Commercial Investment Real Estate Winter 2020 | Page 42

CASH FLOW MODELING
By Todd Kuhlmann, CCIM
LEVERAGE CAN
BOOST EQUITY YIELD
Here’s one example of how returns can be greatly improved
by knowing when to incorporate a loan.
W
hen examining investment prop-
erty as commercial real estate
professionals, we are looking to
buy future cash flow. We’re buying the po-
tential income and assuming the risk that
comes with it. It’s as simple as that.
In this piece, we’re going to talk about
equity yield and how properly using lever-
age can greatly impact yields. Let’s look at a
case study to see how these issues play out.
We found him a proposed apartment
complex in Austin, Texas, with 60 units.
We want to be sure this is a stable property
based on market rents and occupancy. The
project, including land and construction
costs, comes in at $6.5 million. Acquisition
costs are 2 percent, so the total initial in-
vestment is $6.63 million. After five years,
we predict disposition costs are 5 percent.
But before selling this property, we
want to increase income by 3 percent a
year. Laundry machines will provide anoth-
er $4,000 in revenue with 2 percent annual
increases. Expenses will run 40 percent of
gross operating income, with an average va-
cancy rate of 5 percent and average replace-
ment reserves at $250 per unit per year.
DETAILING THE INITIAL INVESTMENT
An investor is looking for a property where
he’s willing to invest $6.75 million of equity
if the annual return is 10 percent. He plans
to own the property for five years and
wants it to be in a strong, growing market.
We next need to predict our future
sales price. In order to calculate both the
property yield and our equity yield, we
must consider the future reversion, or sale,
of the property. For income properties such
as this, analysts and appraisers will use the
income method using cap rate. For this case
study, we will predict the disposition cap
rate at 7.5 percent.
(As a disclaimer, predicting future
cap rates can be very speculative. Several
factors need to be considered, including
cap rate trends from both historical and
current cap rates, as well as cost of capital
and future supply and demand in a partic-
ular market.)
With all these figures in place, what
Investment Analysis
Proposed 60-Unit Apartment Development
# of Units
Unit Mix
Unit Description
Size (SF) Monthly Rent
per Unit
Total Month-
ly Income
Monthly
Rate per SF
Year 1 Potential Rental
Income (PRI)
20 1 Bed/1 Bath 800 $1,000 16,000 $20,000 $1.25 $240,000
20 2 Bed/2 Bath 1,100 $1,250 22,000 $25,000 $1.14 $300,000
20 3 Bed/2 Bath 1,400 $1,500 28,000 $30,000 $1.07 $360,000
66,000 $75,000 $1.14 $900,000
60
40
Total Size
(Sq. Ft.)
COMMERCIAL INVESTMENT REAL ESTATE MAGAZINE
WINTER 2020