Real Property Easements, An Overview. the Purpose & the Risks? (Part 1)

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Image from Pixabay

By Dan Harkey

c 949 533 8315 e [email protected]

This overview of real property easements has relevance to property owners, real estate agents & brokers, mortgage agents & lenders, insurance agents & brokers, escrow officers, and title insurers.

What are real property easements?

An easement is a non-possessory right conveyed from one property owner (#1) to another property owner (#2) to use, enter, or cross over a parcel (or a portion) that is owned by the party (#1). Non-possessory means that party (#2) possesses a right to use, enter, or cross but does not own or have no property ownership claims. claims of ownership to the property.

A non-possessory interest in a property restricts its free use because it is an encumbrance on the property. The non-possessory interest (easement) is generally recorded against the property in municipal public records and serves to cloud the title.

There are two types of possessory interest: freehold and leasehold estates.

Fee ownership Interests are generally subject to certain easements such as utilities and public rights of way.

“A public right of way easement gives the public or organization the right to access and use property in specific situations for limited purposes. A right of way is an easement that established the freedom to use a pathway or road on another person’s property without conferring ownership.”

Easements generally run with the land into perpetuity (for all time) unless expired or canceled by the parties. They may be expressed, implied, by necessity, or by prescription.

https://www.forbes.com/advisor/mortgages/what-is-an-easement/

https://www.lorman.com/resources/easements-in-california-creation-of-easements-16986

https://www.clta.org/page/article6/A-Legal-Introduction-to-Easements.htm

What are reciprocal usage easements?

Reciprocal easements are non-possessory interests conveyed between two or more property owners. An agreement establishes the terms for easements, restrictions, and covenants between two or more different parties. The agreement is mutual between two or more parties to benefit each other, usually equally.

Using the example above, property owner (#1) may use the owner’s (#2) property. Reciprocally owner (#2) may use the owner’s (#1s) property. You scratch my back, and I will scratch yours for mutually beneficial purposes.

https://www.davis-stirling.com/HOME/reciprocal-easements-defined

What are reciprocal easement agreements?

Image from Pixabay

https://www.coxcastle.com/news-and-publications/2013/fall-2013-retail-perspectives-newsletter/understanding-reciprocal-easement-agreements#:~:text=Typically%2C%20reciprocal%20easement%20agreements %20(%22,as%20an%20integrated%20shopping%20center.

https://www.contractscounsel.com/t/us/reciprocal-easement-agreement

Consider two adjacent commercial parcels, each with 20,000 square feet of land. One land parcel has a local grocery store, and the other has a restaurant. The owners structured a reciprocal easement agreement to allow both parcels to provide entry to commercial supply trucks and for parking. With the building footprint, required setbacks, and parking, there is not enough room for large trucks to deliver supplies without overlapping parcels.

What are prescriptive easements?

Conflicts and litigation may arise to prove what may be referred to as claimed rights to pass over a property. A “prescriptive easement” is a “claim of possessory right to pass” across another person’s real property that was acquired by continued use without permission of the owner for a legally defined period. Usually, a claimant has the burden of proof of the elements necessary to establish that the easement has been created over time by prescription (California Code of Civil Procedures 321). In California, a claimant is required to adequately prove that they have possessed the prescriptive easement by continuous use for at least five years. Other states have similar regulations.

The statutory time for prescriptive easements varies from state to state. Each claim is fact-specific, with the possibility of winning some and losing some. Proving the claimant’s rights can take time, resulting in litigation and being fraught with the risk of losing. All this frustration could have been avoided with well-documented agreements.

The issue of exclusive vs. non-exclusive easements must also be proved-up. Will the easement run with the land and bind all future owners? In California, 2d 872 (2002). California Civil Code 1104 provides that a transfer of real property passes all easements attached thereto.

There are many types of easements for dozens of different purposes:

https://en.wikipedia.org/wiki/Easement

Are easements transferable from one party to another?

Image from Pexels

Most easements are recorded and are a matter of public record. When a property is transferred to another party the easements are transferred and remain on title. An easement generally remains with the property.

https://www.findlaw.com/realestate/land-use-laws/easements-and-transfer-of-land.html

Why should property owners, real estate brokers, and lenders make such a big deal about easements? What’s so important?

Owners, realtors, and lenders should be aware of the vast reservoir of property usage limitations caused by property easements limiting property usage and reducing a property’s development potential and value.

“Easements are like having a giant network of squid-like tentacles on your property that you can’t touch, see, or hear but had seriously better handle. Failure to deal with each easement (tentacle) could result in catastrophic consequences, including diminished property value and limited or total inability to develop the property.”

Easements are clouds on the title. An easement is an encumbrance against a property referenced by agreements and claims to enforce rights and obligations. Whether recorded or not, the easement still reflects a clouded title.

When a realtor or lender drives up to a property, they may admire the beauty and tranquility of the setting. The home elevation, topography, floorplan, panoramic views, and hardscape are outstanding. The property location may be the best. Selling the sizzle is appropriate but limited to the realtor’s spectacle performance and buyer’s immediate response. But there is a large prohibitive easement for a neighborhood storm drain running across the yard where the purchaser planned on placing a nice swimming pool. They were not disclosed of the storm drain easement.

Legal risks for an agent may be devastating. “I am the buyer’s agent. I did not read the preliminary title report, ask the title company for copies of all easements, nor ask them to chart out all easement placements on the property.” But the buyer’s confession that they did not read the preliminary title report does suggest a breach of fiduciary duty and constructive fraud. Failure to disclose was felony stupid.

Image from Pexels

“Constructive fraud comprises of any act or omission or concealment involving a breach of legal or equitable duty, trust or confidence which results in damage to another, even though the conduct is not otherwise fraudulent.” Salahuddin vs. Valley of California, Inc. (1994).

Constructive fraud means that fraud was created because any reasonable real estate fiduciary should possess this knowledge or know about these facts/circumstances. Failure to disclose constructive fraud.

What lurks underneath the ground is a web of easements that limit land usage, building size, and economic feasibility, inhibiting overall value. A 100,000 sq ft parcel may only have 10,000 square feet of a buildable pad because of restrictive easements.

A 20,000-square-foot property that appears to be worth $100 per foot, but 80% has limited use because of restrictive easements. Only 20% of the parcel is buildable. A buyer may not be willing to pay $100 per square foot for 20,000 of land when only 4,000 square feet are buildable.

Risk and liability flash red for the principal parties and their agents:

Image from Pixabay

Knowledge is the key. On any transaction, the parties should obtain a preliminary title report, obtain written copies of all easements, and request a survey performed by the title company to determine survey boundaries and potential adverse effects on the property. An appraiser will be interested in the results.

Principal buyers and their agents will decide what easements are appropriate and acceptable and what easements are not. Accepting the property as-is, renegotiating the price, or outright rejecting the purchase are possible options.

History:

Image from Pixabay

Many buildings that were constructed in the earlier part of this century, before the 1960s, lacked adequate parking and, in most cases, lacked formal agreements about common on-site usage for ingress/egress for walking and automobiles. In property law, ingress/egress refers to the rights of a person to pass over a real property for entry, leaving, and return across the property.

Familiar transportation sources were walking, bicycles, horseback, and horse-drawn carriages. Building growth clustered around the center of town was standard. The advancement of the automobile, which made transportation more flexible, had not yet matured. The requirement for expanded parking areas had not matured.

In days gone by, two or more property owners might verbally agree that they would build adjacent buildings and use a small portion of one of the land parcels for ingress/egress, as oral agreements tend to do. Many old verbal agreements have gone wrong, as oral agreements tend to do. Handshake agreements broke down, and conflicts arose with future ownership. Problems also arose when descendants and partners disagreed with the interpretation and or benefits of the original verbal easement agreement.

https://www.findlaw.com/realestate/land-use-laws/express-and-implied-easements.html

Municipalities, property owners, and lawyers began memorializing the agreements in written form. At the same time, the creation of municipal planning departments and zoning ordinances came into being. Owners were then required to hire civil engineers to draft a written placement of physical easements and obtain approval from the municipality. It is common practice to hire a land planning lawyer to handle the application process for various approvals with the respective city planning department.

Upon approval by the city, the agreements and drawing of physical placement of the easements encumbering the property were generally recorded in public records. The objective was for the recorded agreements to provide public notice that the easement existed and would bind all future owners in perpetuity.

