All Forum Posts by: Roger Doe

Here is my take.  Sorry for the disjointed info but just wanted to give as much as I can in limited time.

I think you need to do a lot more due dilligence.  Commercial property is a whole another animal.  You need to really think like a company that is looking for office space, not a tenant looking to live somewhere.

Even if the rent is $10/sq ft, that doesn't mean you can get it.  Parking is a key thing for offices and only a few offices probably have it.  And, they probably gobble up the few companies that need to be in the area.  For example, lawyers or agencies that deal with the city.  Additionally, the space needs to have a minimum level of quality.  There is a reason there is an 80% vacancy.

I disagree with the one person who says you need to get something written or notarized for the elevator.  No city official is going to give you that even if you are allowed to grandfather the elevator.  I'm not saying that you should assume you can grandfather it in (actually I doubt is since if an elevator is taken formally offline, some states mandate you need to bring it up to modern code which may require you to replace many of the elevator components) but you need to do a lot of investigation.  For example, you might try to put the elevator back online during the due dilligence period under the name of the current owner.

There are a ton of things you'll need to investigate.  For example, look into the taxes and the status of tax appeals for the last few years.  the seller might be facing a huge tax increase because an abatement is expiring.  Talk to the tax collection department and talk to them on expected tax rate increases.  Although they wont comment in anything longer than 1 year, they can tell you if rates are going to increase the coming year.  Inspect rent deposits by requesting all bank statements to see if tenants actually pay rent.  Make sure that the seller isn't hiding utility bills.  Basically, you've gotta question every single line item in a income and expense statement.  In my experience, all sellers hide something.  Some sellers hide A LOT.

I can tell you that you'll probably make a lot of mistakes so go in with little money on your first acquisition.  You'll probably lose money but commercial properties are very lucrative.

Not sure how familiar with the technical jargon but beta has lost much of it's popularity in the stock world. And, I think rightly so. The assumptions underlying beta are incorrect. Beta is calculated using the daily stock price fluctuations. The assumption here is that the markets are perfectly efficient. This is one of the fundamental debates for financial theory. I think it's obvious that price is not efficient and is idiotic to even think this.

Whatever, the case is. This knowledge is actually very important I think. To know this stuff is what sets you apart from the competition. This is what will make you succeed.

For example, you cite Argus. It might be the gold standard but the point I was making previously was that it's garbage. It's a watered down version of the analysis done in the financial world. Look at this way, it took the financial world more than a decade to accept CAPM. The real estate world hasn't even accepted it yet. That's how slow real estate is. You can get such an advantage by seeing the limitations of Argus.

Eric K.

We have completely different viewpoints.

First, in real estate, the successful are the ones that know more than others. Saying that the technical jargon should be left for the big players in my opinion the completely wrong way to go.

Second, everything is not opinion. You've got it backwards. You need to turn opinions into hard cold facts. And, the way to do that is to keep perfecting the system that you have in place, making it better than anyone else's. That's why you make a killing. (The huge amount of leverage in real estate doesn't hurt.) =)

Eric K.

I put a response to you above.

@Eric K.

Thanks for your response. I understand that there seems to be no systematic method of determining cap rates. I guess my question was more directed towards you and anyone else on this board. I was hoping that you might share a more systematic, precise way of determining cap rates that you might have come up with. Because the current method of "going on gut" is ludicrous. I'm sure you know but the biggest weakness of NPV is the calculation of the cap rate. A tiniest fluctuation of the cap rate will have a huge effect on the final NPV value. At the same time, cap rates are arbitrarily determined. For example, an investor will think to himself, "Hm...retail at this location seems pretty risky, let's put a 14% cap rate on it." I can't believe this approach, especially when the difference between a 13 or 14% cap rates can make the final NPV fluctuate by more than 50%. Despite this weakness, no one seems to have devised a systematic method of calculating cap rates.

The reason I brought up the Blackstone example was to illustrate how ludicrous the situation is. My friend is pulling in about $3-4 million/year to evaluate development acquistions and all he uses are hurdle rates that they pull out of thin air. I can't understand it. No matter how precise an analyst's estimate on line items such as how much it will take to build door, or how long it's going to build this building, all of this will go out the door if the cap rate isn't accurate. Say you can estimate the cost of this door to be $50 which is more accurate than $60 that everyone else uses. It doesn't matter because the tiniest change in cap rate will have a much more profound effect on final NPV.

Many years ago, I remember going into an interview at Kimco and I mentioned this glaring hole in real estate valuation. They just shrugged it off and said it is what it is. What?! How can you spend hundreds of millions of dollars, knowing that the valuation method is glaringly incomplete?

I guess you disagree but I am of the mindset that subjectivity must be eliminated as much as possible. There can't be an opinion. At the end, the value of a property should always come back to the same number, no matter how many times you run your financial model. Forget the obvious weakness of getting an arbitrary valuation, but the temptation of backing into a number is also just too great.

I guess I'll stop my rant here. I didn't realize how much I was writing. But, if you do have come up with a method of calculating cap rates that more precise, I hope you can share some ideas on how to go about it.

Two other minor points:

1. I wanted to point out for some newcomers. There is a difference between market cap rate and intrinsic cap rate(discount rate). You use the former to calculate your exit value but the latter is the one you use to figure out the value of the property to you. Given your personal risk profile, it might be wildly different. So, when you calculate the value of the property to YOURSELF, you need to use the cap rate that you consider to be correct for yourself. So, when you see 10 Starbucks going at a 5% cap, you would NOT use it in order to figure out your cap because it's irrelevant to you. But, you would use the 5% cap to figure out how much investors will probably pay for your property when you do decide to sell.

