Introductions Your name Where you work Your job
Introductions • • • Your name Where you work Your job responsibilities How long you have been in the industry What you hope to get from this class Course 8: Financial Mgmt
Agenda • • • Investments Adding Value to the Investment Economic Analysis of a Property Budgets Property Valuation Course 8: Financial Mgmt
Chapter 1: Investments We will discuss: - What are investments and whether to make them - Advantages and disadvantages of investing in multifamily housing - Different types of ownership and methods of financing Course 8: Financial Mgmt
Definition: Investment • An investment is the use of funds to earn a profit. Course 8: Financial Mgmt
Four (4) Factors in Investment • Risk – low risk = low return high risk = high return • Income – may depend on risk involved • Growth – means a potential to increase in value >NOI = greater value • Liquidity - ability to convert to cash Course 8: Financial Mgmt
Owner’s Objectives Why is it important to know the owner’s investment objectives for the property you manage? Course 8: Financial Mgmt
Activity #1: How the Four Factors Affect Investments • How do general economic and market conditions affect investments? • Why is it important to know the owner’s objectives for the property you manage? Course 8: Financial Mgmt
Performance Measures • • Rate of return on investment (ROI) Cash-on-cash return Capitalization rate Internal rate of return (IRR) Course 8: Financial Mgmt
ROI • Rate of return on investment = percentage of return on each dollar invested Cash flow/Investment = ROI Course 8: Financial Mgmt
Capitalization Rate • NOI/Purchase Price = Cap Rate • NOI/Cap Rate = Value Course 8: Financial Mgmt
Exercise • We paid $7, 000 for a property and the NOI is $500, 000. What is the cap rate? • Divide NOI by 6% Course 8: Financial Mgmt
Remember • Lower cap rate = higher value • Higher cap rate = lower value Course 8: Financial Mgmt
Advantages of Investments • Advantages include: – Periodic cash payments – Potential for increase in value – Reduction in income taxes due to depreciation – Ability to invest using borrowed funds Course 8: Financial Mgmt
Disadvantages of Investments • Disadvantages include: – Real estate is not a liquid asset – Active participation is often required – Potential for risk (natural disasters, changes in market conditions) Course 8: Financial Mgmt
Forms of ownership • • Direct ownership/sole proprietor Partnership Limited liability partnership Limited liability corporation S corporation Joint venture Real Estate Investment Trusts (REITs) Tenants in Common (TICs) Course 8: Financial Mgmt
Types of mortgages • • Fixed rate Variable rate Balloon Bullet loan Course 8: Financial Mgmt
Where to obtain a mortgage • • Commercial banks Finance companies Savings and loan institutions Insurance companies Pension funds Mutual funds Federal government (Freddie Mac, Fannie Mae) Course 8: Financial Mgmt
Skill Check #1 Chapter 1 - Investments Course 8: Financial Mgmt
Chapter 2 Adding Value to the Investment Course 8: Financial Mgmt
Adding Value: CAM Responsibilities 1. Generating and collecting as much income as possible 2. Controlling expenses 3. Meeting the financial goals of the investment Course 8: Financial Mgmt
Additional ways to add value: • Reduced staff turnover and lower personnel costs • Reduced resident turnover with better customer service • Aggressive rental rates set by unit type • New income sources through resident services • Better collection of resident charges Course 8: Financial Mgmt
Sources of Income • • • Rent Administrative Fees Parking/Garage fees Pet fees Laundry room/Vending • Late fees/collection fees • Clubhouse rental/video rental • Car wash • Cable/Internet/ Phone Course 8: Financial Mgmt
Types of Expenses • • Maintenance Administrative Salaries/Personnel Taxes • • Insurance Utilities Contract services Advertising and Marketing Course 8: Financial Mgmt
3 Factors That Affect Rental Income • Competitive rental rents • Physical occupancy • Collection percent or economic occupancy Course 8: Financial Mgmt
Concession Impact Market rent = $700 Concession = one month rent What is the Effective Rent? Course 8: Financial Mgmt
Law of Supply and Demand • If the demand is high and the supply is low, higher prices can be obtained. • If demand is low and the supply is high, rents must be made competitive to attract residents. Course 8: Financial Mgmt
Economic Conditions • Population growth • Household formation • Job creation Course 8: Financial Mgmt
Balancing rental rates and vacancies • The goal is to maximize income not occupancy • Pricing too high may cause longer vacancy • Pricing too low means you are losing money while the unit is occupied Course 8: Financial Mgmt
Increasing rental rate Market value = $800 Raise rent 10% = $880 Vacancy = 15 days What is the cost of the vacancy? At the new rate, how long before you recover the vacancy loss? Course 8: Financial Mgmt