Many older structures were built prior to creating and enforcing building and zoning ordinances. Zoning ordinances were adopted in California as early as the 1920s and have continued to evolve. Prohibitions related to setbacks, height & density restrictions, floor area ratios, required parking, deed restrictions, necessary amenities, and acceptable building materials all have occurred over time. Laws have been passed that now control aspects of ownership.

(to be continued…)

This article is an overview for a general educational purpose only. The information presented should not be relied upon without the advice of counsel.

Dan Harkey is a contributing author to Weekly Real Estate News and is a Business & Financial Consultant. He can be contacted at 949-533-8315 or [email protected].

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Is It Worthwhile Investing When Interest Rates Are Higher?

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Image from Pixabay

By Adiel Gorel

Many investors are asking, now that interest rates have gone up by 2% relatively quickly, and home prices are up significantly from a couple of years ago, whether buying single-family rental investments is still something to consider.

The main point, at the heart of the matter, is that we can get a 30-year FIXED rate loan when buying single-family homes (technically 1-4 residential units) in the United States. This point is so dominant, it supersedes any other consideration. Surprisingly few investors seriously take this dominant factor into consideration.

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For some who have read other materials I have written, the following is a bit of a repetition, but it’s well-worth understanding this point fully. The 30-year fixed rate loan does not usually get its due as an amazing financial tool that should be utilized by any savvy investor who can get it.

For many foreigners, it is incomprehensible that in the US we can get a loan that will never keep up with the cost of living for 30 years. During that period, essentially everything else DOES keep up with the cost of living, including rents. Only the mortgage payment and balance (which also gets chipped down by amortization) do not keep up with inflation.

You can talk to many borrowers who have taken 30-year fixed rate loans and after, say, 14 years, realized that although there are 16 years remaining to pay off the loan, the loan balance AND the payment seem very low relative to marketplace rents and prices. The remaining 16 years are almost meaningless, since in many cases (statistically and historically) the loan balance will be a small fraction of the home price and not very “meaningful.” Just to get some perspective, most other countries on Earth have loans that constantly adjust based on inflation. Both the payment and the balance track inflation all the time—usually with no yearly or lifetime caps as adjustable loans have in the US.

Image from Pixabay

The power and positive effect on one’s financial future gets magnified when you consider that in 2022, we are still in a period in which interest rates are very low. While investors cannot get the same favorable rates as homeowners, it is nevertheless quite common nowadays to see investors getting a rate of between 5.75% and 6.25% on single-family home investment properties. From a historical perspective, these are very low rates. Most experts think that, in the future, mortgage rates will rise further. From a historical perspective, even 7.5% is considered a relatively low rate. These days, you can “turbo boost” the great power of the never-changing 30-year fixed rate loan by locking in these still-low rates, which will never change. If in the following years interest rates indeed go up, you will feel quite good about having locked under-6% rates forever.

Once you have gotten your fixed rate loans, two inexorable forces start operating incessantly: inflation erodes your loan (both the payment and the remaining balance), and the tenant occupying your SFH pays rent, which goes in part towards paying down the loan principal every month. These two forces create a powerful financial future for you.

Many of us have been “spoiled” during the COVID Pandemic that started in 2020. The Fed lowered rates to the very lowest point in the history of the US. Homeowners could get loans at 2.75%, and even a bit less. Investors could get loans at 3.5%, 3.75% or 4%. Happy times.

Recently, rates rose quite quickly. Homeowners now get loans at 5% or slightly more. Investors get loans at about 6%, depending on credit. It feels like the sky is falling, but it’s important to retain the historical perspective. These rates are still historically very low. Recall also that currently, inflation is at 8.5%. Inflation is your “best friend” when you have a fixed-rate loan, since it constantly erodes the true value of your payment and remaining loan balance. Getting a 6% FIXED rate loan when inflation is over 8% is quite favorable.

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The 30-year fixed rate loan is so meaningful in changing your future that it works well over the long-term, almost regardless of the interest rate. Obviously, the lower the rate, the better. However, by way of an example, when I began investing in the 1980s, interest rates on mortgages were at 14%. Every single investment home I bought back then (and I always made the minimum possible down payment) started out with a negative cash flow. Nevertheless, it was clear to me that since the loan was FIXED, the payment would remain the same, but everything else would keep up with inflation. That meant, to me, that within a couple of years, the negative cash flow would turn into break-even, and a couple of years after that, it was likely to turn into a positive cash flow. A couple of years after that, the cash flow was likely to be a stronger positive, etc.

Those notions came to fruition exactly as I had seen them. I started celebrating every time one of my homes got to “break-even.” I knew that from then on, the cash flow would be evermore positive, on average, as the years would go by. Even with 14% interest rate, the system worked. Those homes changed my financial life enormously.

Of course, when rates went down, I refinanced. First, I refinanced down to 12%, then came the magic “single digit” time, when I refinanced to 9.95% and was ecstatic about it.

Image from Pixabay

I have thousands of investors’ success stories that I hear all the time. One small example is the Silicon Valley engineer who bought 16 homes, then 13 years later saw his loan balances were under 30% of the home values, despite there being 17 years still remaining on the life of the 30-year loan. He sold 4 of the homes, paid his taxes, and used the proceeds to pay off the small remaining 12 loans, retiring on the strength of 12 free and clear homes. Many of these success stories, including his, are from people who started buying when rates for investors were between 7.75% and 8.25%.

Many investors are also taken aback by the price increases that took place during the Pandemic. They feel they are being hit by high prices AND higher interest rates.

One very important thing to remember is that while I am writing this (May 2022), inflation is at 8.5%.

Image from Pixabay

Some people are concerned about starting out with only a break-even, or a very slight positive cash flow, when making 20% down payments. They have gotten accustomed to starting out with a healthy positive cash flow, even with a mere 20% down payment, during the super-low rates era. However, the INITIAL cash flow is just that: initial!

As time goes by, the mortgage payments remain the same. However, rents rise, on average, with inflation. These days there is a huge demand to rent single-family homes in the suburbs, with a yard and room for a home office. There is more demand than supply in the rental space, and rents are going up quite furiously across the nation. Even if rents only rise with inflation, inflation these days is quite high. Either way, the cash flow gets better and keeps getting better as the years go by, while you build equity in the home, changing your future.

I look at these investments as long-term. They will very likely change your future, but they need 10, 12, 14 years to get to the desired result. At the beginning, the “cash flow” that has the most meaning is your own income: the income from your W-2 job, or your small business, in addition to what your spouse may earn as well. THAT is what pays for your food, transportation, utilities, and kids’ expenses at the present. In the future, when the rental homes can get you to retire powerfully, the equation flips and then the rental homes will provide the very meaningful “cash flow” you can retire on, as I describe in the example above.

Image from Pixabay

The mistake many new investors make is thinking that they MUST have immediate large positive cash flow at the outset, despite not really needing it, since they generate sufficient “cash flow” in their jobs. This thinking may create a situation whereby an investor never gets started. Possibly a book the investor had read might have put the idea in their head that initial cash flow is the primary thing to look for. Ten years later, I see people expressing great regret at never having started due to these notions. Some people resort to buying inferior properties in inferior locations, seeking a “better initial cash flow.” Buying bad properties usually doesn’t end up that well.

Today, as in any time I have seen, is an excellent time to acquire single-family rental homes, finance them with the astounding 30-year fixed rate loan, and then letting time pass while inflation does its thing.

We will talk about it in more detail at our upcoming quarterly event, complete with a Q&A.

ADIEL GOREL

Adiel Gorel has more than three decades of successful real estate investing experience. As the CEO of ICG (International Capital Group) Real Estate, a world-renowned real estate investment firm founded in the San Francisco Bay Area in 1987, Gorel has helped investors utilize one of the most powerful investment tools—single family rental homes. He teaches people how to have fun with a process most find complex and speaks about the importance of securing a strong financial future for retirement, business investing, and college education.

Through ICG, he has assisted thousands of investors, from novice to expert, in purchasing over 10,000 properties to date. He is also the author of Remote Control Retirement Riches, and Invest Then Rest: How to Buy Single-Family Rental Properties, which includes numerous investor reports describing their real-life investing experiences. He has also authored Remote Controlled Real Estate Riches, Discovering Real Estate in the U.S. and Life 201.

