Jenny Lilly/Construction Photography/Avalon/Getty
Traditionally, the cap rate has been one of the indicators for valuing investment property. Simply stated, the cap rate shows the rate of return an investor receives before debt service. You can calculate it by taking the net operating income of the property and dividing it by the purchase price. The answer will give you the cap rate related to the property……Story continues…
By:
Source: Forbes
.
Critics:
Real estate properties may generate revenue through a number of means, including net operating income, tax shelter offsets, equity build-up, and capital appreciation. Net operating income is the sum of all profits from rents and other sources of ordinary income generated by a property, minus the sum of ongoing expenses, such as maintenance, utilities, fees, taxes, and other expenses.
Rent is one of the main sources of revenue in commercial real estate investment. Tenants pay an agreed upon sum to landlords in exchange for the use of real property, and may also pay a portion of upkeep or operating expenses on the property. Tax shelter offsets occur in one of three ways: depreciation (which may sometimes be accelerated), tax credits, and carryover losses which reduce tax liability charged against income from other sources for a period of 27.5 years.
Some tax shelter benefits can be transferable, depending on the laws governing tax liability in the jurisdiction where the property is located. These can be sold to others for a cash return or other benefits. Equity build-up is the increase in the investor’s equity ratio as the portion of debt service payments devoted to principal accrue over time. Equity build-up counts as positive cash flow from the asset where the debt service payment is made out of income from the property, rather than from independent income sources.
Capital appreciation is the increase in the market value of the asset over time, realized as a cash flow when the property is sold. Capital appreciation can be very unpredictable unless it is part of a development and improvement strategy. The purchase of a property for which the majority of the projected cash flows are expected from capital appreciation (prices going up) rather than other sources is considered speculation rather than investment.
Research results that found that real estate firms are more likely to take a smaller stake in larger assets when investing abroad (Mauck & Price, 2017). Some individuals and companies focus their investment strategy on purchasing properties that are in some stage of foreclosure. A property is considered in pre-foreclosure when the homeowner has defaulted on their mortgage loan.
Formal foreclosure processes vary by state and may be judicial or non-judicial, which affects the length of time the property is in the pre-foreclosure phase. Once the formal foreclosure processes are underway, these properties can be purchased at a public sale, usually called a foreclosure auction or sheriff’s sale. If the property does not sell at the public auction, then ownership of the property is returned to the lender. Properties at this phase are called Real Estate Owned, or REOs.
Once a property is sold at the foreclosure auction or as an REO, the lender may keep the proceeds to satisfy their mortgage and any legal costs that they incurred minus the costs of the sale and any outstanding tax obligations. The foreclosing bank or lending institution has the right to continue to honor tenant leases (if there are tenants in the property) during the REO phase but usually, the bank wants the property vacant in order to sell it more easily.
Buy, rehab, rent, refinance (BRRR) is a real estate investment strategy, used by real estate investors who have experience renovating or rehabbing properties to “flip” houses.BRRR is different from “flipping” houses. Flipping houses implies buying a property and quickly selling it for a profit, with or without repairs. BRRR is a long-term investment strategy that involves renting out a property and letting it appreciate in value before selling it.
Renting out a BRRR property provides a stable passive income source that is used to cover mortgage payments while home price appreciation increases future capital gains. The phrase was slightly updated in a 2022 Bloomberg News article noting that BiggerPockets added “Repeat” to the end, making it “BRRRR” to describe a real estate investing strategy of Buy, Rehab, Rent, Refinance, Repeat.If the property requires substantial repair, traditional lenders like banks will often not lend on a property and the investor may be required to borrow from a private lender utilizing a short-term bridge loan like a hard money loan.
Hard money loans are usually short-term loans where the lender charges a much higher interest rate because of the higher-risk nature of the loan. Hard money loans are typically at a much lower loan-to-value ratio than conventional mortgages. Some real estate investment organizations, such as real estate investment trusts (REITs) and some pension funds and hedge funds, have large enough capital reserves and investment strategies to allow 100% equity in the properties that they purchase.
This minimizes the risk which comes from leverage but also limits potential return on investment. By leveraging the purchase of an investment property, the required periodic payments to service the debt create an ongoing (and sometimes large) negative cash flow beginning from the time of purchase. This is sometimes referred to as the carry cost or “carry” of the investment. To be successful, real estate investors must manage their cash flows to create enough positive income from the property to at least offset the carry costs.
In the United States, with the signing of the JOBS Act in April 2012 by President Obama, there was an easing on investment solicitations. A newer method of raising equity in smaller amounts is through real estate crowdfunding which can pool accredited and non-accredited investors together in a special purpose vehicle for all or part of the equity capital needed for the acquisition. Fundrise was the first company to crowdfund a real estate investment in the United States.
SAMRRA unlocks data for investment into the multifamily residential property asset class
Leave a Reply