2. Not sure if I would go about valuing a property by using current cap plus opportunities. I might be wrong but I think it's better to mix them in together because that would be the only way to compare the subject property to other potential acquisitions. (ie you can achieve a tax break on this property but this other property, you can renovate.) I agree the "opportunities" only have a specific chance of succeeding so you would incorporate only the possible value of it succeeding. So, if the tax appeal only has a 50% chance of being successful, you would put only 50% of the future tax break. You would have to change the discount rate accordingly due to the increase in volatility. By how much you ask? I have no idea which is the reason for this post.

Here are some points to consider:

1. Watch their show. The quality of the final renovation/rehab is horrendous. It seems to me that they couldn't make it big flipping houses, so they have resorted to peddling this dream of financial freedom. The horrid colors that they pick alone should make you run away. Everything they did was utter crap.

2. There aren't many negative reviews because they make you sign all these forms that prevent you from ever making negative reviews or get sued. Nice set up they have. Majorly shady. If it was such a solid product, they wouldn't make everyone sign non-disclosure documents. This fact alone speaks volumes on their integrity.

Just curious. Sebastian, Steve, or anyone who knows NYC real estate. What's the historical annual compounded growth rate on NYC apartments?

I agree with some of your points but slightly disagree with others.

1. It's great that you've had such an honest, open relationship but my experience has been far from that. The banks have their own objectives which is have a loan portfolio that looks great on paper. In my experience, the relationship hasn't been all rosy. On one hand, we have the loan officer who will do anything to get the deal done. So, they might string you along because it doesn't hurt them to waste your time. And, then we have the underwriter who is presented with all these deals and only picks the most conservative handful. It's hard to get a consistent answer from him/her. One day they want this, another day they want that.

2. I agree that you should be honest. Don't hide anything that will come out later. It makes the loan officer look bad in front of the underwriter. For example, if there is a huge oil tank problem that comes out later that you haven't mentioned, it makes you look shady and then they think, what else is he hiding?

3. At the same time, I wouldn't mention details that would make the loan more complicated. Unless it's a core part of the deal, I wouldn't even bring up rehab details because then the underwriter is going to worry if the rehab is going to jeapordize the current cash flow. Make everything simple. At the end of the day, the underwriter is looking for a property that has long-term, stable cash flows. Keep things simple.

4. I agree that those ratios are what the underwriter is looking for. Those are the first things that they ask for. But, I am assuming that the readers here are more experienced than that. So, I wanted to know a more detailed analysis of the loan process. I guess I wanted to know exactly what/why the underwriter is looking for. What is the ultimate goal of the underwriter? How are the loans syndicated? What is the ratio of commercial/residential should a loan portfolio have? etc....

I wish someone who's an experienced loan officer would chime in. But, here's my experience.

First, make sure you get a good loan officer. Someone who's been doing this at least for 10 years, preferably 20. And, someone who's done at least 3 commercial deals a year. This is really crucial. Even if they've been a loan officer for 20 years, if they don't do many commercial deals, they will do more harm than good. The loan officer is basically you're liason between the underwriter and you. The loan officer fights for you because he only gets paid if the deal is done. But, if he doesn't know what the underwriter is looking for, he's going to present the deal poorly to underwriter. And, you've only got one shot with that bank. (You can come back a year later but that's just wasting your time.)

Ask them straight out how many commercial deals they do a year. Most of them at most only do 1 or 2 every few years or so. Skip them. I've used so many inexperienced guys that simply have wasted my time. It drags week after week, month after month. The loan officer will just keep telling you it's almost done when it's not because he doesn't want to lose the deal. Experienced guys will tell you right away that the loan won't work that that bank and you don't have to waste your time. I now use experienced guys and even they screw up too.

In terms of experience, the bank wants someone who's been doing this for a number of years. They are rightly afraid that someone who buys an apartment building for the first time, won't know what they are doing and the cash flow will suffer. I've seen it so I guess you need to show them you've done this before. Anything to show that you know how to run a real estate business.

Hopefully, someone in banking can chime in....

What do banks look for? Are there any loan officers/underwriters here that can chime in?

Here is what I know. I believe that loan officers make about 1% on loan amount. So, they are always looking for solid investors who will make a lot of future loans. If they do $5 MM in loans every year, they can make an additional $50k to supplement their salary which is huge for them.

But, at the end of the day, the underwriter makes the final decision on loan approval. So, what are these guys looking for? I am probably way off about this but it seems that they look for particular characteristics. It seems that commercial loans (which include apt buildings) comprise about 3-5% of each branch's portfolio of loans. So, they don't want to do too much. Then, they want different types of commercial loans so it's diversified - some residential, some office, etc. Also, they are looking for loans that are as conservative as possible - properties with very stable cash flows (solid tenants with long-term leases).

So, how much weight really goes into looking at LTV, debt income ratio, etc.? Or are these parameters simply the initial things they look at and in order to approve the loan? Because it seems that they really emphasize the credit worthiness of a multiple-tenant base.

I guess I have a lot of questions. The reason for these questions is when I make my loan packages, I just want to know exactly what I should be emphasizing and de-emphasizing.