Gorel has been featured on NBC, ABC, in Fortune Magazine, the San Francisco Examiner, and numerous radio shows showcasing his no-nonsense, insightful approach to rental single family home investing. He speaks worldwide and throughout the U.S., sharing his knowledge on a variety of topics including securing a powerful financial future, investing in single-family homes, the 30-year fixed-rate mortgage, and related subjects.

ICG has established an infrastructure to support investors in many metropolitan areas in the U.S. Gorel owns many properties himself.

To this day, Gorel supports individual investors via planning, assistance in remote home buying, and property management issues resolution.

He holds a master’s degree from Stanford University. His professional experience includes being a Hewlett-Packard research engineer, as well as management and director positions at Excel Telecommunications, and several biotechnology firms. He lives in the San Francisco Bay Area.

Compelling Reasons Why You Should Invest in Real Estate

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Image from Pixabay

By Lloyd Segal, President,
Los Angeles County Real Estate Investors Association

If you’re considering investing in real estate, looked it up on the internet, read about it in books, attended some workshops, and perhaps ask a friend or two, you already know that you should no longer wait and get started today. But if you’re still struggling to figure out why you should invest, this article will highlight some of the most compelling reasons in the hopes of addressing your concerns and finalizing your thoughts about venturing into this brave new world.

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1. Appreciation

Over time, the value of real estate rises (sometimes fast, sometimes slow). This is due to “supply and demand,” a fundamental economic concept, which I’ll address separately. With respect to “demand,” our population is steadily increasing and does not appear to be slowing down any time soon. And until further notice, people prefer to live indoors. As a result, more and more people looking for a place to reside means more demand for housing. So the demand for real estate is gradually increasing. And, according to basic economics, as demand increases, prices rise in response. With respect to “supply,” they are simply not making any more land. So land increases in value with limited supply. Similarly, they’re not building enough houses on that land to meet demand. So the value of what already exists increases. Plus, improvements in the surrounding region also increases value. As a result, the value of real estate appreciates over time.

Image from Pixabay

2. Control

When it comes to real estate, once you’ve paid for the property and met all legal criteria, you own the asset outright and have practically unlimited control over it. You may immediately alter the asset’s value, improve the property, increase cash flow, reduce expenses, and increase the rents. So unlike stocks and bonds, you are not at the mercy of the market or corporate executives. You are in control and can increase the value of your asset.

3. Equity

The difference between the current market value of your properly and the balance of any mortgages encumbering your property is called “equity.” The more equity you have the better. When you invest in real estate, your property’s equity grows over time in two ways. First, as you pay down your mortgages every month, your equity increases. Second, as the value of your property appreciates over time in the marketplace, your equity increases.

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4. Diversification

Diversification is an important strategy to mitigate risk, particularly if you’re putting a lot of money into various investments. Most experts advise diversifying your portfolio so that you don’t lose everything in one fell swoop if the market in which you’ve invested suddenly goes downhill. Real estate is a great asset to put your money – and it’s a lot safer and more stable than a lot of other options, like stocks or bonds.

Image from Pixabay

5. Inflation Hedge

Today, we are dealing with inflation. Although all investments are affected by inflation, real estate is always a good hedge against inflation. Creating products and services is typically more expensive due to normal inflation. They must either increase pricing or accept lesser earnings. In contrast, real estate is a natural inflation hedge since it has no link with equities or corporate profits. Plus, any inflation costs are frequently passed on to tenants.

6. Conclusion.

If you’re still on the fence about real estate investing, hopefully I’ve given you a few compelling reasons why investing should be a wise decision for you. Keep in mind, as with any investment, there is always some risk involved. However, if you want to take advantage of all that real estate has to offer, you should be investing now. Remember, don’t wait to buy real estate – buy real estate and wait.

Lloyd Segal

After practicing law for over 30 years (specializing in real estate litigation), Lloyd Segal assumed the leadership of the Los Angeles County Real Estate Investors Association in 2017 from the late Phyllis Rockower. Lloyd is an author, real estate investor, mentor, public speaker, and landlord. He is the also the author of four real estate reference books, including “Stop Foreclosure in California” (Nolo Press), “Stop Foreclosure Now” (American Management Association), “Foreclosure Investing” (Regency Books), and “Flipping Houses” (Regency Books). The Los Angeles County Real Estate Investors Association is the oldest (1996) and largest investor group in California. In his role as President, Lloyd is busy expanding LAC-REIA’s events and programs for members and real estate investors. For more information, visit www.LARealEstateInvestors.com

What Makes a Good Real Estate Note?

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Image from Pixabay

By W. J. Mencarow

The value of a note ultimately depends upon the economic conditions that support the value of the property.

An owner-occupied single family house in a good neighborhood located in an area with a long-term stable economy is the best collateral possible. It is further enhanced by a payor who has an excellent credit record and unblemished payment history.

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Less desirable collateral, in descending order: owner-occupied (owner lives in 1 unit) duplexes/triplexes; non-owner-occupied single family houses; non-owner-occupied duplexes/triplexes; other non-owner-occupied multi-family units; improved land; commercial (non-industrial) properties; resort properties; subdivided but unimproved lots; raw land (some buyers would use a slightly different hierarchy).

Due to the current regulatory environment in the U.S., industrial properties, gasoline stations, even properties with underground oil tanks have many hidden liabilities. Notes secured by such properties should be avoided. Cooperatives, time-shares, mobile homes and personal property are not real estate and by themselves are not adequate security for notes.

The higher the investment-to-value ratio, the riskier the note (ITV = amount paid for the note + senior lien balance/market value of property).

Image from Pexels

If there is little or no appreciation in the property, the loan-to-value ratio is a barometer of the likelihood of default. Notes on property purchased for $1,000 down or less often default. The higher the downpayment, the better.

An amortized note is more valuable than one with a balloon, since the payor may not be able to make the balloon payment.

The single most powerful financial aspect determining the value of a note is the amount of the monthly payment. For example, all else equal, a 10 year note with a large monthly payment and no balloon is worth more than a 10 year note with a smaller monthly payment and a balloon.

A note in the first lien position is more valuable than one in the second lien position. Third lien or lower notes are worth very little.

A second lien note with a huge balance first lien should be avoided. In case of foreclosure, the owner of the second lien would have to make the payments on the first.

A seasoned note (one with a payment history of several years or more) is better than a green note (little or no payment history).

Image from Pexels

The payor’s credit history is important to help determine the character of the payor and likelihood of default, but it is not infallible. Everyone, even those with the best credit, can lose their incomes, have medical emergencies or suffer other unforeseen catastrophies. The best use of a credit report is to identify a potential bankruptcy candidate.

Again: The value of a note ultimately depends upon the economic conditions that support the value of the property.

Copyright 2022, The Paper Source, Inc. and W. J. Mencarow.
W. J. Mencarow is president of The Paper Source, Inc.

How to Become a Real Estate Investor

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Image from Pixabay

Special from Stratton Equities

While, technically, anyone can become a real estate investor these days, what does it really take to become a real success and what are the steps to get there?

Image from Pixabay

Before you get started, there are a few things to keep in mind that will help you determine what kind of real estate investment you want to be a part of. The first of which is figuring out what kind of real estate strategy you want to be a part of. The spectrum of which ranges between being an active investor and a passive investor.

An active investor will typically involve themselves in fix and flip strategies, wholesaling properties to investors, finding and managing a rental property themselves, or working as a licenced real estate agent in their area in order to build commissions for other future investments. An active investor is likely working non-stop, on multiple projects at once, and is always in need of funding.

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On the other hand, a passive investor can engage with real estate investing through buying shares of a property portfolio, partnering with other investors, or just generally investing in other real estate investments schemes.

The choice between being an active or passive investor is really up to the individual and how much they want to be part of the day-to-day operations and rewards of a property. Aside from some monetary constraints or a license to become a real estate agent, there are no barriers to entry to become a real estate investor as anyone can participate, they must first figure out what kind of investment strategy they wish to become a part of first.

Image from Pixabay

Once you have committed to and figured out an investment strategy, you can then move on to learning up about the properties itself. This next step will require a lot of research information as your end goal is to become a realistic competitive expert in the real estate market.

Some of the key subjects to know are what kinds of properties are there and which ones to focus on, and what is the property’s situation in terms of structural support, renovation, location, community, real estate laws and taxes.

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It is important to note that many properties are very different from each other. For example, what might the investment differences be between a multi-family rental property in rural New York compared to urban New York? Or how about a single-family property? Or a commercial property? Or the difference between the exact same property in the mountains compared to the beach? The point is you must be able to distinguish between all the different categories of real estate on top of all the different legal, geographical, and cultural factors that may arise in order to become an adequate expert in your field.

