What is Internal Rate of Return (IRR)?

In commercial real estate, it’s smart to think ahead and keep a close eye on the numbers.

As a commercial broker with more than two decades in the ring, I’ve continued to rely on a variety of metrics, including Internal Rate of Return, or IRR, to ensure my investments are sound.

IRR stands strong in its ability to identify the value of an investment over time. In essence, it quantifies the yield you’ll achieve after you invest in a property after an approximate ten year period — a metric used based on the average holding period of about seven to ten years.

The calculation accounts for the income generated by the property with expenses, or the Net Operating Income (NOI), and assumes you’ll sell the property based on future income on the tenth year.

calculating IRR

To calculate the IRR, you’ll need to identify expected cash flows for each year, accounting for outflows in the first year. To calculate cash flows, or the Effective Gross Income (EGI), you must subtract potential gross income from vacancy rates and identify your NOI.

Once you’ve identified assumed income achieved for each year, you should be able to see a steady growth. Ultimately, you should achieve an approximate 1 to 5 percent assumed growth rate per year.

Now that you have calculated the expected NOI through year 10, you are in the green to select a capitalization rate, or a cap rate, which is the ratio between NOI and the property’s asset value. You’ll want to make the selection for year 11, when you plan to sell the property.

Often, I’ll set the cap rate to about .5 percent higher than the rate in which I purchased the property — so if I purchased the property at a cap rate of 6, I’ll use a 6.5 rate in year 10 and cap the year 11 income to produce reversionary value.

IRR spreadsheet

Software programs like Excel do wonders in making IRR calculations a cinch. Often, IRR’s sit around 15 percent, however they can get higher if you’re refinancing a property or are involved in a development.

So, if you’re an investor looking to gauge the profitability of a future commercial real estate deal, I’d recommend taking a look at IRR.

How to Use the Investment Property Valuation Calculator: Step Five

Yesterday, myNOI covered Step 4 of the Investment Property Valuation Calculator (IPV). In the fourth step, investors found an estimated valuation of their commercial property by combing the income withe expenses. In Step 5, we’ll examine the debt taken on through your investment and the monthly payments you’ll make on your commercial real estate.

Step 5:

investmenr property valuation calculator

In Step 5 of the IPV Calculator, we’ll perform a financial analysis and take a look at the debt you’ll be incurring by investing in a commercial property.

investmenr property valuation calculator

The first information you’ll be asked for is the down payment and loan amount.

The down payment is the amount of money a buyer needs to pay up front before they can sign the building contract. Most property owners expect some form of down payment as a way to prove buyers have the capital to afford making monthly mortgage payments. The loan amount is simply how much money you’ll be borrowing to purchase the property.

After the down payment and loan amount, you’ll fill in information on Interest Rate, Amortization Period, and Monthly Payment.

The interest rate is the percent charged for borrowing assets. If the bank loaned you money, they make a profit from it by charging you an interest rate based on the total still owed.

An amortization period is the amount of time it will take you pay off the debt with fixed monthly installments. The calculator will then crunch your expected monthly payments based off the total loan and how long you will be paying it off. The finished Investment Property Valuation Calculator report will detail how much you will have left to pay off every month.

The final slots for Step 5, Annual Debt Service and Debt Coverage Ratio (DCR), are automatically calculated for you if all the above information has been filled out.

investmenr property valuation calculator

Your annual debt service is simply how much money you will need to generate yearly to cover both your repayment loans and the interest on top of them. The debt coverage ratio is determined by dividing the NOI by the debt service. Or to put it simply, how much you’ll be making by how much you’ll owe. Typically, a bank with require a DCR of 1%> before loaning you any money, as that signifies your property will generate a positive cash flow.

When you’ve entered all the values you can, hit “Go to next step” to continue valuing your property.

investment property valuation calculator

Come back Monday when we detail Step 6 of the Investment Property Valuation Calculator!

How to Use the Investment Property Valuation Calculator: Step One

 

investment property valuation calculator

The Investment Property Valuation Calculator is an invaluable tool for investors and brokers alike. When used effectively, the IPV Calculator can help you plan ahead with your commercial property investments. An in-depth reading of the results can reveal when the best time to sell would be, areas where building expenses could be trimmed back, and many other insights that will create the best return on your commercial investment.

Over the next week, myNOI will detail each step of the process. You’ll learn what each section is designed to inform you of, what some of the uncommon terms mean, as well as how to use the results to best leverage your investment.

To begin, visit IPVcalculator.com

 

Step 1:

investment property valuation calculator

The IPV Calculator relies on a short, seven step process to supply you with a ten-year plan for your commercial property. To start, answer the question, “What type of investor are you?”

investment property valuation calculator

Are you looking to buy or sell your property?

Next, you’ll specify the Property Type of your building. If you’re unsure, you can learn more about the five general property types here.

investment property valuation calculator

Different commercial real estate property types require different information to give you an accurate reflection of their worth. So it’s important to specify the correct type! The expenses for a multifamily apartment will be very different than those of an office property. As will the type of lease you have established with the tenants.

