So today I'm going to show you a few secrets
of how we underwrite deals each and every week.
So if you watch the last two videos, you saw the first video, which was
all focused on revenue, the second video which was focused on the expenses.
And today this is where it all comes together,
because each deal is exactly the same
income expense, debt, cash flow.
And that's the same formula we're going to follow today.
In this video, we're going to determine goal or no goal.
So does the property cash flow and does it have any upside at all?
In other words, is there a value add to it or is there a story that you could tell
to your investors or your partners or even your spouse?
Just to summarize in video, one, we talked about income and video.
Two, we talked about operating expenses.
Of course, that generates your net operating income or your and apply.
In this video, we're going to focus on debt and cash flow.
And it's important to understand on that a lender
and an underwriter takes a look at the net operating income.
So the net operating income becomes the most important thing in the deal from
a lender standpoint and from an investor standpoint because it produces cash flow.
And in the first two videos I talked to you guys about how to increase income
and manage expenses, the key to all successful real estate investments.
So staying consistent with video number one, we had the market rents,
of course, is 1500 and those are the reds in the market today.
If somebody moved out and back in, you would rent that unit at 1500.
The actual reds, of course, are the rest of the people that live there. Now.
So this would be a lag.
These people would be maybe they live there two or three years,
maybe in four years, but their rents are averaging around 1350.
This creates a loss to lease on the average of about $150 per unit.
This is a very, very important thing to know,
especially if you're looking to add value to your investors.
The third thing we're going to talk about is economic rent,
and that is the actual money that you actually deposit in the bank.
So this number would include vacancy delinquency models,
any kind of issues where you're not collecting rent in a unit that you have.
So set another way, this would be a 10% vacancy number,
but it's economic vacancy, not physical vacancy.
The last piece of the income, of course, is other income.
And I'm always looking for ways to increase income or ways to increase value.
On this property.
We found out that they need some location premium.
For example, a view unit would be less than a unit with no view
or any kind of upgrades like better flooring or even washers and dryers.
So I add in about $100 per unit per month on this particular property.
This is a very typical thing you would find
when you're purchasing a property.
So now let's take a look at the math.
As you can see at full market reds,
this property generates about $900,000 a year.
Currently, however, based on the actual rates,
it's somewhere around $810,000.
That creates a $90,000 loss
to lease opportunity for the new buyer.
In other words, as we would like to say, that's 90 grand that's sitting inside
of the rent roll that could potentially be raised up on turnover of each unit.
The next item is, of course, just managing the property a little bit
better and maybe lowering that economic vacancy from 10% to 5%,
which we've given a value of about $40,000.
So this, of course, is more of a management issue or an oversight
issue where you can actually generate a little bit more cash.
So the $729,000 is actually 90% of the 810.
Don't forget, the actual rents are 810, not 900.
And so 90% of 810 is $729,000.
So on the average, this property today
would be generating about $729,000 in total revenue.
The last piece is, of course,
the other income, and this is $100 a unit times 50 times 12.
It's right around 60 grand.
These would be what we would call value add or a story.
There's a lot of money sitting in this property in the rent roll right here.
In fact, this is about $190,000 opportunity
and even more if you can get that economic rent even higher.
So now let's summarize the numbers.
We know that we had income around $729,000 from the last slide we just looked at
and the expenses are running right around 300 grand.
What puts our at a Y or the net operating income at $429,000.
So most banks are
going to look at this number and apply some kind of insurance policy around that,
which is called a debt service coverage of around, let's say, 30%.
So 30% of $429,000 is about 129 grand.
That puts a debt service right around 300,000
maximum that the bank will lend on this property.
That generates about $129,000 of cash flow.
So this would probably be a very close picture
of exactly what the bank would do if you were to buy this property today.
So let's say you got this property in a package from a broker.
You would take the $429,000,
you would use the cap rate today, which is right around, let's say, 5%.
You take 5% and divide that into the 429
and it gives you a value of around 8.5 million.
So a solid offer would be about 8.5 million.
The problem with this right now is, as you can see here,
that generates only about a 4% cash on cash return.
