This article was written by Leanne Goff, a current REALTOR® University Masters of Real Estate student, and is Part 3 of a 12 Part Series.
This class was when the coursework started getting into the nitty gritty of real estate. Taking graduate level work on real estate finance and investments was a departure from the emotional evaluation that most buyers make in a residential transaction and a step into the investment focus of a commercial investor. We covered information on the structure of a mortgage, accounting techniques associated with evaluating a real estate transaction, and evaluated the investment potential of a commercial building.
Breaking down a mortgage took many different perspectives. First, we evaluated the elements of a mortgage including the interest and payments. The goal was to understand how the various loan packages might benefit different investors. For example, understanding the interest rate and number of payments helps to evaluate the cost of the loan over time. Questions were asked about how much a 30 year loan really costs when evaluated next to a 15 year note. There were also discussions around more creative loan structures such as installment land contracts, or owner carried notes. The class also evaluated the cost benefit of refinancing a loan determining when the breakeven point is achieved. That is the balance between the costs of refinancing by the monthly savings each month to determine when the true savings are achieved.
In addition to understanding the true costs of a loan, in this class we started to evaluate the true cost of money invested when purchasing commercial buildings. This included an evaluation of the Net Operating Income (NOI) anticipated for a property over time. This information was evaluated compared to the Debt Service (DS), or the cost of the loan over time. These calculations broke down the before-tax cash flow, helping us understand the gross income for a potential investment.
Of course, the before tax income isn’t the full picture an investor needs in order to consider the profitability of a property. They need to know what the cash flow will be after taxes. To determine this we called again upon the previous classes where we were breaking down a loan to understand the amortized interest rates over time. In addition, there is depreciation on the property over time. Removing the interest and depreciation of the operating income helps determine the taxable income for property annually. This understanding was applied to our final project, which was to analyze an actual real estate listing for a commercial building that was available in our markets.
My final paper was for a subject property located in Denver which was listed for $5,400,000 claiming to be 100% leased. It was my responsibility to verify as much information as possible to create a presentation on the investment potential of this property. Some of the details that I was considering included a location analysis, where I visited the property and took photos to be included in the paper. A critical component was the financial or cash flow analysis, where I preformed the calculations based on the NOI based on the listing agent’s presentation of expenses and income from the listing packet. Using my fictitious investors potential montages packages to determine the cost of the loan, depreciation of the building I was required to present the taxable income and ultimately potential profit while investing in this property.
These calculations were complicated and difficult to do by hand making this one of the most challenging classes at REALTOR® University. Throughout the completion of the course project I was visiting with commercial REALTORS® in my community constantly asking for their advice and evaluation of my calculations. One of the commercial REALTORS® said to me, “These calculations are what we use every day when selling to our commercial investors.” This agent was amazed and impressed that I was able to both crunch the numbers as well as understand the meaning of their outcome. Taking this class got me excited about the potential of working on commercial projects for people who want to buy real estate for investment purchases. It also showed me how complicated a commercial real estate transaction can be; with that much money at stake mistakes could be very costly. Therefore, I have a very healthy respect for the work of a commercial investor.
Leanne Goff is a managing broker with TrailRidge Realty, an independent real estate agency in Boulder, Colo. She has been licensed since 2008, and is active with the Boulder Area REALTOR® Association. Her work with BARA’s YPN led to achieving NAR’s Small Network of the Year Award in 2014. Connect with Leanne on Twitter: @leannegoff, or on LinkedIn.