To start off, you might want to focus your skills and knowledge on a particular specialized segment of real estate investment to give yourself a potentially unique advantage.

Overall, unlike many other career paths, earning a degree is not required to become a real estate investor; but if you want to become successful at it, you will have to teach yourself and it will take a lot of time and patience.

Image from Pixabay

Once you have mastered the realm of real estate in relation to your investment strategy, you can move on to mastering the market itself. The market is not too difficult to observe itself as it simply is determined by the nature of buying and selling property. However, the difficulty arises in figuring out the right properties and the right prices.

As you probably understand, the market is not perfect. There are some properties that are overvalued and some that are undervalued. Hence the practice of real estate investment. However, understanding the market will require one to observe these properties for what they are actually worth and determine whether the process of fixing-and-flipping, or whatever investment strategy you are using, is actually worth it. And that itself is the challenge as you not only have to take into account the property itself, you also have to account for the market as a whole and where you think it is heading, which may not always be the case.

Image from Pixabay

After you have mastered the real estate market, you can move on to acquire financing, again, depending on your investment strategy of choice. Here is where your research can finally start to gain you ground in implementing your project.

As one begins to enter the industry, it will be more challenging to find other investors or people who will give you loans as you have not built the relationships yet or had the experience to prove your success. But you have done enough research to register a plan to showcase to investors to get them hooked on your idea.

It is important to know that most investment projects require a lot of capital on your end so you will want to get as much cash on hand as possible. That is where other investors and private money lenders can come in as they can give you enough money to fund your project so that you can live out your real estate investment dream.

Just make sure your strategy is sound and well-presented when trying to acquire more funds. Over time, this process will get easier as you have a longer history, reputation, and credibility within the real estate investment world.

Image from Pixabay

Lastly, just before you go out and purchase your first property, you should read up on the local and state laws so that you are prepared for any legal situation that could stand in your way. No matter how experienced one is, there are always going to be challenges you did not foresee, but the better informed and knowledgeable one is about the property, investment strategy, and local customs and legalities, the better your chances are at overcoming the adversities present towards you.

Image from Pixabay

Okay! You should now know all that there is to get started as a real estate investor. That being said, these are summarized guidelines that merely point out the general steps it should take to get started and become a successful investor. There is a lot to learn and a lot to keep in mind when practicing real estate investing. Just know that more likely than not, it is probably not going to go the way you expect. It could be that managing a rental building is much more costly and demanding than you expect. But, don’t fear. The smarter the strategy, the better the plan, and the more aware you are of the real estate market, the better your chances of success are. Good luck!

If you’re looking for financing on your next real estate investment, Stratton Equities is the leader in Nationwide Direct Hard Money and NON-QM Lending in the real estate market. Reach out to a member of our team today by applying now at www.strattonequities.com

Tokyo’s Urban to Suburban Migration

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Image from Pixabay

By Priti Donnelly

For years, Japan has tried to prevent its population from being overly concentrated in Tokyo, a city sprawling with nightlife, work life, and a tourist hotspot. Economic and social shifts of the pandemic developed into the start of a natural progression of migration out of the capital. Although the greater Tokyo area grew in 2021 by 26,323 for a gain of 0.07%, that figure was down roughly 110,000 from a year ago. In 2020 net migration by locals into Tokyo shrank by 27,000, or roughly one-third from previous years as people embraced telework and crowd distancing.

Initially, at the start of the pandemic, to avoid commuting, Japan adopted the work-from-home concept already popular in many parts of the world. As employers learned to adapt to matters of productivity and controlling hours of work, employees discovered the concept value in work and family balance plus the benefits of saving time from hours of commuting. Then, ongoing lockdowns turned flexibility into a lifestyle leading to the realization of the potential to settle outside urban centres. And, so began the urban to suburban or even rural movement.

Image from Pixabay

One Tokyoite, Kanamori sought to leave his luxurious life and job of the Roppongi Hills complex in Tokyo’s Minato ward for solace in the city of Yamagata. A place familiar to him as the place of business of his parents’ long established sake store. Initially he moved to Tokyo to attend university, then joined an IT company in 2017 selling computer tablets with an application that helped retail operators keep track of sales. But, after three years, the business took a couple of hits. First, the consumption tax was raised to 10% in October 2019. Then profits were hit harder after Covid. This, in addition to the long working hours and overtime deeply rooted in Japan’s industrial ethics. It is not unusual for employees to work more than 80 hours of overtime a month, according to a 2016 government survey and those extra hours are often unpaid. Kanamori’s lifestyle became all about work and he didn’t like who he was turning into.

Recognizing that those long work hours translated less into productivity and more into exhaustion, he left his job for a change in lifestyle and moved to Yamagata. There he became a member of the city’s community development team that aims to make better use of vacant homes, working four days a week, no overtime. On his days off, yes, he has days off, he goes camping with his friends. Peaceful living.

Image from Pixabay

Kanamori is not alone. The mountain resort town of Karuizawa in Nagano prefecture added 595 people via migration, the largest increase of any town. For the first time since July 2013, the number of people moving out of Tokyo outnumbered the number of people moving in by 1,069. In June 2020, inbound migration topped outbound migration once again, but from July 2020 through February 2021, more people moved out of Tokyo than people moved in and the trend has continued, with the exception of the months of March and April when more people generally move into Tokyo because of starting new jobs or enrolling at university, at the beginning or end of the fiscal year.  

Should I stay or should I go? Although Tokyo is attractive for its job opportunities, thriving business hub, and growth-focused initiatives for start-ups, people are discouraged by the high cost of living. The nationwide average monthly rent, not including utilities, for a one-room apartment (20 to 40 sqm) is between 50,000 and 70,000 yen. Rent for similarly sized apartments in central Tokyo and popular neighbourhoods nearby usually start from around 100,000 yen.

Image from Pixabay

But, the high cost of living is just one deterrent from permanent settlement. Where people once enjoyed the ease of fast food to satisfy the palate and the belly, they are now finding solace in places surrounded by greenery with access to fresh seafood, fruits and vegetables. For the sole purpose of slowing down to take care of oneself, the concept of growing and preparing foods for its freshness, nutritional value including low sodium and carbohydrates by comparison to fast-food, has been revived.

The attraction to the suburbs or rural areas is real, but it is hard to tell if it is more of a sabbatical, or a trend as we strive to stay safe. Either way, Tokyo is not entirely out of the picture. Even Kanamori still thinks he might return to Tokyo in the future for business opportunities. The city is after all a thriving international hub and continuously evolving for entrepreneurs to launch and be successful. As the old adage goes, “You can take the person out of Tokyo but you can’t take Tokyo out of the person.” But, this time on healthier terms.

Sources: The Japan Times, Nikkei Asia, Japan Guide

Priti Donnelly

Priti Donnelly is the sales and marketing manager at Nippon Tradings International, a Japanese proxy helping foreigners access the second largest real estate economy in the world. As a Canadian with a background in mortgages and marketing, Priti keeps foreigners informed of the latest trends, business news and featured properties in the Japanese real estate market. Her articles have been featured in REtalk Asia, REthink Tokyo, REI Wealth, and Asian Property Review.

Have You Considered Adding Brownfield Development to Your Real Estate Portfolio?

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Image from Pixabay

By Patricia Gage, Principal,
RE Solutions

It’s understood that having a real estate component within your investment strategy is a tried-and-true way to diversify your risk and increase your investment returns. And while most people and companies find real estate opportunities with more common approaches, there is a less conventional way to turn a profit in real estate: brownfield development.

According to the Environmental Protection Agency, “a brownfield is a property, the expansion, redevelopment, or reuse of which may be complicated by the presence or potential presence of a hazardous substance, pollutant, or contaminant.” It is estimated that there are more than 450,000 brownfields in the U.S. Some l brownfields are obvious, like a former oil refinery. Others may be a surprise, for example, an urban infill site that housed a dry cleaner in the 1950’s may now be the ice cream shop you’ve loved since you were a kid – who would ever think it could be contaminated?

