Problem:
Assume that you are able to obtain a loan from the bank for up to $10,000,000 at 7% interest annually. You are to create a portfolio of real estate investments from real estate properties currently listed for sale. Select a minimum of 3 properties that you can purchase with this loan from any source, for example, Realtor.com. These investments can be from anywhere in the United States and from any price range (use current market values). Calculate the expected total cost of purchase for these investments. Calculate the expected annual payments for mortgage interest, property taxes, and insurance. Calculate expected gross rents and net operating income. Compare the expected net operating income to your expected mortgage interest, property taxes, and insurance payments. Make conclusions as to whether these investments are profitable based on your analysis. Use concepts found in the course to defend your position. You can make any realistic assumptions necessary.
Case Study 1
Select a minimum of 3 real estate properties that you can purchase with the $10,000,000 loan. -Try to get close to the loan limit. At a minimum stay at over 50%. You also need to consider whether you are getting a loan for 10M or if the 10M is the limit with the assumed 30% down payment. It doesn't matter to me but it is the difference of 3M.
Calculate the expected total cost of purchase for these investments.
Total cost needs to include closing cost and any down payment you expect to put down. Students often forget about closing cost but these can be substantial. They will differ based on your type of property so once you have selected your properties do a search on average closing cost for your type of property.
Calculate expected annual payments for mortgage interest, property taxes, and insurance.
The principal and interest component can be done in Excel or using a payment calculator you find online. As far as the rate goes you will need to research this since it does change over time. You do not need to reach out to lenders but you do need to search the internet for a fair approximation. For property taxes you may find them in your listing or you can also try the county assessor office. As a very last resort a rule of thumbs such as 1.25% of the purchase price can be used. Insurance will be more difficult and I anticipate that most of you will just use a rule of thumb that you find since many variables play a role and I do not want you to solicit quotes.
Calculate expected gross rents and net operating income. -
This material is covered in chapter 6. I will also provide a 10 minute video and example that can help with this topic. It will also be useful for the exams.
Expected gross income and net operating income may be provided if you use a site like loopnet. In fact this may be a deciding factor when choosing your properties. For gross rents if you are evaluating residential you can try looking up market rents using a tool like rentometer.com or simply looking for available rentals in the area and what they are going for. If you expect them to climb annually at what rate do you expect and why? For the NOI you will need to find the vacancy rate for your area as well as the expected operating expenses.
Compare expected net operating income to your expected mortgage interest, property taxes, and insurance payments.
This is a combination of the above two requirements. The goal here is to determine whether your property will be in the black or red
Make conclusions as to whether these investments are profitablebased on your analysis.
How are you going to gauge profitable? Is it based on a percent of return? Will you use a simple holding period return? A cap rate? Maybe a cash on cash return? I am not concerned with how you gauge profitability but that you make a choice on the measure and draw a conclusion.
Case 1 Notes
These bullets address common areas that students miss or receive less than full credit on.
- When asked to calculate the total cost of purchase this is not just your equity position but should also include expected or assumed closing cost.
- The annual payments that you compute should not be based on arbitrary assumptions. For example, when computing your mortgage payments realistic assumptions should be made and referenced. This also relates to the cost of insurance.
- Gross rents can generally be retrieved from the listing but if this is not the case use outside resources to justify your gross rent assumptions
- When you arrive at your NOI figure remember that this takes into account operating expenses. Because these figures may not be in your listing you may need to make several assumptions here as it relates to your operating expenses. Chapter 5 shows a few exhibits that could help you to generate the line items and statements you will need to arrive at NOI.
- When making conclusions make sure to reference what you are using to draw a conclusion. Are you just referring to gross rents? NOI? Basing your conclusion on only one factor is not an ideal.