The document provides steps for analyzing a commercial real estate investment, including determining net operating income, selecting a loan, calculating cash flow before taxes, and returns. It outlines analyzing a case study property listing for $750,000 with a 9% cap rate to achieve a 9% cash-on-cash return through adjusting the purchase price, net operating income, or interest rate. The document emphasizes understanding an investment's risks, returns, and suitability for the investor's goals.

1. Analyzing a Commercial Real Estate Investment Westfield North Building, 2730 University Blvd, Ste. 200, Wheaton, Maryland 20902 301-949-1771 (Phone) 301-949-5441 (Fax) www.pditraining.net Presents: By D. Scott Smith, CCIM 443.691.8153 www.expertcre.com [email_address]

2. Class Room, DLLR, and MREC Rules!!! You must sign in and out to get CE (show ID) No eating, sleeping, or using electronics You must be on time Raise your hand to ask questions Be polite

3. Analyzing a Commercial Real Estate Investment Review 4 basic steps to find a pulse on an investment. Part 1. Determine Net Operating Income (NOI) Part 2. Loan Selection Part 3. Determine Cash Flow Before Tax (CFBT) Part 4. Calculate Returns NOTE: There are many additional steps needed to fine-tune each analysis. Today We Will:

4. Analyzing a Commercial Real Estate Investment A few things first: Analysis Paralysis is over analyzing a deal to attempt to remove risk. The only way to completely avoid risk is to not invest. Different methods often provide different results. “ Garbage in, garbage out”

5. Analyzing a Commercial Real Estate Investment Some Industry Standards for Analysis Internal Rate of Return (IRR) Cash-on-Cash Return (COC) Financial Management Rate of Return And Cap Rate, to name a few

6. Analyzing a Commercial Real Estate Investment The Key to a successful investment is to be able to answer : What is your risk tolerance? Does the investment make sense to you? Does it meet your goals?

7. Analyzing a Commercial Real Estate Investment Step 1. Net Operating Income (NOI)

8. Analyzing a Commercial Real Estate Investment Step 1. Net Operating Income (NOI) Potential Rental Income - Vacancy and Credit Loss = Effective Income + Other Income = Gross Operating Income - Operating Expenses = NOI

9. Analyzing a Commercial Real Estate Investment Step 1. Net Operating Income (NOI) Operating expenses consist of: Real estate taxes Property insurance Property management and maintenance Utilities Legal fees Advertising And accounting, to name a few

10. Analyzing a Commercial Real Estate Investment Step 1. Net Operating Income (NOI) A few more things … BOMA Expense Ratios for each asset class in each market Income statements – may include many additional income streams for the current owner

11. Analyzing a Commercial Real Estate Investment Step 1. Net Operating Income (NOI) A few more things … A Cap Rate as a Way of Measuring an Investment and is not THE RETURN of the investment. Cap Rate is a measurement rate of the first year NOI as it relates to the current value of the investment. Is a Cap Rate complete?

12. Analyzing a Commercial Real Estate Investment Step 1. Net Operating Income (NOI) IRV Formula Note: A Cap Rate does not account for debt service and income tax for the investment. INCOME RATE VALUE X ÷ ÷

13. Analyzing a Commercial Real Estate Investment Step 2. Loan Selection

14. Analyzing a Commercial Real Estate Investment Step 2. Loan Selection What you need to know: Types of loans available Types of loan structures (Hard Money, Swap, Equity) Which lenders offer the loans you need/want Always have your own trusted lender for custom packages.

15. Analyzing a Commercial Real Estate Investment Step 2. Loan Selection Consider the Debt Service Coverage Ratio (DSCR) when evaluating loan options. DSCR will be provided by your lender. DSCR is the net operating income divided by the annual debt service. You will need to reflect and negotiate what loan structure will be available and achievable for the asset.

16. Analyzing a Commercial Real Estate Investment Step 2. Loan Selection It’s important to do the following: Build relationships with lenders. Find a mentor. Ask questions.

17. Analyzing a Commercial Real Estate Investment Step 2. Loan Selection We will use the following loan structure for the remainder of the steps and analysis today. 25-year mortgage, fully amortized 8% interest Monthly payments Debt Service Coverage Ratio (DSCR) of 1.25

18. Analyzing a Commercial Real Estate Investment Step 3. Cash Flow Before Tax (CFBT)

19. Analyzing a Commercial Real Estate Investment Step 3. Cash Flow Before Tax (CFBT) CFBT is the heart of the analysis. This will give you the amount of income before tax your property is providing. This is the benchmark to calculate your return.

20. Analyzing a Commercial Real Estate Investment Step 3. Cash Flow Before Tax (CFBT) NOI of $50,000 / DSCR or 1.25 = $40,000 This means that $40,000 is the max annual debt a NOI of $50,000 can cover. If the NOI drops below $50,000, DSCR will change and increase the lender’s risk of losing on the investment.