Image from Pixabay

Assuming the developer of a brownfield property has acquired a Phase One environmental assessment (and a Phase Two environmental assessment if recommended by the Phase One) and is ready to move forward with the project, potential project investors should consider the following financial questions:

  1. What is the cost of the land? In general, there should be a discount for a brownfield parcel. When compared to an equivalent clean site, the price of a brownfield should be discounted by the cost to remediate the site plus some amount to compensate for the risk inherent in the cleanup and the additional profit that should come with cleaning up a contaminated site.
  2. Does the development budget include sufficient contingency for normal construction risk as well as the risk of remediation cost overruns or delays? While a 4-5% contingency is typical for a greenfield site, the development budget on a brownfield should include that standard contingency PLUS 20-25% of the expected remediation cost if the remediation contractor is working under a cost-plus contract, which is typical. The contingency should also be sufficient to cover any delays if remediation takes longer than expected.
  3. Has the developer obtained environmental insurance? A Pollution Legal Liability policy will protect against unknown contaminants and third-party liability claims.
  4. When you make your investment, will the balance of the capital (debt and equity) be in place? If not, recognize that a construction loan on a brownfield property will likely be underwritten more conservatively than a loan on a greenfield property. Some commercial banks won’t consider lending on a brownfield. When a loan is available, the loan-to-value and loan-to-cost ratios may be 5-10% lower than for a clean property.
  5. Is there a financing gap that wouldn’t occur on a similar greenfield property? Because debt and equity may be less available for a brownfield site, the developer will often have the option to cover remediation costs with a public finance mechanism such as tax increment or special district financing. Many municipalities have a Brownfields Revolving Loan Fund to provide developers with low-cost debt to cover remediation costs, which incents developers to clean up toxic sites. Some states also offer tax credits for brownfields cleanup.
  6. Is the project return reasonable given the risk associated with a brownfield site? Developers expect a premium return for taking on the risk of a contaminated property – investors should be rewarded with a portion of that premium.

Image from Pixabay

This is by no means an all-inclusive list of due diligence an investor should consider, or of the risks associated with brownfield redevelopment. We always recommend obtaining appropriate legal and tax advice before investing. That said, the best risk-mitigation strategy lies in underwriting the developer. Invest with those that have significant brownfields experience and a proven track record. Ask about their relationships with the regulatory agencies, lenders, design professionals, contractors, prior investors, insurance providers, and environmental consultants.

Real estate developers often raise money from individual investors in relatively small increments, allowing qualified investors the opportunity to participate directly in the success of a single development project. These investments are not without risk, and your due diligence should be thorough. Along with understanding the project’s market, projected returns, construction risk, and competition, an investor should be fully aware of the site’s prior uses and any contamination that may be present.

Everyone can win in a brownfield redevelopment – you as an investor, the developer, and the overall community. Financial benefits are compelling but contributing to the elimination of blight and toxic contamination in a neighborhood is the true reward.

Patricia Gage

Patricia Gage is a principal at RE Solutions, a company specializing in creating value for brownfield development projects. She can be reached at [email protected] or 303.482.2618.

The Capitalization Approach to Income Property Valuation

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Image from Pixabay

By Dan Harkey
Real Estate & Finance Consultant

Definition of capitalization of earnings:

The concept of the capitalization approach is a method of estimating the fair value of an asset such as income-producing real estate by calculating the net present value (NPV) of expected future net profits or net cash flow referred to as Net Operating Income. The capitalization of earnings is determined by taking the property’s projected annual net income and dividing it by the market capitalization rate (Cap Rate).

Understanding the income capitalization approach (Cap Rates) in the property valuation process is critical when investing in income-producing real estate or obtaining a loan. This concept is essential to commercial realtors, lenders, developers, and investors in income-producing real property. The concept is commonly referred to as the income approach.

Net income divided by the capitalization rate will reflect the expected value of the income-producing asset. Re-stated: Net operating Income divided by the capitalization rate= value (NOI/Cap Rate=Value).

Example: Property Income and Expense Statement Format
The calculation to arrive at the Net Operating Income

Stated one more time: Capitalization Rate represents the annual Net Operating Income (NOI) divided by the cap rate to derive the property asset value (NOI/Cap Rate= Value).

Why do we use Capitalization Rates?

The capitalization approach is a “comparative method” of valuing property with similar properties, similar income streams, in similar geographic locations, and similar risks that will yield a comparable rate-of-return. Once the value is established, the comparative method can calculate the loan-to-value to determine if property value falls within the lender’s loan underwriting guidelines.

Cap Rates are only one metric. Since the capitalization approach is calculated as if the property is debt-free the value will be the same whether the property has leveraged debt or is debt-free. It represents a market snapshot at the investment time and does not consider loan debt service or financing costs.

If an investor finances his acquisition, as most people do, further analysis such as cash-on-cash return will be helpful. Sophisticated loan underwriters and investors may also calculate an Internal Rate of Return. These calculations assist in establishing that the property is income-producing and a worthwhile investment.

Image from Pixabay

A licensed commercial appraiser may perform a rent survey to determine market rents for a property type in a geographic area. Market rents may or may not be the same as actual rents (contract rents). There are many instances where the existing rents are above or below-market rents. A tenant with a long-term lease may have locked in lower rents sometimes in the past.

I once underwrote a loan transaction on an industrial building near San Francisco that was about 100 years old. The property has a long-term lease of 18 cents per square foot, while the current market was $1.75 a square foot. Since current market rents were much higher, the valuation metric used was based upon the locked-in lower rental rate.

A property owner may own the property in one title method such as The Archie Bunker Corporation and occupy all or a portion of the building in different title method such as Archie Bunker Limited Liability Company. He may charge above or below-market rents to himself for tax purposes. Actual rents may also be higher than the market. In this case, the appraiser would use market rents rather than actual rents to determine the Cap Rate.

There are other instances where a conventional market Cap Rate analysis is inappropriate. The alternative method is a discounted cash flow analysis such as original ground-up construction. The building cost and the cash flow from a lease-up need to be projected over a reasonable time to the point of stabilized occupancy. This is done by a competent appraiser who can construct a model estimating a future projected cash flow and using net present value discount formulas to estimate the capitalization rate. The result may differ from the market comparison method.

Suppose you have income properties with similar characteristics in a geographically close location sold in arm’s length cash transactions, and the income stream data is available. In that case, there are web-based databases that track comparison capitalization rates (Cap Rates.)

Market rents are the amount of rent that can be expected for a property, compared to similar properties in the same geographic areas. Contract rent or actual current rent is what the same units are being rented for today. Many lenders will request a rental survey from an appraiser as an add-on task to the requested appraisal job.

There is an essential difference between market rents and current actual(contract) rents in the Cap Rate valuation process. Compare two different buildings, both identical, but the first property is well-kept and rented at a market rate, and a second building that has deferred maintenance. The property with deferred maintenance is rented for under-market rates by under 30%. In both cases, a lender and the appraiser will use market rents to determine the (NOI). The assumption about the second building is that a new owner will upgrade the building and adjust the rents upward to a market rate. The value of the second building would be adjusted downward or discounted to offset the cost to cure (cost to upgrade the building).

The only time that a lender, or appraiser, would use the lower rents is when those rates were locked into a long-term lease or a rent-controlled property. I underwrote the following example: A prospective loan for an industrial building in Richmond, California. The property was leased fee, leased out to a third party for 99 years, with 50 years remaining. The locked-in rent was only 18 cents per square foot triple net. The property owner and broker argued belligerently that current value should be based upon today’s rents.

An inconvenient fact in this example is that the property owner is locked into an 18 cent per square foot monthly income stream for the next 50 years. Capitalized rents will be based upon 18 cents per square foot lease rate. The capitalized value with an 18 cents per square foot will have a dramatically lower NOI compared to a similar building next door that rents at $1.75 per square foot lease rate monthly.

Image from Pixabay

A historic rents comparison databases are available to determine market rents to calculate a correct capitalized valuation. Historic market Cap rates may vary, even in the exact geographic location, depending upon the building improvements, effective age, class of construction, off-street parking, furnished or unfurnished, condition, compliance with zoning, easements or lack of needed easements, and amenities. Examples include Class-A vs. Class-C office, industrial, apartments, older dated, economically obsolete and under parked compared to a new modern building with adequate parking and currently popular amenities.