That’s it for Step 1 of the IPV Calculator! Pretty simple. When you’re ready for Step 2, hit “Go to next step” to continue valuing your property.

investment property valuation calculator

Come back tomorrow when myNOI details Step 2 of the Investment Property Valuation Calculator!

Commercial Real Estate News for Friday, Feb. 10

Happy Friday, investors and brokers! In today’s commercial real estate news, a write-up on Dodd-Frank’s slow roll out, a chastising of luxury brands slow online adoption, and Whole Foods struggles for its sixth straight quarter.

Killing Dodd-Frank Before the Rules are Even Fully Written

Despite being around for nearly 7 years now, nearly a third of Dodd-Frank’s regulations never been implemented. Lawful review and oversight committees have slowed down sections of the gigantic regulations bill. Donald Trump has promised to repeal broad swaths of it.

These Retailers are Still Way Behind the Curve When it Comes to Online Sales

Luxury brands are struggling in the age of e-commerce. The companies are slower to adapt their websites, due to a lower amount of customer data when compared to their cheaper competitors. Overall, online sales account for only 8% of the luxury market’s revenue. Brands with broader appeal have more than double that.

Whole Foods Is Closing Nine Stores After a Year of Sluggish Sales

Shares in Whole Foods shrank by 2.1% after posting its sixth straight quarter of store revenue decline. The natural grocer faces mounting pressure from online retailers like Amazon and Blue Apron. The company will be closing nine stores and “examining every aspect of [its] retail operations,” according to co-founder John Mackey.

Commercial Real Estate Crowdfunding Laws: Lets Get Technical

Commercial real estate crowdfunding laws can be dense, yet more than ever, commercial investors are harnessing the power of the internet to raise funds on the fly.

Crowd-sourcing websites like realtyshares.com, realtymogul.com and realcrowd.com draw in droves of investors on the daily, and the demand doesn’t appear to be slowing down anytime soon. In 2015, real estate investors dropped an estimated $484 million in crowdfunding sites alone.

Dubbed “the best way to invest in real estate,” these websites have leveled the playing field for investors of all financial capacities, but it hasn’t always been that easy. In fact, small investors have only been able to invest in these ventures for just over a year.

Before real estate crowdfunding hit its stride, investors made use of a method called syndication. In effect, an investor would often hire a sponsor to essentially track down a property and manage its sale. Project investors funded a large sum of the investment and eventually split the profit evenly based on share. Syndication was challenging to market, especially considering the types of technology on the market today.

The JOBS Act:

Jump ahead to 2012 and the commercial real estate crowdfunding laws change quickly — the Jumpstart Our Business Startups (JOBS) Act, Title III, was signed into law and effectively made real estate investment crowdfunding possible. The law required heavy involvement from the US Securities and Exchange Commission, which was tasked with rolling out a series of new rules before the JOBS Act went into full effect in 2015.

commercial real estate crowdfunding laws

The SEC started with advertising by deconstructing a part of the JOBS Act called Regulation D. In 2013, the agency lifted prior restrictions that prohibited the solicitation of private offerings for accredited investors while establishing protections against fraud under rule 506(c).

In 2015, the SEC altered Regulation A+, to open crowd-sourced investment opportunities to non-accredited investors, meaning an investor who has a net worth that’s less than $1 million and a gross income of $200,000 per year.

The regulation broke asset classes into two tiers — the first at $20 million or less, and the other falling between $20 million and $50 million raised per year. With this rule, anyone has the option to invest; for non-accredited investors, the cap is 5 percent of their annual income.

Finally, in January 2016, real estate crowdfunding websites could begin registering with the SEC.

For a full guide on SEC crowdfunding rules and regulations, visit the government’s website.

 

5 Commercial Real Estate Markets to Watch in 2017

As we head into the new year, it’s helpful to know which commercial real estate markets are expected to see increased activity in 2017. Nailing down which areas are set to perform well is not an exact science, but Zillow, Realtor.com and REFM have all released lists highlighting potentially strong markets. These are five cities found in at least two of those lists, with some context behind why experts expect them to succeed.

 

Seattle

The largest city in the Pacific Northwest ranks #2 on Zillow’s list of growing 2017 markets. The company points to Seattle’s property appreciation growth (5.6%) and relatively low unemployment rate (4.4%). Add on the city’s wide variety of industries and growing tech sector and you can see why the future looks bright for investors there.

Orlando

Commercial Real Estate Orlando

Orlando has long been a hot-spot for overseas investors to sink money into their commercial real estate portfolio. Thanks to the growing need for warehouses in the e-commerce market, industrial properties are expected to be in high demand in the coming year. In 2016, rent prices went up in every sector.

