Some more financial education
Entrepreneur of the Week Alon Gilmore
# Post 3
* Hebrew is a gender language. And today, twice because it's good - I want the post to be in female language, a bit of balance - but of course the intention is absolute, for both sexes. Thanks.
***
About a week and a half ago, I built with Kate, our renovation manager in Pittsburgh, a renovation plan for a particular house we toured — in preparation for renting it out.
—
About two and a half hours ago, my dentist in Tel Aviv, built me a thorough renovation plan for my 2 teeth, while doing a cute root canal that I did with a third tooth.
And here's the difference between investing and committing.
The first - operating expense - the second - operating expense.
And here is the educational conclusion I want to convey from the little Case Study we have here:
Do not skimp on dental floss.
***
Today, as I promised you, I'll show you what a deal review looks like from the entrepreneur's eyes, long before it becomes a presentation to an investor. Do an X-ray for the marketing investment presentation. Want to see what's back there.
From my experience working with hundreds of investors over the years, I have found that for many of them, everything that seems important in a deal - is actually the least important, and as for what is cardinal, in any real estate transaction offered to them - most of them will not pay attention. For the simple reason that they are not their day to day business. I do not know what my dentist will do there, but I'm not interested at all. she said? I do. Why? For one reason only. Because I trust her.
No theoretical knowledge replaces knowledge gained from action. It is impossible to learn to swim by correspondence.
***
Then came to us the developers, a multifamily deal. Suppose a residential building, suppose 100 units (apartments),
Each unit (or door) is priced at $ 50,000, meaning the entire project costs us $ 5 million green. Right?
Suppose the transaction is in our area of activity and therefore we will proceed from the assumption that the shell area, the macroeconomic data shell, everything is checked and approved. Let's move forward.
Do you remember I wrote that, unlike houses, singles, which depend on market prices - in multiples the game is Performance.
The building is a business. Every apartment does not have a landlord. But the whole building belongs to one owner. And is the property company owned by investors. And its function, to give good residence to the tenants, and to make profits to the owners of the building.
We are looking for a building that has a market distortion, for example: the rent is significantly lower than what is customary in the area. Or a property that has run really badly historically, or the owner just does not want / can not renovate in order to improve and is willing to sell us at a price lower than the value.
Or the occupancy of the property is low. We want an asset to which value can be added, to improve operating income.
Why do I want operating income to go up? Awwwwwwwwww ……. Do you know Show me the money?
So this money is right here. Where's the money? Here's the money. In improving operating profit. Or called NOI- Net Operating Income
And what is it really? That's a number. A number that sums up the annual income we have from the property, (rent, washing machines, etc.) everything in the building that makes us money. Of which reduces operating expenses (taxes need? Insurance need? Appliances? Maintenance and upkeep,, management need ?, advertise the property to new tenants, need? Need!)
The NOI is so important, because it is the basis for valuing the property, and if we manage to increase it (this line of operating profit) it will have such a dramatic effect on the value of the building or the whole property, (I will turn you on to that, another second).
***
So a moment before you go to examine a deal through the eyes of an entrepreneur, here are some basic concepts in income-producing assets, without which it is impossible to move forward. For those who are not trained in concepts there is a moment of learning here. Are you registering? - Cap Rate
It's really important to understand: it's an estimated percentage of return that the property will generate on our investment. So we said the sale price of our building is $ 5,000,000. And suppose he had an NOI (operating profit, you remember) of… number shots? Come on, $ 300,000 a year.
So in this case the Cap will be 6% (300,000 / 5,000,000) a drop lost? Let's get you back fast: Suppose after we buy the property, unlike the previous owner, we allow pets into the apartments.
And of course we charge another 30-40 dollars a month for it (very acceptable). I'm not even talking about remodeling anymore - just a small example of a small improvement in profit, for NOI. How much do you think the building is worth now? Let’s count: $ 35X 100 units X 12 months = $ 42,000 more per year.
How much is $ 42,000 divided by 6% (the cap)? Madam, the answer is $ 700,000. Yes. In this building, we raised its value by $ 700,000 just because you allowed everyone to bring their pets.
And if this situation stays like this long enough - then the bank, when we repay the loan, will give us at $ 5.7 million and not at its current value. Hmm?
magic. Multi-family.
There's one huge quote by Woody Allen I think, that I'm dying for (on the quote), he says: "There's only one thing that separates me from genius - and that's me.
