All Forum Posts by: Kim Hopkins

Well, in case anyone is curious. I FINALLY figured out all the mathematical connections between cap rate, interest rate, and what I call the "break even interest rate" that determines when your return will increase or decrease with debt. 

I created a portfolio wide analysis where I use all the "math" on our existing portfolio to assess property performance and analyze whether to: 

1. Do Nothing

2. Refi and Reinvest (i.e. keep property and buy another) or 

3. Sell and Reinvest. 

Here is a 6 minute video that walks through the process in case anyone is curious or would like to try to apply this to their own portfolio. 

Welcome feedback as always!

Kim

HI there! Are you still having meetings? I only see the August one. Also are you aimed at experienced or more beginning investors? Commercial or residential? We have about $40M of AUM in commercial. Looking to meet other experienced investors. Thanks!

Hi! I'm looking for more meetups in Scottsdale! Do you ever do breakfast since you're a "breakfast club"? Also, are you aimed at experienced or new investors? Commercial or residential? We're commercial investors and have about $40M of assets under management. Thanks!

 @Evan Polaski Excellent breakdown.

For your rentals aka "Direct, single families", what do you count as cash flow for a given year if you put on a new roof on for $10k? (So if your cash flow is typically $900/mo, it would now be $65/mo after including this expense).

 @Evan Polaski, thanks for your feedback. Well, you are 100% right that I'm certainly overthinking it. LOL. This is what happens when the recovering mathematician is let out of the bag, I suppose. 

The thing that got me stuck was that I have this definition of what I think "return" or "cash flow" should mean for ROI and COC which is different from anything else I can find in any of the discussions of ROI or COC on the internet. And if I can't find anyone else who talks about something a certain way, I usually take it as an indication that something is incorrect with my thought process.

Indeed, I would argue that I was thinking about it incorrectly. Instead of leaving all one-time expenses (e.g. roof replacement, lease commissions, TI) out of the "return"/"cash flow" number, I think the right answer now is to include an amortized version (e.g. amortized roof payment, amortized lease commissions, amortized TI etc.). 

But that still doesn't match the typical real estate investor's definition of cash flow / return, nor does it match the definition of taxable income (since I'm deducting the entire annual debt service payment with principal and interest, like you mentioned). 

It's some definition in between the two. 

And so alas, I continue to wonder what everyone else is doing out there... 

 I'm bundling the ones I can, just to clarify. One subset of Portland warehouses cannot be bundles with the rest because the standard carriers all declined them, but these Portland warehouses are bundled together with a non-standard carrier. 

 Oh snap, @Cameron Moore I almost didn't see your post! Thank you so much for this explanation. This is extremely helpful and insightful.

Two follow up questions - 

First, when you talk about "Discount Reviews",

Do I just ask my agent if they have any discounts? 

Second - we are working with an agent that is in a city where we have a lot of properties, but we have most of our properties in other cities/states and we do not live in the same state as the agent. I appreciate what you said about long term relationships and not  "plan shopping" for sure. Do you think, however, that it would somehow benefit us in the long run to make a one-time switch to an agent that is local to where we live? Note we do not actually own any properties where we live. 

Thanks!

 Hi Lane,

Thanks, but that wasn't my question. I was asking about the definition of "Return" (i.e. the numerator) in ROE. 

My point was that it's usually defined as cash flow which is defined as: 

Cash Flow: = NOI - One Time Expenses - Debt Service.

Here, One Time Expenses includes things like: 

* Leasing commissions

* Capital improvements 

* Tenant unit improvements

My point was that if you deduct something like a new roof from your cash flow in a given year, then the ROE for that property will plummet for that year and not give you a clear picture of the performance of this property. 

Similarly, if you sign a new 5-year lease, you will have to pay a large leasing commission, which would also drive down ROE in the given year and be misleading. 

Maybe in the examples above, you do want to amortize these expenses in your definition of cash flow, i.e. redefine cash flow as:

Cash Flow := NOI - Amortized One-Time Expenses - Debt Service.

But you don't want to include something like depreciation for example, because if you do a cost seg study, it could give you a negative ROE for example, which is also misleading since the property was likely cash flow positive. 

THAT was my question. 

Hi  @V.G Jason,

No, leverage is NOT going to almost always show you a better return. That's the entire point of what I've shown above, and you echo the same point at the end of your comment where you say: "It's just going to be an incredibly difficult time to think being cute with debt is as fun." 

The reason this is true is what I've said above. 

There's a specific interest rate, I, so that the mortgage constant, M(I) is equal to the cap rate. 

If the interest rate you can get for your property, i, is LESS than I, then it is TRUE that cash on cash INCREASES as a function of loan amount. So what you said is true in this case.

However, if the interest rate you can get for your property, i, is GREATER than I, then cash on cash DECREASES as a function of loan amount. So the more debt you take on, the worse your property performs. This is what makes your last point true - that you cannot be "cute" with debt right now. To say it another way, the interest rates right now make it IMPOSSIBLE to increase the return of your property using leverage. 

Furthermore the mortgage constant, M(i) is always greater than the interest rate i itself, and M is an increasing function of i, so the interest rates have to be MUCH less than the cap rate (i << M(i) < M(I) = cap rate) in order to get a cash on cash return that beats no-leverage. 

So we need to come a LONG way down in interest rates for leverage to be cute again. 

 Hi @David M.

I'm trying to be able to analyze properties in my portfolio for a keep or trade analysis.

some of the properties are debt-free, and so I need to also look at whether adding debt to the property improves the return. (And even for properties with debt, the same analysis is helpful to know if refinancing improves returns.)

I want to be able to analyze this keep or trade decision as simply as possible, having to analyze as few possibilities as possible.

So for example, based on what I wrote above, I can solve for "I" above with a very simple spreadsheet calc, using my property's current cap rate.

Then I can take the current market interest rate for a typical loan for my asset class, and compare it to I. 

This will tell me immediately if adding debt to this property could possibly improve the returns over the current return.

as another cute little application, it turns out that if the cap rate of my current property is less than 1/Y where Y is the years of amortization for a loan, then any interest rate and any loan amount will give a cash on cash less than the cap rate of the property without debt. So for example if you take Y to be 25 years which is the typical amortization for my asset class, then 1/Y is 4%. I have some older properties with undermarket rent where the cap rate is less than 4%. I now know immediately that adding debt to these properties will not improve their return no matter what the loan amount is OR the interest rate! No calculations at all needed!