Commercial Investment Real Estate Winter 2020 | Page 43
5-Year Equity and Effective Loan Rate
Unleveraged Investment
Cash Flow and 5-Year Yield
outlines the deal without financing, in-
cluding an upfront investment of $6.63
million. The cash flow meets your in-
Equity Investment
vestor’s requirements, while the prop-
Cash Flow & 5-Year Yield
erty IRR remains the same regardless
of financing. The second represents the
N
$
annual financing cash flow, which in-
0
($1,482,000)
cludes the initial loan proceeds, annual
1
$135,616
debt service, and the final loan balance
2
$151,054
repayment in Year 5 of $4.97 million.
=
The last column shows the investment
3
$166,955
with the 80 percent loan — this rep-
4
$183,332
resents your money.
5
$3,160,780
As you can see, using financing
more than doubled the property IRR/
Equity IRR/Yield = 23.39%
yield for an equity return of 23.39 per-
cent annually, an increase of 13.11 percent
from the 10.28 percent property IRR. By
making the most of available financing,
you’ve positioned your client to more than surpass the
initial goals for this multifamily development, while re-
ducing the necessary upfront investment.
As an experienced, knowledgeable com-
mercial real estate professional, you want to be able
to deliver this kind of value add to your clients. In this
case, you have a cash buyer with the funds to cover
With positive
the $6 million-plus investment. But with positive
leverage, you
leverage, you can boost the equity yield, literally dou-
bling the returns for your client.
Financing Cash Flow
and Effective Rate
N $ N $
0 ($6,630,000) 0 $5,148,000
1 $500,000 1 ($364,784)
2 ($364,784)
2 $515,838 3 $531,173 3 ($364,784)
4 $548,116 4 ($364,784)
5 $8,131,734 5 ($4,970,954)
+
Property IRR/Yield =
10.28%
Effective Loan Rate =
5.19%
does this mean for your investor? Projecting out five
years in the chart below, you can see that cash flow
before taxes steadily rises from $500,400 in the first
year to $564,984 in Year 5. That’s a nice chunk of
change, but your investor was looking for 10 percent
annual return. In Year 5, when income is at its high-
est, the cash-on-cash return is only 8.52 percent.
EXPLORING OTHER OPTIONS
But once your investor sells the property after
five years, he will bring in another $936,750 above
the purchase price. With this, along with the cash
flow, the annual property yield (IRR) of the invest-
ment reaches 10.28 percent.
Let’s look at other options for this investment
— namely how a loan could turbocharge returns.
Let’s say the investor could get a loan for 80 percent
of the apartment complex at 5 percent. (Based on
the current 10-year Treasury rate, this is on the high
side.) The bank will get 1 percent with 25-year amor-
tization and a 10-year term.
The initial investment drops considerably,
from $6.63 million to $1.482 million. But the overall
return more than doubles, to 23.39 percent.
The chart above has three columns showing
how a proposed deal changes with a loan. The first
can boost
the equity
yield, literally
doubling the
returns for
your client.
Todd Kuhlmann, CCIM
President/founder of TheAnalystPRO,
a CRE Tech Inc. company in Austin, Texas
and a senior instructor at CCIM Institute
Contact him at [email protected].
Editor’s note:
This article was adapted from
“Cap Rate and Rent Setting:
Analyzing a Proposed Development,”
Kuhlmann’s presentation at the
2019 CCIM Global Conference in San Diego,
presented with Karl Landreneau, CCIM.
5-Year Cash Flow
For the Year Ending Year 1
Aug 2020 Year 2
Aug 2021 Year 3
Aug 2022 Year 4
Aug 2023 Year 5
Aug 2024
POTENTIAL RENTAL INCOME (PRI) $1,012,958
$900,000 $927,000 $954,810 $983,454 - Vacancy / Credit Loss $45,000 $46,350 $47,741 $49,173 $50,648
EFECTIVE RENTAL INCOME $855,00 $880,650 $907,069 $934,281 $962,310
$4,000 $4,080 $4,162 $4,245 $4,330
GROSS OPERATING INCOME (GOI) $859,000 $884,730 $911,231 $938,526 $966,640
- Operating Expenses $343,600 $353,892 $364,493 $375,410 $386,656
NET OPERATING INCOME (NOI) $515,400 $530,838 $546,738 $563,116 $579,984
- Capital Express / Replacement Reserves $15,000 $15,000 $15,000 $15,000 $15,000
$0 $0 $0 $0 $0
$500,400 $515,838 $531,738 $548,116 $564,984
+ Other Income
- Annual Debt Service 1st Lien
CASH FLOW BEFORE TAXES
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