Just before you all now want to seek to flood the US apartments with animals, stop for a second, and remember that this is just an easy example to illustrate, what the power of adding value to an income-producing property, can do. The reality is that such an improvement is only found in posts. The reality is tougher and more complex.
***
So what we need to know and get from our seller and our sources is this data: what is the NOI of the property, and what is the cap in the area. (The cap varies from area to area, and neighborhood to neighborhood). High cap - lower price. Low cap - higher price. (And both yields and lower risk). Then I know by NOI how much the asset is worth, (NOI / Cap rate)
Cash flow Cash flow - easier to explain, really really simple. It's the same NOI, only you reduce the cost of financing (the mortgage). Then the net flow is obtained.
And last before we start playing - Cash On Cash - a very fun term. I will try to explain it in a different way than usual. It serves us to know how fast our money is growing. If we invested in equity say $ 100, that figure will tell us how quickly we will recoup the investment. If we returned the entire amount within 10 years, it means our COC is 10% per annum. How easy? ***
So when you are considering a deal in the eyes of the developer, what we call due diligence you want to check what results this property produces today. Right? What are we paying for?
Where do you see it? We will not go into too much depth, you are probably tired of the previous section anyway, but by and large there are 2 reports for this: a current profit and loss report, (Actual) and there is the pro forma. (Describes what the potential could be).
Usually the seller will strive to sell proforma, but we will stick to Actual.
We want to see: Economic occupancy rates: Not just how many tenants there are currently, but how many tenants are paying. We of course want to see revenues higher than our expenses and our NOI
We want to see that the NOI is higher than the expected bank financing payments.
As for the cash flow- very simple, must be positive.
Next I want to check similar properties in the area, and make a comparison between all of them regarding SHAD, price per door, price for SF, regarding occupancy rates, see that we are talking about the same CLASS.
Then, when I have all the information (it's huge, the research is many days per property), I calculate the return on the project, plan the type of financing that will accompany the project (usually a balloon loan for the first few years, which pays only the interest and rejects the principal , To produce cash flow as fast and edgy as possible).
After I have everything, including an inspection report from a building engineering company that reveals to me how many renovations need to be done inside the apartments and the outer shell to maximize rent - I build an internal business plan, called in professional language "Underwriting" which will later be submitted to the financing bank as part From the loan documents. And from it will also emerge the business plan for investors and marketing presentations for recruitment. So I know how much I am willing to pay for the property. Of course offers much less.
So we closed, everything is great.
Builds a business plan.
The plan consists of: the cost of purchase, the cost of renovations, cushion (reserve funds), closing costs (brokers, title company, attorney, etc.). Marketing, due diligence, legal, and more and more and more blue which is by the sea.
It also consists of the expected revenue, the pace of progress of renovations and improvements, and of course the costs of bank financing.
The result is an L&P report - a profit and loss statement, which actually tells the story of the investment.
And when I know from all this, what is the return of the project, (not to the investor, but to the project) and I know how much money needs to be raised for equity - from this start cutting into participation units (which will become something like the project partners stock which also leaves assets). The partner for the entrepreneur - that will be symmetrical for everyone's contribution to the project.
Then- there are also expected returns at the level of each investor according to his participation unit.
And finally - if the numbers work, then come on: Show Time. Build a presentation, and set out, to you the investor, to recruit you for a partnership.
***
Now you know what the investment is, how much money and when it will come back to you at each stage, you know where this money comes from and what the economic logic behind it is. You know, there must be logic in the story of every property offered to you. You just have to understand it from the entrepreneurial angle.
***
There is no doubt that I skipped / forgot / omitted an infinity of steps along the way. The goal is not to do an entrepreneurship course here.
All I wanted was to show you what's possible for you. And why I do what I do.
And why financial education is as important as knowing what is healthy for you to eat and like walking with your eyes open.
And be scared of the fact that no Social Security / provident fund / State of Israel will be there when you have to live off your pension, if you do not take responsibility and start taking care of it yourself. since when? from yesterday.
***
I always think, that there really is a lot to learn and know, it never ends. And it can be .Overwhelming
Do not give up financial education for you and their child, I am also constantly learning. This is our life.
Besides, take comfort, always remember that there will always be someone who has learned harder than you.
Ask my dentist.
Responses