Advantages and disadvantages of the Capitalization approach to value:

Advantages:

  1. This method converts an income stream into an estimate of the value of the income-producing real estate.
  2. The method is a common standard in the appraisal, lending, and development business.
  3. While the income capitalization approach is common in evaluating commercial income-generating properties, it can theoretically be applied to any income stream, including businesses.
  4. Commercial appraisers are a reliable source for determining market cap rates.
  5. Commercial realtors provide an excellent source of cap rates with websites such as Costar and Crexi
  6. There are online databases such as the CBRE/US-Cap-Rate-Survey-Special-Report-2020 to obtain reliable data.

https://www.cbre.us/research-and-reports/US-Cap-Rate-Survey-Special-Report-2020

Disadvantages:

  1. The method is used for “comparison only with similar properties in a close geographic area.” The method does not consider liens on the property and debt service. A cap rate calculation is done as though the property is debt-free. Cap rates cannot be used to calculate overall net cash flow or cash-on-cash yield when a loan attached to the property (Income, less operating expenses, less debt service).
  2. The results of a cap rate calculation are specific only to a similar area with similar properties in certain segments of the market. You could no use Newport Beach, California cap rates to compare with a similar building with similar usage in Riverside, California. Also, the demand for properties and cap rates for different segments of the real estate market change. Current examples are residential income properties and Industrial are and will continue to be in demand. I read one estimate that industrial in the U.S. will require an extra billion square feet of warehouse by 2025. Office and lodging/resort related properties, not so will. Patterns change!
  3. The method contemplates stable economic market conditions. If a market experiences a significant downturn, collapses, or is subject to extreme political uncertainty, the calculations using market cap rates may be rendered irrelevant.
  4. Relying on a cap rate with an unstable market condition is difficult. Using market rents may become suspect because higher rates of foreclosures, tenants’ default much more frequently, vacancy rates go up, and replacement tenants will ask for higher rent concessions, thereby bringing the market rents down. Additionally, owner operating expenses may become constrained.
  5. Calculating forecasting future income streams involves a high degree of professional judgment, and therefore subject to variation.
  6. Professional judgment is subject to subjective vs. objective interpretations about expectations of future benefits.
  7. The method may result in miscalculations when estimating the cost of capital outlay for upgrades to bring the property up to current standards. All subsets of the job have a cost, time and frustration allocation, including municipal approvals, reconstructing the building, modern materials, safety, zoning, environmental, and social equity requirements.
  8. Property amenities, parking, easements, recorded encumbrances, and compliance with building and zoning regulations require a complex analysis.
  9. The lease-up period is only an estimate and may not be correct.
  10. Alleged appraiser and lender biases for racially segregated neighborhoods have been known to exist.

Tenancies: A landlord and tenant may enter into four types of rental or lease agreements. The type depends upon the agreed-upon terms and conditions of the tenancy. All rental amounts and terms of a lease will be reflected in the capitalization evaluation.

Types include:

Image from Pixabay

1) Fixed-term tenancy is a tenancy with a rental agreement that ends on a specific date. Fixed terms have a start date and an ending date. According to the written lease document, time terms may be short or long such as ten years with multiple extensions.

A landlord can’t raise rents or change lease terms because the terms are codified in a written agreement. A key advantage for a landlord is to receive today’s market rents.A key for a tenant is to lock in a long-term lease where the rents are or become below market over time.

A tenant’s company’s profits are enhanced if they pay substantial under market rents. On the other hand, if a tenant’s company is making a good profit with rents substantially below market and a lease is coming due soon, the increased or negotiated upward lease rate may wipe out some or all the profits.

2) Periodic tenancy is a tenancy that has a set ending date. The term automatically renews into successive periods until the tenant gives the landlord notification that he wants to end the tenancy. Month-to-month tenancies are the most common.

The strength of the tenancies from national credit with long-term leases and corporate guarantees down to mom & pops month-to-month tenancies will result in a substantially different Capitalization Rate. National credit tenants with corporate guarantees have a considerably lower cap rate. Mom & pop tenancies will reflect a higher cap rate because they inherently have more risk.

The lower the market Cap Rate, the lower the perceived risks of property ownership. The higher the market Cap Rate, the higher the perceived risks. An exception would be where the national credit tenant locks in a lease rate that does not increase as the market dictates or anticipates increases. Eventually, over time, this tenant will reflect below-market rents.

A mom-and-pop tenant could be converted to a market rent more quickly because the term is usually shorter.

Market rents are obtained by surveying local brokers and appraisal data- bases of local market rents.

3) Tenancy-at-sufferance (or holdover tenancy). This form of tenancy is created when a tenant wrongfully holds over past the end of the duration of period of the tenancy.

I bring up this type of tenancy because of because of COVID. The government allowed tenants to skip out and default on paying rents without consequence. The tenants either defaulted on the rent or overstayed the term.In either event, the tenant becomes delinquent, and the owner attempts to evict them. The tenant or affiliates may become illegal trespassers.

There are many examples of a landlord attempting to get rid of an illegal tenant only to be jerked around through the court system, with multiple appeals requested by the tenant. They are usually granted.Then comes multiple bankruptcies, not only of each tenant, one by one, but unknown people who supposedly moved in without notice to the landlord.Then comes the transients and fictious folks who show declare that they are a tenant and request that the process start all over because of their fraudulently claimed tenancy. The courts, particularly in states like California just turn their backs on this behavior.

The focus for the property owner becomes using legal avenues to evict the tenants and regain occupancy of the property. This process has great cost and frustration.

4) Tenancy-at-Will. This form of tenancy reflects an informal agreement between the tenant and landlord. The landlord gives permission, but the period of occupancy is unspecified. The term will continue until one of the parties give notice.

Rehabilitated property or New Construction:

Image from Pixabay

Establishing market rents becomes essential in underwriting a rehabbed or new building. When there is an extended time delay for a lease-up period, such as with the new construction of an income-producing property, future cash flows need to be estimated to the point of income stabilization. Then the future stabilized income will be discounted, using an estimate of a market capitalization rate and a discount rate formula.

Work with a competent commercial appraiser to assist and calculate the correct market Cap Rate. Do not try to do this yourself without the help of an appraiser who knows the type of real estate and local market.

Below is an example: The market Cap Rate for a commercial property with triple net leases (NNN) has been determined to be 6.5%. Triple Net or (NNN) refers to a leased or rented property where the tenant pays all expenses related to the operation such as taxes, insurance, maintenance, and occasional capital improvements. The 10,000 square foot multi-tenant property under consideration generates monthly rents of $1.50 per foot. On a (NNN) example for a Cap Rate analysis, one would apply a 10% vacancy collection and loss factor and 5% for non-chargeable expenses that tenants usually do not pay including reserves. The NOI would be $153,900.

The NOI and Market Cap Rate are known so you can calculate the value:

10,000 SF rentable X $1.50 = $15,000 Per mo. X 12 Mos. = $180,000 = potential gross income.
$180,000–$18,000 for 10% vacancy = $162,000–$8,100 for 5% non-chargeable expenses to the tenants = NOI = $153,900
$153,900 NOI /.065 Cap Rate = value = $2,367,692

From an investment standpoint, market Cap Rates can show a prevailing rate of return at a time before debt service. The cap rate procedure will assist a lender and investor to measure both returns on invested capital and profitability based on cash flow. An informed lender or investor should understand that there may be dramatic variations in a property’s value when unsupported or unrealistic Cap Rates are applied.

Cap Rates as well as demand for income-producing properties will move up or down depending on market conditions. The term Cap Rate compression reflects a movement of the rate down because investors perceive real estate as a lower-risk, higher reward asset class relative to other investment options. Cap Rate decompression may result from demand for real estate purchases where cap rates increase, reflecting lower valuations. This may be a byproduct of higher interest rates or government intervention such as rent control.

Loan-To-Value Ratio (LTV):

Cash-on-Cash Return:

Cash on cash return is a quick analysis to determine the yield of an initial investment. The cash-on-cash return is developed by dividing the total cash invested (the down payment plus initial cost) or the net equity into the annual pre-tax net cash flow.

Image from Pixabay

Assume the borrower purchased the property, which costs $1,200,000 and provides an NOI of $100,000, with a $400,000 down payment representing the equity investment in the project. The cash-on-cash return for this property would be:

$100,000/$400,000 = 25% = cash-on-cash yield.

If the borrower were to purchase the property for all cash, as contemplated in a Cap Rate calculation, then the cash-on-cash return would be:
$100,000/$1,200,000 = 8% (this example the 8% is both the cash-on-cash yield and Cap Rate).

It is clear from this formula that leveraging or financing real estate transactions will yield a higher cash-on-cash return, provided the transaction is financed at a favorable interest rate.

