Introductions
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Your name
Where you work
Your job responsibilities
How long you have been in the industry
What you hope to get from this class
Course 8: Financial Mgmt
Agenda
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Investments
Adding Value to the Investment
Economic Analysis of a Property
Budgets
Property Valuation
Course 8: Financial Mgmt
Chapter 1: Investments
We will discuss:
- What are investments and whether to
make them
- Advantages and disadvantages of
investing in multifamily housing
- Different types of ownership and
methods of financing
Course 8: Financial Mgmt
Definition: Investment
• An investment is the use of funds to earn a
profit.
Course 8: Financial Mgmt
Four (4) Factors in Investment
• Risk – low risk = low return
high risk = high return
• Income – may depend on risk involved
• Growth – means a potential to increase in
value >NOI = greater value
• Liquidity - ability to convert to cash
Course 8: Financial Mgmt
Owner’s Objectives
Why is it important to know the
owner’s investment objectives for the
property you manage?
Course 8: Financial Mgmt
Activity #1: How the Four Factors
Affect Investments
• How do general economic and market
conditions affect investments?
• Why is it important to know the owner’s
objectives for the property you manage?
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Performance Measures
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Rate of return on investment (ROI)
Cash-on-cash return
Capitalization rate
Internal rate of return (IRR)
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ROI
• Rate of return on investment = percentage
of return on each dollar invested
Cash flow/Investment = ROI
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Capitalization Rate
• NOI/Purchase Price = Cap Rate
• NOI/Cap Rate = Value
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Exercise
• We paid $7,000,000 for a property and
the NOI is $500,000. What is the cap
rate?
• Divide NOI by 6%
Course 8: Financial Mgmt
Remember
• Lower cap rate = higher value
• Higher cap rate = lower value
Course 8: Financial Mgmt
Advantages of Investments
• Advantages include:
– Periodic cash payments
– Potential for increase in value
– Reduction in income taxes due to
depreciation
– Ability to invest using borrowed funds
Course 8: Financial Mgmt
Disadvantages of Investments
• Disadvantages include:
– Real estate is not a liquid asset
– Active participation is often required
– Potential for risk (natural disasters, changes
in market conditions)
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Forms of ownership
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Direct ownership/sole proprietor
Partnership
Limited liability partnership
Limited liability corporation
S corporation
Joint venture
Real Estate Investment Trusts (REITs)
Tenants in Common (TICs)
Course 8: Financial Mgmt
Types of mortgages
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Fixed rate
Variable rate
Balloon
Bullet loan
Course 8: Financial Mgmt
Where to obtain a mortgage
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Commercial banks
Finance companies
Savings and loan institutions
Insurance companies
Pension funds
Mutual funds
Federal government (Freddie Mac, Fannie
Mae)
Course 8: Financial Mgmt
Skill Check #1
Chapter 1- Investments
Course 8: Financial Mgmt
Chapter 2
Adding Value to the Investment
Course 8: Financial Mgmt
Adding Value: CAM Responsibilities
1. Generating and collecting as much
income as possible
2. Controlling expenses
3. Meeting the financial goals of the
investment
Course 8: Financial Mgmt
Additional ways to add value:
• Reduced staff turnover and lower personnel
costs
• Reduced resident turnover with better customer
service
• Aggressive rental rates set by unit type
• New income sources through resident services
• Better collection of resident charges
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Sources of Income
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Rent
Administrative Fees
Parking/Garage fees
Pet fees
Laundry
room/Vending
• Late fees/collection
fees
• Clubhouse
rental/video rental
• Car wash
• Cable/Internet/ Phone
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Types of Expenses
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Maintenance
Administrative
Salaries/Personnel
Taxes
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Insurance
Utilities
Contract services
Advertising and
Marketing
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3 Factors That Affect Rental
Income
• Competitive rental rents
• Physical occupancy
• Collection percent or economic occupancy
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Concession Impact
Market rent = $700
Concession = one month rent
What is the Effective Rent?