Lowering rental rate • • Market value = $800 Lower rent 10% = $720 Loss per month = $80 Loss per year = $960 What would you lose if you did not lower the price and the apartment sat vacant for a month? Course 8: Financial Mgmt
Before adjusting rent, analyze the 4 P’s: • • People Product Promotion Price Course 8: Financial Mgmt
Determining Pricing • Conduct a market analysis • Use an automated revenue management system Course 8: Financial Mgmt
When to consider a rent increase • When any floor plan remains 95% or more occupied or that remains full even when the community turnover ratio averages below 55% • When rents fall below levels indicated by a comparative rent analysis • Anytime a community is full • Upon owner request Course 8: Financial Mgmt
Rental increases: Current residents • Increase rent as leases expire, OR • Increase rent selectively on expired leases using a quantifiable, non-discriminatory standard (years of residence or number of previous renewals) • Consider a renewal rate that is slightly lower than the new market rate as an incentive to stay • Provide 60 days notice prior to the effective date of the increase Course 8: Financial Mgmt
Managing Occupancy: Reports • • • Occupancy reports Rent roll Delinquency report Deposit/Income reports Concession report Demographics report Course 8: Financial Mgmt
Managing Occupancy: Methods • Calculate occupancy trend • Manage lease expirations • Calculate turnover ratio Course 8: Financial Mgmt
Expenses • • • Fixed – property taxes, insurance Variable –utilities, turnover costs, etc. Capital- appliances, HVAC, etc. Replacement Reserve Account Debt service Course 8: Financial Mgmt
Cost Benefit Analysis • Potential Expense – Dollars – Time – Image • Potential Benefit – – – Income Time Employee satisfaction Market position Image Course 8: Financial Mgmt
Accounting Practices • • Budget control log Invoices Purchase discounts Check request or payment vouchers Petty cash Resident records Resident security deposit Collection of former resident accounts Course 8: Financial Mgmt
Skill Check #2 Chapter 2: Adding Value to the Investment Course 8: Financial Mgmt
Chapter 3 Economic Analysis of a Property Course 8: Financial Mgmt
Economic Analysis When analyzing a property, ask - How well has a property performed over a specific time period? - Where does a property stand at a given date in time? Course 8: Financial Mgmt
Course 8: Financial Mgmt
Course 8: Financial Mgmt
Accounting methods • Accrual- records all income and expenses in period they were earned or incurred, regardless of when received or paid • Cash- records all income and expenses when they are actually received or paid Course 8: Financial Mgmt
Cash Flow • The amount of money left after all sources of income are collected and operating expenses, capital expenses and debt service have been paid • Often referred to as the operating statement Course 8: Financial Mgmt
Gross Potential Rent (GPR) • Current charged at 100% occupancycombines the sum of occupied units at current lease rents plus vacant units at market rents • 100% of possible income • All other income and expenses measured and evaluated as % of GPR Course 8: Financial Mgmt
Market Rent • Total annual income received if 100% of all units were occupied and paying market rents Course 8: Financial Mgmt
Loss to Lease • Variance between market rent and lease rent • Market rent that is “lost” due to lease rents at rates lower than the market rate • For many companies it is a separate line item on the operating statement Course 8: Financial Mgmt
Loss to Lease Example • Annual market rent of $1, 375, 025 with a loss to lease of $125, 700 has a loss to lease of 9. 1% • 125, 700/ 1, 375, 025=. 0914 or 9. 1% • GPR of $1, 249, 325; market rent of $1, 375, 025 less “loss of $125, 700 Course 8: Financial Mgmt
Vacancy, Concession, and Collection Loss (VAC) • Total value of rent loss from vacant units, concessions given, collection losses from bad debt write-off, rent loss from nonrevenue units • Standard for uncollectible/bad debt- 2% of GPR • VAC can be higher than 10% of GPR Course 8: Financial Mgmt
EFFECTIVE GROSS INCOME (EGI) • GPR less vacancy, concessions, and collection loss. Also called net rental revenue or total rental income • Represents all rent and only the rent income at the property • GPR-VAC= EGI Course 8: Financial Mgmt
OTHER INCOME (OI) • Income from items other than rent • Laundry, cable, parking, amenity charges, pet fees, application fees, administrative fees, lease premium fees, late fees • Fee policies established by owner or manager • Up to 10% of GPR- NAA survey in 2010 7. 2% of GPR or $753 per unit Course 8: Financial Mgmt
GROSS OPERATING INCOME (GOI) • EGI + OI = GOI • Property’s total revenue • Available to pay property’s operating expenses, capital improvements, and debt service Course 8: Financial Mgmt