Internal Rate of Return (IRR):

Internal rate of return (IRR) refers to the yield that is earned or expected to be earned for an investment over the period of ownership. IRR for an investment is the yield rate that equates the present value of the outlay of capital and future dollar benefits to the amount of money invested. IRR applies to all dollar benefits, including the outlay of the initial down payment plus cost, the positive monthly and yearly net cash flow, and positive net proceeds from a sale at the termination of the investment. IRR is used to measure the return on any capital investment before or after income taxes. Ideally, the IRR should exceed the cost of capital.

Is there an ideal Cap Rate?

Each investor should determine their risk tolerance to reflect their portfolio’s ideal risk-reward level. A lower Cap Rate means a higher property value. A lower Cap Rate would imply that the underlying property is more valuable, but it may take longer to recapture the investment. If investing for the long-term, one might select properties with lower Cap Rates. If investing for cash flow, look for a property with a higher Cap Rate. Declining Cap Rates may mean that the market for your property type is heating up, and demand is intensifying. For Cap Rates to remain constant on any investment, the rate of asset appreciation and the increase of NOI it produces will occur in tandem and at the same rate.

Below are examples of changes in NOI and Cap Rates that cause asset values to rise or to go down:

As NOI increases and Cap Rates remain the same, asset values will increase.
($300,000 reflects net operating income and .06 reflects a 6% cap rate)
$300,000 /.06 = $5,000,000
$350,000 /.06 = $5,833,000
$400,000 /.06 = $6,666,666
$450,000 /.06 = $7,500,000

As NOI remains the same and cap rates rise asset value will go down:
($500,000 reflects net operating income and .03 reflects a 3% cap rate)
$500,000 /.03 = $16,666,666
$500,000 /.04 = $12,500,000
$500,000 /.05 = $10,000,000
$500,000 /.06 = $8,333,333

Correlation Between Cap Rates and US Treasuries:

The US Ten Year Treasury Note (UST) is deemed to be the risk-free investment against which returns on other types of investments can be measured. USTs yields have been on a broad decline for many years but may soon rise. As interest rates increase those investors who bought USTs at a lower rate will find that their bonds will go down in value. Bonds purchased at the new higher rates will be in high demand.

Image from Pixabay

As interest rates rise, cap rates will go up, and consequently, there will be a reduction in asset values over time. With so many uncertainties in the market and growth projections constantly being revised, the spread between UST and Cap Rates has not remained constant.

When the government intrudes in the market, the results are artificial. This has caused capitalization rates to go down, reflecting higher values. Near-zero interest rates have also caused a dramatic inflationary spike in all goods and services.

Summary:

Property appreciation from excess demand has been one of the most significant reasons for investing in real estate Appreciation is not part of the Cap Rate calculation. For investors, lower interest rates, tax benefits of owning commercial real estate may, in and of themselves, be the driving force to make such an investment. If the property is to be leveraged, there may be write-offs for loan fees, interest expenses, operating expenses, depreciation, and capital expenses.

As interest rates have been forced down to extremely low rates, below inflation, by government mandate! Refinancing at lower rates has resulted in lower debt service payments. Cash flows of income-producing properties have gone up, reflecting a higher net operating income.

The government intentionally creates market distortions that benefit the insiders at the top of the economic spectrum. The results are artificial. This has caused capitalization rates to go down, reflecting higher values. Near-zero interest rates have also caused a dramatic inflationary spike in all goods and services. All asset classes have now been “spiked with 200-proof illusions” that make everything seem fantastic on the surface. But hangovers the day after the party ends are no fun.

A one-to-two hundred basis points increase in lending rates (1% to 2%) would shatter the punch bowl into fragments. It is my opinion that an imediate 2% interest increase would collapse the economy overnight. Main Street and small capitalist entrepreneurs would bear the brunt of the widely spread financial damage.

Interest rates are increasing because the government realizes that inflation will only accelerate if they do not stop or slow it. Increased interest rates will result in newly originated loans having higher payment structures. Higher loan payments indirectly and over time cause cap rates to rise and values to go down.

Values may not go down immediately, but the demand to purchase income- producing properties will subside because ownership makes less economic sense. To add flames to this fire government, including federal and state, is passing legislation that will destroy investor motivation to own.

Over time the four-pronged whammy will become apparent. 1) Rising interest rates, 2) increase in interest rates reflecting larger loan payments, 3) general loss of investor confidence in the overall economy, 3) loss of investor interest in purchasing an income property, 4) overburdening & abusive government intervention into property ownership will come home to haunt the entire real estate market across the United States. 5) All of the above will cause cap rates to go up, and property values go down.

Image from Pixabay

Remember that increased debt service based upon higher interest rates is not considered in the capitalization approach. But, over time, as interest rates go up, borrowers will feel the sting of higher debt service payments. Some property transactions may become less appealing financially. As purchasers and borrowers elect not to purchase, that may compound and create more unsold inventory. Some sellers may get desperate and reduce the price to sell quickly. The lowered price would result in a higher cap rate. Higher interest rates will lower all real estate prices on a macro level.

How dramatic will lower real estate prices be over time? Between 2007 and 2010 we witnessed the downward value contagion spread resulting in substantially lower values and increased Capitalization Rates.

The four-pronged whammy is not a new phenomenon. It has just been forgotten while enjoying the Federal Reserve’s “free-for-all 200-proof infused financial punchbowl.”

Dan Harkey

Dan is President and CEO at California Commercial Advisers, Inc. He consults on subjects of Business Growth & Private Money. Dan often creates articles interrelated to these subjects. He has been active in the real estate and financial services industry since 1972 & possesses a lifetime teaching credential for secondary and adult education. He has taught over 350 educational seminars on subjects related to real estate lending, private money lending & loan underwriting for commercial/industrial properties.

Contact Dan Today
Mobile: 949.533.8315
Email: [email protected]

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Why Should Physicians Invest in Real Estate?

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By Blue Ocean Capital LLC

Since the news emerged regarding doctors investing in real estate, more physicians are looking into this option. Not just because they want to get passive income but also because they want to further decrease their overall tax exposure. They want to slow down and avoid burnout. You would agree that we all enjoy practicing medicine but we want to have some degree of control over our lives and future. We can add that by including passive income for physicians. Would you agree?

Why should physicians invest in real estate? With a number of benefits, it’s a great line of work to delve into if you’re looking for a way to earn some passive income for doctors and physicians or add security to your retirement portfolio with the least amount of volatility.

The number of physicians investing in real estate is on the rise. According to recent data from the Urban Institute, a research organization based in Washington, D.C., nearly 41% of doctors have reported that they have invested in some form of real estate. The attractiveness of real estate, when compared to other investments, becomes more apparent as one takes a closer look at how a real estate investment can play an important role in the financial portfolio by increasing its overall returns.

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Real estate investing can give you a huge financial advantage as a physician, but many of you don’t even know where to start or how this investment tool could help your retirement. Today we’re going to tackle what you should know about real estate investing so that you can start taking steps towards realizing your financial potential today.

Tangible Rewards One reason physicians may want to consider investing in real estate is that they can see the rewards they reap. If you own your own practice, you probably work long hours and deal with the stress of running a business. The nice thing about passive investing in real estate is that you don’t have to deal with the day-to-day operations. Instead, you can hire someone to handle things and concentrate on growing your business and making more money. The main perk of being a physician is having the status, financial stability, and respect that come along with the job title. Investing in real estate allows you to achieve those same benefits without putting in 80-hour weeks. Your money is working as hard as you are while it grows in the background.

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Here are a few reasons that every Physician should strongly consider:

Investing in real estate is a great way to earn some passive income for Physicians and add security to your retirement portfolio. But why should physicians invest in real estate?

  1. Real estate has consistently outperformed all other investments, including the stock market.
  2. Many doctors lack the time needed to actively manage their own real estate investments.
  3. Diversification is key in any investment portfolio, and real estate can provide an excellent hedge against the volatility of the stock market.
  4. With the right guidance, doctors can get started in real estate with very little money down, allowing them to diversify their portfolios quickly while minimizing risk. Yes, you can start investing passively by investing 50k if you do it each year and compound it over 10 years at a 15% return you will end up above 1.3 million in your bank. Does it sound like an interesting way to grow your wealth while you are working at your primary job?
  5. Selling your primary residence is considered tax-free under current law, providing much-needed capital for future purchases.