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Law of Supply and Demand
• If the demand is high and the supply is
low, higher prices can be obtained.
• If demand is low and the supply is high,
rents must be made competitive to attract
residents.
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Economic Conditions
• Population growth
• Household formation
• Job creation
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Balancing rental rates and
vacancies
• The goal is to maximize income not
occupancy
• Pricing too high may cause longer
vacancy
• Pricing too low means you are losing
money while the unit is occupied
Course 8: Financial Mgmt
Increasing rental rate
Market value = $800
Raise rent 10% = $880
Vacancy = 15 days
What is the cost of the vacancy?
At the new rate, how long before you
recover the vacancy loss?
Course 8: Financial Mgmt
Lowering rental rate
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Market value = $800
Lower rent 10% = $720
Loss per month = $80
Loss per year = $960
What would you lose if you did not
lower the price and the apartment sat
vacant for a month?
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Before adjusting rent, analyze the
4 P’s:
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People
Product
Promotion
Price
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Determining Pricing
• Conduct a market analysis
• Use an automated revenue management
system
Course 8: Financial Mgmt
When to consider a rent increase
• When any floor plan remains 95% or more
occupied or that remains full even when the
community turnover ratio averages below 55%
• When rents fall below levels indicated by a
comparative rent analysis
• Anytime a community is full
• Upon owner request
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Rental increases: Current residents
• Increase rent as leases expire, OR
• Increase rent selectively on expired leases using a
quantifiable, non-discriminatory standard (years of
residence or number of previous renewals)
• Consider a renewal rate that is slightly lower than
the new market rate as an incentive to stay
• Provide 60 days notice prior to the effective date
of the increase
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Managing Occupancy: Reports
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Occupancy reports
Rent roll
Delinquency report
Deposit/Income reports
Concession report
Demographics report
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Managing Occupancy: Methods
• Calculate occupancy trend
• Manage lease expirations
• Calculate turnover ratio
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Expenses
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Fixed – property taxes, insurance
Variable –utilities, turnover costs, etc.
Capital- appliances, HVAC, etc.
Replacement Reserve Account
Debt service
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Cost Benefit Analysis
• Potential Expense
– Dollars
– Time
– Image
• Potential Benefit
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Income
Time
Employee satisfaction
Market position
Image
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Accounting Practices
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Budget control log
Invoices
Purchase discounts
Check request or payment vouchers
Petty cash
Resident records
Resident security deposit
Collection of former resident accounts
Course 8: Financial Mgmt
Skill Check #2
Chapter 2: Adding Value to the
Investment
Course 8: Financial Mgmt
Chapter 3
Economic Analysis of a Property
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Economic Analysis
When analyzing a property, ask
- How well has a property performed over a
specific time period?
- Where does a property stand at a given
date in time?