OPERATING EXPENSES(OE) • All expenses fixed and variable incurred in the course of managing the property • Controllable and uncontrollable expenses • Capital expenses and reserve for replacement costs are not typically considered operating expenses Course 8: Financial Mgmt
NET OPERATING INCOME(NOI) • GOI-OE=NOI • Applying cap rate to NOI allows you to determine property value using the income approach Course 8: Financial Mgmt
OPERATING EXPENSE RATIO • Expense to income ratio • Evaluation tool to measure property performance and expense control • % of GPR used to pay operating expenses • Ratio depends on age, location, property type, and expense classification • OE/GPR= operating expense ratio • 2010 NAA survey showed national OE ratio of 40% Course 8: Financial Mgmt
CAPITAL Expenses (CE) • Also called capital improvements • Includes non recurring expenditures like appliances, roofing, carpet replacement, etc. intended to add to the life of the property and its fixtures • Offer ability to depreciate over time Course 8: Financial Mgmt
DEBT SERVICE • Mortgage or loan payment- principal and interest payment • Fixed rate mortgages usually have level monthly payments that amortize the loan Course 8: Financial Mgmt
Break-even Occupancy Ratio (OE + DS) ÷ GOI 1, 803, 800 +1, 278, 000= 3, 081, 800 ÷ 4, 359, 000 = 71% Course 8: Financial Mgmt
Break-even rent per sq. ft. (OE + DS) ÷ total square feet $1, 803, 800 + $1, 278, 000= $3, 081, 800 ÷ 760, 000 = $4. 05 Course 8: Financial Mgmt
CASH FLOW CALCULATION • • Gross Potential Rent (GPR) -Vacancy, Concessions, collection losses (VAC) = Effective Gross Income (EGI) + Other Income (OI) = Gross Operating Income (GOI) - Operating Expenses (OE) = Net Operating Income (NOI) - Capital Expenses (CE), Reserve Payments (RR), and Debt Service (DS) • = CASH FLOW Course 8: Financial Mgmt
Activity #3: Cash Flow Calculate the cash flow of the NAA Apartments Course 8: Financial Mgmt
The General Ledger • Provides more detail of major financial statements • Chart of Accounts • Know cut-off date for invoices to be submitted Course 8: Financial Mgmt
Skill Check #3 Chapter 3: Economic Analysis of a Property Course 8: Financial Mgmt
Chapter 4 Budgets Course 8: Financial Mgmt
Purpose of a budget 1. To estimate expected income and expenses to determine what occupancy levels will be needed to cover expenses and provide a return on investment 2. To monitor the property’s performance 3. To evaluate performance of personnel Course 8: Financial Mgmt
Lease-up Budget • Special attention paid to activities and costs associated with attracting residents, signing leases and generating income • Information used for projecting expenses depends on your and your supervisor’s previous experience Course 8: Financial Mgmt
Modernization Budget • Reflects larger allocations for capital expenses and labor • Must be flexible if the work is dependent on contractors schedules and vendors supplies • May include periods of no rental income while work is being done in part or all of the building • May be prepared separately from the operating budget of a property and be for a short time only Course 8: Financial Mgmt
Stabilized Operating Budget • Reflects varying expenses from month to month Examples: – Utilities for heating would be higher in winter months – Utilities for cooling would be higher in summer months – Snow removal would be posted only for winter months Course 8: Financial Mgmt
Tips for developing budgets • • • Use round numbers Use current figures Prepare early Seek input Extrapolation/Annualization Course 8: Financial Mgmt
CAM Responsibilities • • Managing the budget Analyzing variances Explaining variances Recommending action Course 8: Financial Mgmt
Skill Check #4 Chapter 4: Budgets Course 8: Financial Mgmt
Chapter 5 Property Valuation Course 8: Financial Mgmt
Property Valuation • Is the process of determining the value of a property in order to make financial decisions regarding the property Course 8: Financial Mgmt
The Cost Approach • Estimates the current cost of reproducing or replacing the improvements, minus the loss in value from depreciation due to age, condition or obsolescence, plus land value • Important when there is no market activity and a sales approach cannot be used to value a property Course 8: Financial Mgmt
The Sales Comparison Approach • In this approach, the market value of a property is directly related to the prices of comparable competitive properties • Most useful when there are several similar properties in the local market that have been recently sold or are currently for sale Course 8: Financial Mgmt
The Income Capitalization Approach • This approach uses methods, techniques and math procedures to – analyze a property’s ability to generate income and – convert future earnings to present-day dollars Course 8: Financial Mgmt
Capitalization Value = NOI/Overall capitalization rate Course 8: Financial Mgmt
Skill Check #5 Chapter 5: Property Valuation Course 8: Financial Mgmt
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