introductions - national apartment association...1 introductions • your name • where you work...

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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 2

Agenda

•  Investments •  Adding Value to the Investment •  Economic Analysis of a Property •  Budgets •  Property Valuation


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


Definition: Investment

•  An investment is the use of funds to earn a profit.


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


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Owner’s Objectives Why is it important to know the

owner’s investment objectives for the property you manage?


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?


Performance Measures

•  Rate of return on investment (ROI) •  Cash-on-cash return •  Capitalization rate •  Internal rate of return (IRR)


ROI •  Rate of return on investment = performance

measure used to evaluate the efficiency of an investment

•  “Return” can be cash, cost to manufacture vs. price, appreciation growth or some other benefit compared to cost

Benefit/Cost = Return


Capitalization Rate

•  NOI/Purchase Price = Cap Rate •  NOI/Cap Rate = Value


Exercise

•  We paid $7,000,000 for a property and the NOI is $500,000. What is the cap rate?

•  Divide NOI by 6%.


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Remember

•  Lower cap rate = higher value

•  Higher cap rate = lower value


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


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)


Forms of Ownership •  Direct ownership/sole proprietor •  Limited liability partnership •  Limited liability corporation •  S corporation •  Joint venture •  Real Estate Investment Trusts (REITs) •  Tenants in Common (TICs)


Types of mortgages

•  Fixed rate •  Variable rate •  Balloon •  Bullet loan


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)


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Skill Check #1 Chapter 1- Investments


Chapter 2

Adding Value to the Investment


Adding Value: CAM Responsibilities

1.  Generating and collecting as much income as possible

2.  Controlling expenses 3.  Meeting the financial goals of the

investment


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


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


Types of Expenses •  Maintenance •  Administrative •  Salaries/Personnel •  Taxes

•  Insurance •  Utilities •  Contract services •  Advertising and

Marketing


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Three Factors That Affect Rental Income

•  Competitive rental rents •  Physical occupancy •  Collection percent or economic occupancy


Concession Impact

Market rent = $700 Concession = one month rent What is the Effective Rent?


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.


Economic Conditions

•  Population growth •  Household formation •  Job creation


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


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?


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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?


Before adjusting rent, analyze the four P’s: • People • Product • Promotion • Price


Determining Pricing •  Conduct a market analysis •  Use an automated revenue management

system


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


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


Managing Occupancy: Reports

•  Occupancy reports •  Rent roll •  Delinquency report •  Deposit/Income reports •  Concession report •  Demographics report


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Managing Occupancy: Methods

•  Calculate occupancy trend •  Manage lease expirations •  Calculate turnover ratio


Activity #2: Adding Value


Expenses •  Fixed – property taxes, insurance •  Variable –utilities, turnover costs, etc. •  Capital- appliances, HVAC, etc. •  Replacement Reserve Account •  Debt service


Cost Benefit Analysis •  Potential Expense

–  Dollars –  Time –  Image

•  Potential Benefit –  Income –  Time –  Employee satisfaction –  Market position –  Image


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


Skill Check #2 Chapter 2: Adding Value to the Investment


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Chapter 3 Economic Analysis of a Property


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

Balance Sheet May 31, 2010

ASSETSPetty Cash 300Cash 11,055Cash Fund 7,700Prepaid Insurance

Building 16,350,000Less Depreciation 885,000

Building Net 15,465,000Land 3,750,000

Furniture & Equip 400,000Less Depreciation 100,000

Furniture & Equipment Net 300,000Escrow 223,000

Total Assets 19,534,055

LIABILITIESAccounts Payable 55,000Notes Payable 12,275,000Accrued Interest Payable 637,700Accrued Property Tax 422,000Security Deposit Liability 96,000

13,485,700

EQUITYPartners Equity 9,010,355Distributions to Partners -432,500Prior Period Earnings -2,544,500Current Earnings 15,000

6,048,355

Total Equity 19,534,05545 Course 8: Financial Mgmt

Rental Income $19,450,000Other Income (Fees, Vending, Utilities) 1,815,000Vacancy & Collection Loss -97,500Effective Gross Income $21,362,500

Operating ExpensesFixed Expenses

Real Estate Taxes $1,268,000Insurance 97,600

Variable ExpensesPayroll 238,100Repair & Maintenance 598,800Utilities 1,636,000Contract Services 335,000Administrative & General 272,000Management Fee 102,000Advertising & Leasing 190,000

Total Operating Expenses $4,737,500

Net Operating Income $16,625,000

Other ExpensesInterest 912,000Replacement Reserves 200,000

1,112,000

Total Expenses 5,849,500

Cash Flow 15,513,000

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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


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


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Gross Potential Rent (GPR) •  Current rent charged at 100% occupancy-

combines 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


Market Rent •  Total annual income received if 100% of all

units were occupied and paying market rents


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


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


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 non-revenue units

•  Standard for uncollectible/bad debt- 2% of GPR

•  VAC can be higher than10% of GPR


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


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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


Gross Operating Income (GOI)

•  EGI + OI = GOI •  Property’s total revenue •  Available to pay property’s operating

expenses, capital improvements, and debt service


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


Net Operating Income (NOI)

•  GOI-OE=NOI •  Applying cap rate to NOI allows you to

determine property value using the income approach


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%


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


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Debt Service •  Mortgage or loan payment- principal and

interest payment •  Fixed rate mortgages usually have level

monthly payments that amortize the loan


Break-even Occupancy Ratio

(OE + DS) ÷ GOI 1,803,800 +1,278,000= 3,081,800 3,081,800 ÷ 4,359,000 = 71%


Break-even Rent Per Sq. Ft. (OE + DS) ÷ total square feet $1,803,800 + $1,278,000= $3,081,800 $3,081,800 ÷ 760,000 = $4.05


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


Activity #3: Cash Flow Calculate the cash flow of the NAA Apartments


The General Ledger •  Provides more detail of major financial

statements •  Chart of Accounts •  Know cut-off date for invoices to be

submitted


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Skill Check #3 Chapter 3: Economic Analysis of a Property


Chapter 4

Budgets


Purpose of a Budget •  To estimate expected income and expenses

to determine what occupancy levels will be needed to cover expenses and provide a return on investment

•  To monitor the property’s performance •  To evaluate performance of personnel


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


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


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


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Tips for Developing Budgets •  Use round numbers •  Use current figures •  Prepare early •  Seek input •  Extrapolation/Annualization


CAM Responsibilities

•  Managing the budget •  Analyzing variances •  Explaining variances •  Recommending action


Activity #4: Review a Budget

Identify figures that may point to extraordinary conditions or needs.


Skill Check #4 Chapter 4: Budgets


Chapter 5

Property Valuation


Property Valuation •  The process of determining the value of a

property in order to make financial decisions regarding the property


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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


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


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


Capitalization Value = NOI/Overall capitalization rate


Skill Check #5 Chapter 5: Property Valuation


introductions - national apartment association...1 introductions • your name • where you work...

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