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Balance Sheet
ASSETS
Petty Cash
Cash
Cash Fund
Prepaid Insurance
Building
16,350,000
Less Depreciation
885,000
Building Net
Land
Furniture & Equip
400,000
Less Depreciation
100,000
Furniture & Equipment Net
Escrow
Total Assets
LIABILITIES
Accounts Payable
Notes Payable
Accrued Interest Payable
Accrued Property Tax
Security Deposit Liability
EQUITY
Partners Equity
Distributions to Partners
Prior Period Earnings
Current Earnings
Course 8: Financial Mgmt
Total Equity
May 31, 2010
300
11,055
7,700
15,465,000
3,750,000
300,000
223,000
19,534,055
55,000
12,275,000
637,700
422,000
96,000
13,485,700
9,010,355
-432,500
-2,544,500
15,000
6,048,355
19,534,055
Income Statement
Income
Rental Income
Other Income (Fees, Vending, Utilities)
Vacancy & Collection Loss
Effective Gross Income
Operating Expenses
Fixed Expenses
Real Estate Taxes
Insurance
Variable Expenses
Payroll
Repair & Maintenance
Utilities
Contract Services
Administrative & General
Management Fee
Advertising & Leasing
Other Expenses
Interest
Replacement Reserves
Total Expenses
Net Income
12/31/2000
$19,450,000
1,815,000
-97,500
$21,362,500
$1,268,000
97,600
238,100
598,800
1,636,000
335,000
272,000
102,000
190,000
$4,737,500
912,000
200,000
1,112,000
5,849,500
Course 8: Financial Mgmt 15,513,000
Accounting methods
• Accrual- records all income and expenses
in period they were earned or incurred,
regardless of when received or paid
• Cash- records all income and expenses
when they are actually received or paid
Course 8: Financial Mgmt
Cash Flow
• The amount of money left after all sources
of income are collected and operating
expenses, capital expenses and debt
service have been paid
• Often referred to as the operating
statement
Course 8: Financial Mgmt
Gross Potential Rent (GPR)
• Current rent charged at 100% occupancycombines the sum of occupied units at
current lease rents plus vacant units at
market rents
• 100% of possible income
• All other income and expenses measured
and evaluated as % of GPR
Course 8: Financial Mgmt
Market Rent
• Total annual income received if 100% of all
units were occupied and paying market
rents
Course 8: Financial Mgmt
Loss to Lease
• Variance between market rent and lease
rent
• Market rent that is “lost” due to lease rents
at rates lower than the market rate
• For many companies it is a separate line
item on the operating statement
Course 8: Financial Mgmt
Loss to Lease Example
• Annual market rent of $1,375,025 with a
loss to lease of $125,700 has a loss to
lease of 9.1%
• 125,700/ 1,375,025= .0914 or 9.1%
• GPR of $1,249,325; market rent of
$1,375,025 less “loss of $125,700
Course 8: Financial Mgmt
Vacancy, Concession, and
Collection Loss (VAC)
• Total value of rent loss from vacant units,
concessions given, collection losses from
bad debt write-off, rent loss from nonrevenue units
• Standard for uncollectible/bad debt- 2% of
GPR
• VAC can be higher than10% of GPR
Course 8: Financial Mgmt
EFFECTIVE GROSS INCOME
(EGI)
• GPR less vacancy, concessions, and
collection loss. Also called net rental
revenue or total rental income
• Represents all rent and only the rent
income at the property
• GPR-VAC= EGI
Course 8: Financial Mgmt
OTHER INCOME (OI)
• Income from items other than rent
• Laundry, cable, parking, amenity charges, pet
fees, application fees, administrative fees, lease
premium fees, late fees
• Fee policies established by owner or manager
• Up to 10% of GPR- NAA survey in 2010 7.2% of
GPR or $753 per unit
Course 8: Financial Mgmt
GROSS OPERATING INCOME
(GOI)
• EGI + OI = GOI
• Property’s total revenue
• Available to pay property’s operating
expenses, capital improvements, and debt
service
Course 8: Financial Mgmt
OPERATING EXPENSES(OE)
• All expenses fixed and variable incurred in
the course of managing the property
• Controllable and uncontrollable expenses
• Capital expenses and reserve for
replacement costs are not typically
considered operating expenses
Course 8: Financial Mgmt
NET OPERATING INCOME(NOI)
• GOI-OE=NOI
• Applying cap rate to NOI allows you to
determine property value using the income
approach
Course 8: Financial Mgmt
OPERATING EXPENSE RATIO
• Expense to income ratio
• Evaluation tool to measure property
performance and expense control
• % of GPR used to pay operating expenses
• Ratio depends on age, location, property type,
and expense classification
• OE/GPR= operating expense ratio
• 2010 NAA survey showed national OE ratio of
40%
Course 8: Financial Mgmt
CAPITAL Expenses (CE)
• Also called capital improvements
• Includes non recurring expenditures like
appliances, roofing, carpet replacement,
etc. intended to add to the life of the
property and its fixtures
• Offer ability to depreciate over time
Course 8: Financial Mgmt
DEBT SERVICE
• Mortgage or loan payment- principal and
interest payment
• Fixed rate mortgages usually have level
monthly payments that amortize the loan
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Break-even Occupancy Ratio
(OE + DS) ÷ GOI
1,803,800 +1,278,000= 3,081,800
3,081,800 ÷ 4,359,000 = 71%
Course 8: Financial Mgmt
Break-even rent per sq. ft.