Phoenix

The capital of Arizona boasts growing employment numbers and a shrinking vacancy rate. Together with positive rent growth, these factors have many investors giddy about the city’s commercial real estate potential in 2017. An Urban Land Institute report suggests multifamily units are a forward thinking investment.

 

Salt Lake City

Salt Lake City Commercial Real Estate

The City of Saints experienced historic commercial real estate development in 2016. Many brokers found it hard to believe how extraordinary the market was doing. Zillow expects the trend to continue with property values predicted to grow by 4.3% and unemployment levels at a meager 2.8%.

Austin

The same Urban Land Institute report points to Austin as another hot market. From their findings, Austin withstood the financial crisis of ‘08 fairly well, and now benefits from a diverse local economy. The population is educated and growing as millennials travel south to a ‘hip’ city.

 

 

 

Commercial Real Estate News for Friday, Jan. 20

Happy Friday! Before you head off to your weekend, read these commercial real estate articles covering projected CMBS issuance, the record number of skyscrapers erected last year and growing rent prices.

Projected CMBS Issuance for 2017 Under $80 Billion

Higher interest rates and more risk retention rules may bring up issuance in 2017. A number of firms have forecast approximately $75 billion in the coming year. The numbers sits between 2016’s $60 billion and 2015’s $90 billion.

More New Multimillion-Dollar Skyscrapers Rose in 2016 Than Any Other Year in History

Nearly 130 commercial buildings reaching over 655 feet or higher were erected in 2016, beating 2015’s record of 114. A whopping 84 percent were built in Asia, which remains the most populated area for skyscrapers.

Rent in December Soars to Highest Growth Since Start of Recession

Limited supply and growing demand pushed rent prices 4% higher in December, the highest rise in rates since the Recession. To learn more about how supply and demand affect the real market, read our piece on the commercial real estate cycle.

Commercial Real Estate News for Tuesday, Jan. 17

In today’s commercial real estate news: an update on the blossoming real estate sector in Asia, marijuana’s link to high lease price rates, and traps for first time investors to avoid.

Capturing Growth in Asia’s Property Management Frontier

A letter on Asia’s commercial real estate market from Michael Lanning, the president of the Institute of Real Estate Management. Asian markets are watching America’s business model closely, hoping to learn from it and adopt the best practices.

Marijuana Interest Driving Real Estate Deals

As marijuana is set to become legalized in Maine on Jan 30, industrial properties are seeing record high lease prices. Entrepreneurs anxious to get in on the budding industry are looking for indoor farming spaces and storefronts.

Property Investing Pitfalls: A No-Fail Plan for First Timers

A handy list of pitfalls many first time commercial real estate investors fall into. In summary, don’t be too emotional, control your eagerness, do your research, and watch your finances. One of our most recent articles offers more tips on how to be a successful first time investor.

Commercial Real Estate News for Monday, Jan. 16

Welcome back!  In today’s commercial real estate news: Trump’s anti-regulatory stance encourages developers, construction firms brace for an influx of infrastructure projects, and the apartment sector begins to cool.

Homebuilders See Profit in Trump Bulldozing Environmental Rules

Developers are optimistic President-elect Trump will slash environmental regulations when he takes office this week. Homeownership is currently at a historic low, a fact many developers blame on the costs associated with meeting regulations. Despite this, nearly two-thirds of Americans say the laws are worth the price.

US Contractors Gearing up for Trump Spending Windfall

Nearly 75% of construction firms plan to hire on more employees in 2017, according to a survey released last week by developer firms. The optimistic outlook is founded on the hope Trump will make his campaign promises a reality by investing billions in American infrastructure.

Rooms to Go: Expect to See Less Apartment Construction in the Coming Months

After years of growth, the apartment sector may finally reach a plateau in 2017. Rising construction costs, a lack of desirable spaces and a labor shortage are all factors contributing to the cooling off.

Commercial Real Estate News for Friday, Jan. 13

Happy Friday! Our commercial real estate news aggregation today covers a forecast for the world’s commercial market in 2017, an analysis of why REITs are struggling in the S&P and coverage of a bill proposed to help Florida’s businesses with their commercial leases.

How Much Longer will Charlotte’s Commercial Real Estate Boom Last?

Kevin Thorpe, global chief economist for Cushman & Wakefield, spent Thursday forecasting the future of Charlotte’s commercial real estate market, as well as the world’s. For the short term, Trump’s tax cuts, combined with a boost to infrastructure projects, should give a boost to the US economy.

REITs Stumble After S&P Debut

REITs have had difficulty gaining momentum since forming their own S&P 500 real estate sector in late August. Acute sensitivity to increasing interest rates may be to blame for the under-performing stocks.

Larry Ahern Files Bill to Provide Commercial Sales Tax Relief

Good news for Florida business owners. State Rep. Larry Ahern proposed a bill to do away with the tax Florida tenants pay on their commercial real estate leases. According to Ahern, the law will affect 300,000 businesses in the first year, with 1 million eventually benefiting.