Blue Ocean Capital Latest Offerings for Passive Income for Doctors

Mercury Multifamily portfolio is a fantastic value-add opportunity in the fastest-growing Arlington and Weatherford, Texas. A rare and augmented opportunity to join our team. Hurry Up! Invest Now the offering is Open for Investment. To access the Investor Kit which includes the live webinar replay, updated offering memorandum, and other details about the offering.

If you are interested in this opportunity, Schedule a free one-on-one strategy call on our calendar.

Also, have a look at our closed deals which help to earn passive income for Physicians and doctors.

Conclusion:

If you’re looking for a way to help grow your retirement portfolio without worrying about price fluctuations, investing in real estate may be right for you. In addition, if you plan on spending money on retirement travel or other expenses, investing in property can help ease the financial burden associated with those expenses. Please join our exclusive investor group for Professionals like you. www.bluoceancap.com

Is Austin The Wrong Place to Invest In 2021?

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By Adiel Gorel

I get many calls from people interested in buying in various cities and want my opinion.
One of the popular markets right now is the Austin metro area (people get excited about the overall thriving of the local high-tech scene, Elon Musk publicly decamping to Austin, and others moving there from California). It is tempting to think of Austin as a good destination to buy in 2021. However, in my opinion, it is not! Austin, in fact, is a good city to be a SELLER in 2021. Austin prices have climbed rapidly in the past six years, while rents went up much more slowly. As a result, the rents are too low to cover all expenses. One expense in Austin (and in the state of Texas overall) is the very high property taxes. The property taxes in the Austin metro can get to almost 3% of the home value per year (depending on county and town). That is over 2.5 TIMES the property tax rate in Oklahoma (or California). Together, the high prices, relatively low rents (relative to the prices, that is), and the high property taxes, as well as high insurance costs, create an untenable cash flow.
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Here is a partial headline of a Business Insider article “Elon Musk and other tech powerhouses are flocking to Texas, pushing an already bonkers real-estate market to new heights”. Just logically, do you want to be a buyer in a market that is “already bonkers” and now is being pushed up even more? They have a name for such a market in the real estate world: “A strong Seller’s’ Market”.
Do you want to be the BUYER in that strong Sellers’ market? You will be the one paying “bonkers” price to the savvy sellers, fending off multiple offers higher than list price.
It is very tempting for a California resident to say, “What? I can buy a new home in Austin for “only” $320,000? That is so cheap! Yes, it is. “Cheap” relative to San Francisco prices. However, it is not cheap to buy as a sound rental home, and has bad cash flow. Austin is a place where many of our savvy investors are now SELLING, as the selling market is strong. It is not uncommon to see an investor selling one Austin home and buying 3 brand new homes in a 1031 tax-deferred exchange in Oklahoma City, or Tulsa, or Baton Rouge, or Central Florida. This move creates much more quality real estate owned, more 30-year fixed loans at todays’ super low rates, and brand-new properties with brand new roofs, ACs and all other parts of the homes.
Similar logic applies to the Dallas Ft Worth metro area (DFW), Houston, Phoenix, Las Vegas, Nashville, Denver, Salt Lake City, Boise, and others. I even get some investor talking about Seattle and Portland, which make no sense at all. Some misguided reporters (who in many cases have no actual experience in real estate investing themselves) confuse high prices and growth with an attractive place to invest in. The two are not necessarily linked. An example of another very popular destination for Silicon Valley people leaving to other states, is Miami. Miami is popular, large (much larger than Austin, for example), has an international airport, great weather, beautiful beaches, and proximity to great vacation spots. Miami also has a thriving tech sector. Sounds perfect, right? We should invest in Miami, right? No! Miami prices are way too high to make sense at this time. While the property tax is “only” about 160% of that in Oklahoma or California, the price/rent ratio makes it an unattractive place to invest. Miami has been a magnet for the wealthier set of tech and finance people as of late. The prices reflect it. There is an interesting article in Business Insider written by a tech person who had moved from San Diego to Austin and regrets it. It’s titled: “I moved my family from California to Austin, Texas, and regretted it. Here are 10 key points every person should consider before relocating.” The author mentions the harsh Texas heat, coupled with humidity, which, in the summer keeps you indoors and runs your AC 24/7, while also bringing scorpions and the like, and being hard on the houses. Of course, he mentions the super-high property taxes and high insurance costs. He talks about the very high cost of power and water, much higher than he had in California. Overall, he was surprised by the cost of living being much higher than he had anticipated. He mentions the travel difficulty, as Austin doesn’t have a large airport, requiring an extra “hop”. He laments the relative lack of public parks and spaces, to which he was used in California. While this is only the account of one high tech family who moved to Austin, and may not reflect everyone’s experience, some of the points are absolute.
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We have investors who actually LIVE in Austin. They are absolutely not interested in investing in Austin. They live there. They know how little sense it makes to buy in Austin in 2021. They seek investments in saner markets where the prices, rents, and property taxes, are in much better balance. We also have investor who live in Miami, Phoenix, AND Las Vegas, as well as Portland and Seattle, among many other places. All these investors wouldn’t dream of buying rental homes in the market they live in at this time. They know the insane sellers’ market that exists there, and the way-too-high prices.
This phenomenon is not new. Investors declare they want to “Buy Low, Sell High”. However, in reality, many investors end up “Buying High and Selling Low”. Right now, Austin is the darling market touted for its growth and Elon Musk. The people who are buying super-high in a “bonkers” market, pumped by the media hype, will be the first ones to sell frantically when a recession hits, or even lose those homes to foreclosure. We have seen these scenarios throughout history, time and time again. You see the same phenomena in the stock market. People secretly love to “Buy High”.
The reason is usually “But this market will appreciate a lot!” Really? You mean you know the future? No one else does. Just because a market behaves a certain way, and even booms, it is not necessarily a guarantee of everlasting constant appreciation. We have seen it in many areas of the country.
One other factor that is important to discuss is, again, the heart and soul of single-family home investing in the United States. The reason single family rental homes change futures so effectively and powerfully: The 30-year fixed-rate loan. I talk a lot about the wonder of this loan. A very quick recap for new readers: The monthly PI payment never changes, while everything else in the US economy constantly changes with the cost of living. Same is true for the mortgage balance, which goes down due to amortization, but also never keeps up with the cost of living. This creates incredible futures for people, as inflation constantly erodes the real value of the loan balance and monthly PI payment. No need to wait for 30 years. Typically, after 12, 14, 16 years, the loan balances are very small relative to the home price. The monthly payment is very small relative to the rent. It is not uncommon for a person to find, after 14 years, that the loan balance (even though the loan still has 16 years to go), is merely 20%-25% or so of the home price. Many sell a couple of homes at this point, and use the after-tax proceeds to pay off several other small loans, and leaving several free and clear homes, enabling them to retire. People also see how this can send kids to college (even costly colleges), and achieve many other long-term financial life goals.
The reason I hark back to this point in this article, is to remind you that the most important point is to buy a good new single family rental home, put a down payment, and then get the constant power of inflation and the payments by the tenant, to pay off and erode the loan balance, building equity for your future wealth. With today’s astoundingly low rates, strong results may be seen even sooner, perhaps 10, 11 years.
The single-family home is the VEHICLE to let inflation work its magic on the 30-year fixed-rate loan. The location of where you buy the home (as long as it’s large metro areas in the Sun Belt states, where the numbers make sense), is of secondary importance. It would behoove the smart investor to buy in a market where the prices are not “bonkers” and where the rents measure up to the price well, preferably in an environment where property tax and insurance costs are low. This enables the owner to enjoy cash flow (especially with today’s low rates), which building their wealth for the future with the help of inflation.
ICG (International Capital Group) Real Estate Investments was established in the 1980’s. Adiel Gorel, founder and CEO, has been helping people achieve financial security for over three decades, and in that time worked with investors to purchase over 10,000 homes. Gorel is a real estate broker in several states in the U.S., an international keynote speaker, and notable author of three books: Remote Controlled Retirement Riches – The Busy Person’s Guild to Real Estate Investing, Invest Then Rest – How to Buy Single­Family Rental Properties and Remote Control Retirement Riches – How to Change Your Future with Rental Homes. He has been featured on major television and radio networks across the country and in Fortune Magazine. He has also been featured on Public Television with his show, “Remote Control Retirement Riches with Adiel Gorel.” To invite Adiel Gorel to speak for your group, email [email protected] and visit AdielSpeaks.com. For more information on ICG Real Estate Investments visit icgre.com.