(OE + DS) ÷ total square feet
$1,803,800 + $1,278,000= $3,081,800
$3,081,800 ÷ 760,000 = $4.05
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CASH FLOW CALCULATION
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Gross Potential Rent (GPR)
-Vacancy, Concessions, collection losses (VAC)
= Effective Gross Income (EGI)
+ Other Income (OI)
= Gross Operating Income (GOI)
- Operating Expenses (OE)
= Net Operating Income (NOI)
- Capital Expenses (CE), Reserve Payments (RR), and
Debt Service (DS)
• = CASH FLOW
Course 8: Financial Mgmt
Activity #3: Cash Flow
Calculate the cash flow of the NAA
Apartments
Course 8: Financial Mgmt
The General Ledger
• Provides more detail of major financial
statements
• Chart of Accounts
• Know cut-off date for invoices to be
submitted
Course 8: Financial Mgmt
Skill Check #3
Chapter 3: Economic Analysis of a
Property
Course 8: Financial Mgmt
Chapter 4
Budgets
Course 8: Financial Mgmt
Purpose of a budget
1. To estimate expected income and expenses
to determine what occupancy levels will be
needed to cover expenses and provide a
return on investment
2. To monitor the property’s performance
3. To evaluate performance of personnel
Course 8: Financial Mgmt
Lease-up Budget
• Special attention paid to activities and
costs associated with attracting residents,
signing leases and generating income
• Information used for projecting expenses
depends on your and your supervisor’s
previous experience
Course 8: Financial Mgmt
Modernization Budget
• Reflects larger allocations for capital expenses
and labor
• Must be flexible if the work is dependent on
contractors schedules and vendors supplies
• May include periods of no rental income while
work is being done in part or all of the building
• May be prepared separately from the operating
budget of a property and be for a short time
only
Course 8: Financial Mgmt
Stabilized Operating Budget
• Reflects varying expenses from month to month
Examples:
– Utilities for heating would be higher in winter months
– Utilities for cooling would be higher in summer
months
– Snow removal would be posted only for winter
months
Course 8: Financial Mgmt
Tips for developing budgets
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Use round numbers
Use current figures
Prepare early
Seek input
Extrapolation/Annualization
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CAM Responsibilities
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Managing the budget
Analyzing variances
Explaining variances
Recommending action
Course 8: Financial Mgmt
Skill Check #4
Chapter 4: Budgets
Course 8: Financial Mgmt
Chapter 5
Property Valuation
Course 8: Financial Mgmt
Property Valuation
• Is the process of determining the value of
a property in order to make financial
decisions regarding the property
Course 8: Financial Mgmt
The Cost Approach
• Estimates the current cost of reproducing
or replacing the improvements, minus the
loss in value from depreciation due to age,
condition or obsolescence, plus land value
• Important when there is no market activity
and a sales approach cannot be used to
value a property
Course 8: Financial Mgmt
The Sales Comparison Approach
• In this approach, the market value of a
property is directly related to the prices of
comparable competitive properties
• Most useful when there are several similar
properties in the local market that have
been recently sold or are currently for sale
Course 8: Financial Mgmt
The Income Capitalization
Approach
• This approach uses methods, techniques
and math procedures to
– analyze a property’s ability to generate
income and
– convert future earnings to present-day dollars
Course 8: Financial Mgmt
Capitalization
Value = NOI/Overall capitalization rate
Course 8: Financial Mgmt
Skill Check #5
Chapter 5: Property Valuation
Course 8: Financial Mgmt