All Forum Posts by: Cornell M. Dayne

Nope? The bank won't lend money on a deal like that either.

Danny, there is something called NOI or net operating income and there are a million different factors that influence, some of which are direct and others indirect.

You're going to have to figure that number out first.

Once you have that then you can figure out your annual debt service (ADS) because the bank will give you the debt service coverage ratio (DSCR). You can figure out the investment value based on a market cap rate. Tons!

Plus why would you purchase a property to break even?

Excellent point(s) Will.

Looking back, this has been a very good thread wouldn't you all say?

Thanks to all for contributing.

Thanks to Chris J for the question.

Essentially, when discussing real estate, ROE and COC are synonymous. Both are ratios that compare and contrast annual net income or cash flow and your down payment or equity interest. As Steve's implies, none of these formulas are static. Year after year the deciding variables can change dramatically, for better or for worse, and give you a totally new number for year two or three and so on.

Even though that is a valid point, I personally tend to use COC as a part of an larger rubric for qualifying a property. And because of that I don't normally revisit and reuse this formula unless I've chosen a turnaround or value add property with a short investment horizon.

I still stand by what I said on the 25%-50% COC. This can be accomplished simply by bringing in a debt partner and you in turn treating this partner as debt financing/an additional mortgage. A high COC does not mean that you made a tremendous amount of money. No, it only means that you shared a good deal with others, mitigated your risk exposure, got your money back in a timely manner, put down less than you had to, and negotiated your butt off.

P.S. At times, it can also mean that you practically took the legs from under the seller and stole the property.

As far as the bank goes, I have found that they appreciate an investor who protects their interest by limiting their risk exposure on the deal. They will love you for it but it will mean that you have to do a bit more work to find partners. If it is a deal that you have never down before ie, size and scope, or asset type would suggest you look for the equity partners who have the experience and track record that you lack but lack the deal that you have.

Try and talk with the prez or vp of a local community bank or portfolio bank. I have found them to be very helpful in introducing me to others that have similar goals as me. They also like to play golf, which is an advantage for me because it takes me 2 days to play 18 holes. LOL.

Make sure the guy you talk to sits on the board and helps to make the final decision on funding your deal. Call him/her your bully pulpit. This person is usually the VP or bank prez.

Good luck

Well, I agree with Steve in that it really all depends on your strategy.

However, I asked earlier why is this ratio IMPORTANT, and no one answered. What does it tell the investor?

Well I will answer that question and you all can be the judge as to whether it is an arbitrary number or an important one:

THE ROE/COC TELLS THE INVESTOR HOW LONG IT WILL BE BEFORE HE GETS HIS DOWN PAYMENT BACK.

For example, at 33% ROE/COC it would take you three years worth of cash flow to equal your down payment; at 10% it would take you 10 years and so on.

The sooner you can get that money back the faster you can do it again.

I concede that there are tons of ways to get your money out of a property, but this thread is about COC and this is what COC tells the investor. Hardly an arbitrary number in my opinion.

But as Steve suggests it depends on your strategy; it depends on your investment horizon; it depends on your investment criteria. The investor has to figure out what works for him/her.

Ryan,

What if you told the bank that you only need to borrow 55% from them for the property? And you got the remaining funds from either the owner or other investors. Do you think that it would be difficult then? Do you think that the bank would feel comfortable doing this considering the AMOUNT OF SKIN that you would have in the game?

I guess I would answer your question with a question: Why wouldn't it be a good time to invest in commercial real estate?

Chris J,

This guy was part of a very large commercial real estate investment firm and this alone could be the reason why he does not expect to get the type of ROE that I or other investors expect and I'll explain.

1. There are different property classes (4) within real estate. You've got class A (the best), B, C, and D (obviously the worst). These classes are determined by the age of the respective properties, the condition, and the amenity items expected by the market. Most LARGE investment firms are called institutional investors and typically these guys compete for class A properties because they command higher rents, have lower maintenance costs (due to the younger age), and they are much easier to manage. With such properties it is a little more difficult to achieve the ROE that one might be able to get in any of the other property classes.

This has to do with the risk and the advantages associated with that particular property class.

2. He may not expect the bargain that I or some of the other investors expect. And who says that this large investment company hasn't made some bad decisions. Look at Lehman. Big doesn't always mean smart.

3. To reiterate what has been said earlier, the ROE formula can be manipulated by adjusting either the Down Payment/equity or the cash flow (which you can only be calculated after the debt service so the argument over the consideration of financing is a moot point). Maybe this large institution goes at it all alone with no investors, partners, etc. and this is why they have a hard time getting a 20% ROE. Maybe a smaller down payment on the companies part and bringing in some debt partners would make 50% possible?

4. Real Estate is hardly monolithic. Maybe this guy is investing in San Francisco, CA when I invest in Roanoke, VA and William Barnard invests in Oklahoma City, OK. In other words, maybe in his particular market of expertise it is extremely competitive and thus impossible to find properties with great ROE's. If that be the case it does not mean that HIGH ROE's aren't achievable it just means that they are not achievable in his market.

5. Asset type is also a worthy consideration here too. Maybe he only invests in apartments that coupled with the his geographic location of expertise could keep him from achieving a high ROE.

I think that I may be beating a dead horse here. But I will ask you a question: Have you established why COC/ROE is an important staple within your personal investment criteria?

Commercial Real Estate is a game of assumptions. There is no law here and there are no impossibilities. NEVER forget that. As Trump would suggest there is an ART to the deal.

Lastly, there is an inherent difference between ROI and ROE. They are not the same. Look it up when the chance arrives.

Good luck.

1. Believe it or not my personal minimum ROE is 25% and I shoot for 50%.

2. Its not easy to find these deals no, however the key to a high ROE/COC is your use of leverage. For example, suppose you put down less of your own money in the deal (10%) and you achieve this by way of pooled funds or a syndication. Then this means that YOUR down payment excluding the money from the bank and the money from the partners/investors will be used to find your ROE/COC. Why is this? Because the amount above and beyond the supposed (10%) you put down in this scenario are considered borrowed funds when using this equation. The higher the downpayment the harder it is to achieve that magic number of 20%.

3. Never go through with a deal that does not fall within your guiding parameters. NEVER.

20% is not out of line. Especially not in this market. LOL. And it will get better believe me. Some people are able to get returns 100% COC. Also keep in mind that there are tons more variables like increasing the NOI within the first year thus increasing cash flow or reducing expenses.

The key is not always what the COC/ROE is today but what it WILL be tomorrow with your brain calling the shots.

GOOD LUCK

Chris S,

I totally agree. The only thing that I would add is the following and maybe this will clear up a few things for the initial questionaire Chris J:

1. The Cap Rate is nothing more than a ratio. Its a useful number for comparing comparable property types in the same class. The number will vary widely across different asset classes. As Chris S suggests this is how one goes about determining risk. Its just a simple means of finding the properties current yield.

2. The Cap Rate is an indicator of how profitable a property is before leverage. I suggest that the cap rate that you use be at least 2 points higher than your expected interest rate (blended or otherwise) because this provides a cushion considering financing and other factors.

Chris J there is no real need to modify the formula as it is important for comparison reason and back of the napkin calculations. and there are so many other things to consider when analyzing a property.