21. Analyzing a Commercial Real Estate Investment Step 3. Cash Flow Before Tax (CFBT) NOI of $50,000 / DSCR of 1.25 = $40,000 The above analysis will have a result of: $10,000 a year CFBT (NOI of $50,000 – ADS of $40,000 = $10,000 CFBT) or NOI of $4166.67 a month Mortgage payment of $3,333 a month CFBT of $833.33 a month

22. Analyzing a Commercial Real Estate Investment Based on an NOI of $50,000, with a DSCR of 1.25, the max loan amount would be $431,838. With an asking price of $500,000 (or a 10% Cap Rate), you would have to put down $68,161.45.

23. Analyzing a Commercial Real Estate Investment Step 4. Calculating Returns

24. Analyzing a Commercial Real Estate Investment Step 4. Calculating Returns Determine the maximum loan amount and down payment based on: Net Operating Income (NOI) of $50,000 Debt Service Coverage Ratio (DSCR) of 1.25 Annual Debt Service (ADS) of $40,000 Loan – 8% interest, fully amortized over 25 years Current asking price of $500,000

25. Analyzing a Commercial Real Estate Investment Step 4. Calculating Returns Compare the $10,000 CFBT you receive against the down payment amount of $68,161.45. Which is called…

26. Analyzing a Commercial Real Estate Investment Step 4. Calculating Returns Cash-on-Cash Return (COC) is: The first year’s Cash Flow Before Tax (CFBT) / Initial Capital $10,000/$68,161.45 = 15% Return on Equity Investors usually think of this percentage as “ THE” return!

27. Analyzing a Commercial Real Estate Investment Step 4. Calculating Returns Internal Rate of Return (IRR): A rate of return earned on each dollar, for as long as it stays inside the investment. More appropriately, the discount rate, if you add up all the future cash flows, reduced to present value where that total equals the initial capital investment. That percentage would be the Internal Rate of Return.

28. Analyzing a Commercial Real Estate Investment Step 4. Calculating Returns In order to achieve a desired IRR of 10%, determine: Amount at which you need to sell the property When you would need to sell (Assuming all things remained the same inside the investment over the holding period.)

29. Analyzing a Commercial Real Estate Investment Step 4. Calculating Returns Suggestion: You may want to use the HP10BII to complete this advanced step. 1. (-$68,161) down CFJ key 2. $10,000 CFBT in CFJ 1-4 3. $10,000 + $50,000 a. $550,000 sales price in 5 years – $500,000 of initial purchase) in the CFJ 5 key.

30. Analyzing a Commercial Real Estate Investment Step 4. Calculating Returns 4. Push Gold key then IRR key 5. IRR = 10.34 You could also achieve this result by putting down $50,000 less of initial capital.

31. Analyzing a Commercial Real Estate Investment Case Study

32. Analyzing a Commercial Real Estate Investment A property is currently on the market for a sales price of $750,000 with a Cap Rate of 9%. What purchase price would you need to achieve to receive a 9% COC return? Case Study

33. Analyzing a Commercial Real Estate Investment Step 1: The NOI (if real) should be ________ based on a 9% Cap Rate and market price of $750,000. Step 2: If the NOI is $67,500 and you know that your lender has a loan program of 8% interest, fully amortized over 25 years, no points, and a DSCR of 1.25, your max Annual Debt Service (ADS) will be: $67,500 / 1.25 = ___________ ADS Case Study

34. Analyzing a Commercial Real Estate Investment Step 3: $67,500 NOI - $54,000 ADS = $4,500 a month = $13,500 CFBT = $1,125 a month Step 4: A monthly payment of $4,500 consisting of 8% interest over a 25-year term will bring the max loan amount to $583,040. Compare that to your purchase price of $750,000. You will have to put down $166,960 and receive $13,500 a year. The COC is 8%. Case Study

35. Analyzing a Commercial Real Estate Investment Step 3: $67,500 NOI - $54,000 ADS = $4,500 a month = $13,500 CFBT = $1,125 a month Step 4: A monthly payment of $4,500 consisting of 8% interest over a 25-year term will bring the max loan amount to $583,040. Compare that to your purchase price of $750,000. You will have to put down $166,960 and receive $13,500 a year. The COC is 8%. Case Study

36. Analyzing a Commercial Real Estate Investment You could look at the following to achieve 9% COC: 1. Lower your asking price. 2. Achieve a higher NOI. 3. Get a lower interest rate. 4. Any combination of the above. All of these will get you there! Let’s look! Case Study

37. Analyzing a Commercial Real Estate Investment By reducing the asking price to $735,000 or by 2%, a COC of 9% can be achieved. If you increase the NOI by 2% a year ($1,350), your NOI would be $14,850, giving you a COC of 9%. An interest rate of 7.75%, but keeping monthly payments at $4,500, would produce a COC of 9%. Case Study

38. Analyzing a Commercial Real Estate Investment GOT QUESTIONS? Case Study

39. Westfield North Building, 2730 University Blvd, Ste. 200, Wheaton, Maryland 20902 301-949-1771 (Phone) 301-949-5441 (Fax) www.pditraining.net We Thank You and hope to see you again! By D. Scott Smith, CCIM 443.691.8153 www.expertcre.com [email_address]