the potential financing terms would be 80% loan-to-value, 1.20 minimum debt coverage ration, 6.75% interest (fixed for 5 years and floating for the remaining 15 years of a 20-year term), with 1 point payable at the closing. Based on your research into recent sales and your interrogation of a local appraiser, you conclude that the current market capitalization rate for properties of this type in this neighborhood is about 9%."

I determined the value to be $1,506,533:

Value = NOI/Cap Rate

Value = $135,588/0.09

Value = 1,506,533

I put down 20% ($301,306)

I pay 1 point ($15,065)

I pay for title insurance and a lawyer ($7,101)

Total: $323,472

"After your research, you decide to project a 3% annual increase for both the income and expenses."

Now for the numbers:

Year 1             Year 2          Year 3           Year 4             Year 5

INCOME

Gross Scheduled

Rent Income                         266,400        274,392         282,624         291,102           299,836

TOTAL GROSS INCOME      266,400        274,392         282,624         291,102           299,836

VACANCY & CREDIT LOSS       7,992            8,232             8,479              8,733               8,995

GOI                                        258,408        266,160          274,145         282,369          290,840

OPERATING EXPENSES

     Accounting                          2,000             2,060               2,122             2,185              2,251

     Advertising                          1,000             1,030               1,061             1,093              1,126

     Insurance                           15,000          15,450            15,914            16,391            16,883

     Janitorial Service                 4,800             4,944              5,092              5,245              5,402

     Lawn/Snow                          2,400             2,472              2,546              2,623              2,701

     Legal                                     4,000             4,120              4,244              4,371              4,502

     Property Management   12,920            13,308            13,707           14,118            14,542

     Repairs/Maintenance     15,000            15,450            15,914            16,391           16,883

     Supplies                                 500                 515                  530                 546                 563

     Taxes

            Real Estate                40,000            41,200            42,436            43,709            45,020

     Trash Removal                10,400            10,712            11,033            11,364            11,705

     Utilities

           Electricity                      2,800              2,884              2,971              3,060               3,151

           Sewer/Water             12,000            12,360            12,731            13,113            13,506

TOTAL OPERATING

      EXPENSES                      122,820          126,505         130,300          134,209           138,235

NET OPERATING 

      INCOME                         135,588          139,655         143,845          148,160           152,605

                                                Year 1             Year 2            Year 3            Year 4              Year 5

NET OPERATING

     INCOME                     135,588           139,655          143,845         148,160          152,605

- Debt Service                109,969           109,969          109,969         109,969          109,969

- Cap Additions                          0                      0                       0                     0                      0 

CASH FLOW BEFORE

           TAXES                       25,619             29,686           33,876            38,191            42,636

Cash-on-Cash Return          7.92%              9.18%          10.48%          11.81%           13.19%

(CFBT/Cash Inv.)

Capitalization Rate              9.00%              9.27%            9.55%             9.83%            10.13%

Debt Coverage Ratio             1.23                1.27                1.31                1.35                1.39

PROJECTED SELLING

           PRICE                     1,506,500      1,551,700       1,598,300      1,646,200        1,695,600

- Costs of Sale                     105,455         108,619          111,881         115,234           118,692

-Mortgage Payoff           1,175,708       1,144,134       1,110,361      1,074,237        1,035,598

BEFORE-TAX SALE

    PROCEEDS                      225,337          298,947          376,058         456,729            541,310

IRR Before Tax -22.39% 4.85% 13.83% 17.55% 19.25%

Thank you for taking the time to analyze these numbers! I'm VERY eager to understand how to accurately calculate the IRR, but honestly don't understand how Mr. Gallinelli determined these numbers given the information in these categories.

My initial investment was $323,472 (expressed as a negative).

Cash Flow Year 1 = 25,619

Cash Flow Year 2 = 29,686

Cash Flow Year 3 = 33,876

Cash Flow Year 4 = 38,191

Cash Flow Year 5 = 42,636

Where am I going down the wrong trail?

Thank you again for taking the time to explain this to me!

Justin Greenwood

Hello Everyone,

I've learned a lot from Frank Gallinelli's "What Every Real Estate Investor Needs to Know About Cash Flow," however, the Internal Rate of Return concept is still a little confusing to me.

In this book there is a case study in chapter 6 that considers an "Apartment Building Investment" (pgs. 108-120). I have worked through all the categories (i.e. "NET OPERATING INCOME," "CASH FLOW BEFORE TAXES," "PROJECTED SELLING PRICE," and "BEFORE-TAX SALE PROCEEDS") and have the EXACT same numbers that Mr. Gallinelli has in the book. When I try to figure out the "Internal Rate of Return, Before Tax", however, my answers are WAY off.

Would someone who has read this book PLEASE help me understand how Mr. Gallinelli came to the IRR projections that he did?

Thank you in advance!