Well, as we all know, we can get a better return than that in the bank today.
So if you stop right here, you might pass on this deal.
So here's how this deal might go down.
You take the $8.5 million offer,
you take it to the bank and you ask how much loan will they give you?
At about 65% loan to value, which is low,
It's about 5.5 million, which of course requires
about a $3 million equity, which is the down payment.
And you take the $129,000 in cash and you divide that into the 3 million.
And you can see that that's not a very good return of sitting around 4%.
However, we have applied our story.
We haven't applied our value add to this asset at all yet,
and that's where the opportunity is.
You can't make that decision yet for a go or no go
until you look at the whole picture and what you might do on this property
moving forward.
So now let's talk about where we could take this project,
the exact property still generates about $429,000.
We know from Slide one that we have about $190,000
value add sitting in the Revel, as shown you earlier in this video.
So that brings your potential to about $919,000.
Now you can see that I actually incur expenses from 300 to 350.
Now, I'm pretty conservative these days.
We are seeing higher property taxes.
When you purchase something at a higher price
and we are seeing higher insurance costs and higher utility costs.
So just to be conservative, I actually increased the expenses for this video.
So I can show you that
there's still a very good value add, even though the expenses may have gone up.
So once again, I take the income minus the expenses and I've now got an A.I.
of $569,000.
As you know, that's a significant increase of what we started with.
So here's what it might look like on a yearly basis.
Year one we already showed earlier in the video that we have
about $129,000 of cash flow in year two.
Maybe you capture about 100 grand of the 190,
and so your cash flow is closer to 229.
In year three, it's a little over 300,000 at 319.
So you can see over the three year period,
the goal is to capture the $190,000
value add inside of the rent roll to grow your A.I.
to 569,000.
So using the exact same number, 5%
cap rate brings now the value to 11.3 million.
As you can see, just by doing this and the higher expenses,
I was able to deliver a value add of almost
$3 million from the original purchase price.
This is what gets investors excited.
Now you take the 569,000 A, you apply the 5% cap
assuming cap rates are the same and you get a value of about 11.3 million.
This, of course, is almost a $3 million value
add almost entirely found just in the right role.
So we're going to take 65% loan to value, which is what we did on the last slide.
And we're going to get 65% against 11.3,
which is about a $7.5 million loan.
So that's $7.5 million loan as essentially a cash out refinance.
So you take the $7.5 million loan and you pay off the $5.5 million loan
that we had here.
And what you have now, as you have an extra $2 million, this,
of course, is just a return of equity, which is just fine.
But what you've done is you taken $3 million of your money
or somebody else's money and invested it and just add a few years.
By growing the net operating income, you're able to return two of it back
tax free because it's a return of capital on the original equity,
leaving only a $1 million equity balance in the property.
But of course, this cash out refinance also means you're going
to have a higher debt payment from, let's say, 300 to 400000,
which is going to reduce your cash flow again, leaving your cash
flow at about $169,000.
The beautiful thing here is you invested $3 million three years ago.
You've gotten 2 million of it back tax free.
Now available to invest somewhere else again.
And you have 1 million left, which is producing
a $169,000 of cash flow, which is now a little over 16% cash on cash return.
So this property clearly is a go as opposed to a no go,
which it almost looked like in the beginning of the video.
But you have to pay attention to all the details,
including your income and your expenses and how that all drives the cash flow.
One big caveat here, I use current interest rates.
So this was around five and a half percent interest rate
on the seven and a half million dollar new loan.
I also use 65% loan to value
and I also used a 5% cap rate.
These things can vary from lender to lender and from market to market.
So I know some cap rates that are still quite low, lower than 5%.
And I know some markets that are actually a little bit higher.
So make sure that you understand what's going on with these three things
before you start to take a look at these values and more importantly,
that you fix this and lock this down today
because you might be sitting on a property for a long period of time
if the interest rate goes up or the cap rate goes up even more,
you might have trapped equity in this property for a long period of time.
So it's really important that you understand all the risks
as you start to look at your exit or whatever deal you're buying.