Final Project Instructions
August 9, 2020
Since Bb is down this weeks, it seems like a good time to provide details on the final project. Feel free to submit a comment (use the form at the bottom of this post) so I can respond to questions for all to see.
I’ve broken the project into 2 pieces. The first piece is essentially a rough draft and counts toward your regular assignment for Module 7. The second piece is the final product and the presentation.
Assignment 7: Investment Proposal Presentation Outline (80 points)
- Identify a commercial investment property
- No Single Family homes
- Multifamily Residential (Apartment Building) is preferable
- Office or Retail or other commercial is okay with permission
- Minimum 10 units
- Prepare a PowerPoint presentation you will use to pitch to investors
- Include a valuation estimate
- Include a complete ROI analysis
- Include estimate of up-front capital required
Assignment 8: Final Project Presentation (200 points)
- Preferred: Present your investment proposal live (10-15 min) during a Zoom conference (date/time TBD), or
- Optional (if #1 isn’t possible): Record a video presentation.
- Video quality isn’t terribly important. Your phone camera/recorder is sufficient. The video doesn’t need annotation or professional touch ups.
- Audio quality IS important – I must be able to understand you
- Files to submit
- PowerPoint File
- ROI Analysis spreadsheet
- Video (if applicable)
So, Step 1 is to identify your commercial property. It should be listed for sale. These properties are more difficult to find. You won’t find them on Zillow. Some are listed on the MLS but some aren’t. Instead, you’ll have to use a website like LoopNet. There may be other good websites. Let me know if you find a good one!
Step 2 is valuation. The reason multifamily residential is preferred is because it’s fairly straight forward to estimate value. If you choose a different type of commercial real estate the valuation step may be trickier.
Valuation metrics for multifamily residential:
- Video Explanation
- Price per unit
- Simply divide asking price by number of units
- For example, if a 20-unit building is listed for $1,000,000
- Price per unit = $1,000,000/20 = $50,000 per unit
- Gross rent multiplier
- Estimate annual rent (monthly rent per unit x units x 12 months)
- Divide list price by annual rent
- For example, if a 20-unit building generates $725 per unit
- Monthly rental income is $725 x 20 = $14,500
- Annual rental income is $14,500 x 12 months = $174,000
- Gross rent multiplier is $1,000,000/$174,000 = 5.7 (rounded)
- Cap rate (capitalization rate)
- This is the most commonly used metric, at least among commercial real estate agents and brokers
- It’s similar to Gross Rent multiplier but based on net income
- You calculate net income by estimating annual rent and annual expenses, but typically without cost of mortgage financing.
- Let’s say the 20-unit building costs $8,000 per month to run and maintain. So, annual operational expenses = $96,000
- Net income is then $174,000 – $96,000 = $78,000
- Cap rate = $78,000/$1,000,000 = 7.8%
- Your Final Project submission and presentation should include each of these three valuation metrics.
Step 3 is ROI analysis. It’s basically the same deal as the single family ROI analysis you already completed. But some of the numbers may be more challenging to estimate. Don’t worry. I’ll help.
I’ll provide more details here as we go along.
Questions? Submit below.
When looking to select a property for this next assignment, since we are trying to pitch this idea to investors, should we still look to find something in our area such as Pueblo, Colorado Springs, or San Diego? Or are we more open to finding properties outside of our local area? I know the stock of 10+ unit apartment complexes in Pueblo specifically are slim, especially right now. Also, does this need to be somewhat realistic for what we could possible afford or are we able to find something that may cost lets say $1 million or more after closing and renovations?
Good questions. First, close to home is best but you’ll have to look beyond Pueblo. Let’s say anything on the Front Range (Pueblo to Fort Collins) is fair game. Matt is welcome to anything within 2 hours drive of San Diego. If you want to go far from home then please ask for permission and have a good reason. There should be plenty to choose from in Denver metro. Second, think of this as a pitch to an investor. Your bank account balance is irrelevant. You’re looking for a great deal that will make your investor rich. Hopefully you’ll make a few bucks along the way. So, go as big as you’d like.
Thanks for the question. Keep them coming!
Syed asked a good question about the valuation process for commercial multifamily. For some reason his question isn’t appearing here. In commercial real estate valuation is typically based on rental income rather than using the comparable market analysis approach. I will post material to help with valuation soon. In the meantime, you can begin working on the ROI analysis using the asking price as the default valuation. Make sense? Please post something here, anything to let me know you’re plugged in.
How is the real estate market likely to respond to the economic fallout from the COVID-19 pandemic?
The real estate market will be affected since wages will not keep up with home prices there will be a burst bubble. The underlying market may have a greater amount of equity and less risky loans; however, as unemployment rises there is always a risk to the real estate market. The commercial market is being affected and many businesses are moving exclusively online, which will reduce the occupancy of commercial buildings and affect rent and projected revenues.
Which real estate sectors (e.g., single family, multifamily, commercial office, commercial retail, etc.) are most vulnerable to price declines?
The commercial real estate sectors are most vulnerable to price declines. This is due to businesses no longer being able to afford leasing office space. Revenue for commercial real estate companies will decline as occupancy rates decline in commercial real estate.
Will single family home prices fall as sharply as they did during the 2008 Great Recession?
It is possible that single family home prices could fall as sharply as they did during the 2008 Great Recession. The fact that interest rates are at near zero means that the only way interest rates go lower is with negative interest rates. Therefore, even if home prices do not increase, monthly payments will increase simply because the Federal Reserve must raise rates in the future. Negative interest rates are unsustainable in the long run.
How is today’s market different from the market 12 years ago?
The real estate market today has more equity and fewer risky loans. However, high and prolonged unemployment will erode the ability for homeowners to make payments. Even if the property has equity, missed payments will lead to foreclosures.
Do you think that real estate valuations will have to correct once the economy enters are rising rate market again?