If you have a retirement account with over $200,000 and are looking for cash flow, more stability, and a secure retirement portfolio you need to attend our upcoming free seminar.

Tuesday, November 15, 2011

7:00-9:00pm

Phoenix Inn, 850 Franklin Blvd, Eugene

To Register Call: (541) 987-2232

 A key to buying commercial real estate successfully in this market is with low leverage.  The cap rate has to be about 2% in excess of the current interest rate that would be charged for the new loan on such property.  If you are obtaining a loan the lender’s require a Debt Coverage Ratio of about 1.3 so you need to be attentive to that too.

To ensure that you are buying a quality investment you should carefully study the past three years of:

1.  Year-End Property Manager’s Operating Statements; and,

2. Owner’s Schedule E’s for the same years

The operating expense should be about 40% to 44% of the actual rental income received. If it is less than that, then be cautious in using the resulting Net Operating Income for your valuation.

Good luck and let me know if you have any additional questions!

Apartment demand continues to gain steam and strong demand is emerging. It’s a great time to buy!

Vacancy rates continue to rise in most commercial sectors and are not expected to level out in most markets until the end of this year or early 2011, according to the National Association of Realtors^®.

Lawrence Yun, NAR chief economist, said there is one bright spot in commercial real estate. ”The multifamily sector can expect increased demand as the economy creates jobs and new households are formed, likely in the second half of this year,” he said. ”However, the office, warehouse and retail sectors continue to experience the delayed effects of the recession. These sectors should see gradual improvement after jobs pick up and create additional demand for space, meaning a broader improvement in commercial real estate is likely in 2011.”

The Society of Industrial and Office Realtors^®, in its SIOR Commercial Real Estate Index, an attitudinal survey of nearly 700 local market experts,(1) confirms that significant fallout from the recession remains, but to a lesser extent.

The SIOR index, measuring 10 variables, increased 2.7 percentage points to 38.2 in the first quarter, compared with a level of 100 that represents a balanced marketplace. This is the second gain following nearly three years of declines; the last time the market was in equilibrium was in the third quarter of 2007.

Development activity remains at a standstill with nine out of 10 respondents saying that it is virtually nonexistent in their markets.

Looking at the overall market, commercial vacancy rates appear to be approaching a plateau, according to NAR’s latest COMMERCIAL REAL ESTATE OUTLOOK.(2) The NAR forecast for four major commercial sectors analyzes quarterly data in the office, industrial, retail and multifamily markets. Historic data were provided by CBRE Econometric Advisors.

Office Market
With an elevated level of sublease space available, vacancy rates in the office sector are projected to increase from 16.9 percent in the first quarter of this year to 17.6 percent in the first quarter of 2011, but should ease later next year.

Annual office rent is likely to fall 2.3 percent this year and decline another 2.1 percent in 2011. In 57 markets tracked, net absorption of office space, which includes the leasing of new space coming on the market as well as space in existing properties, is forecast to be a negative 24.6 million square feet this year and then a positive 25.5 million in 2011.

Industrial Market
Leasing activity in the industrial sector is below historical levels with higher vacancies, more tenant concessions from landlords and a steeper decline in rental rates. In addition, obsolete structures remain on the market. Industrial vacancy rates are expected to rise from 14.3 percent in the first quarter of 2010 to 14.8 percent in the first quarter of 2011, then decline modestly as the year progresses.

Annual industrial rent will probably drop 6.3 percent this year, and decline another 1.5 percent in 2011. Net absorption of industrial space in 58 markets tracked is seen at a negative 90.0 million square feet this year and a positive 135.6 million in 2011.

Retail Market
Retail vacancy rates should rise modestly from 12.6 percent in the first quarter of this year to 12.8 percent in the first quarter of 2011, and should hold at that level for most of next year.

Average retail rent is projected to decline 1.5 percent in 2010, then edge up by 0.4 percent next year. Net absorption of retail space in 53 tracked markets is likely to be a negative 3.7 million square feet this year and then a positive 8.9 million in 2011.

Multifamily Market
The apartment rental market — multifamily housing — is expected to benefit from an improving economy and job market. Multifamily vacancy rates are forecast to decline from 7.3 percent in the first quarter of this year to 6.3 percent in the first quarter of 2011.

With recent additions to supply, average rent is likely to slip 1.5 percent this year, and then rise 1.2 percent in 2011. Multifamily net absorption should be 145,700 units in 59 tracked metro areas this year, and another 214,500 in 2011.

The COMMERCIAL REAL ESTATE OUTLOOK is published by the NAR Research Division for the commercial community. NAR’s Commercial Division, formed in 1990, provides targeted products and services to meet the needs of the commercial market and constituency within NAR.

The NAR commercial components include commercial members; commercial committees, subcommittees and forums; commercial real estate boards and structures; and the NAR commercial affiliate organizations — CCIM Institute, Institute of Real Estate Management, Realtors^® Land Institute, Society of Industrial and Office Realtors^®, and Counselors of Real Estate.

Approximately 79,000 NAR and institute affiliate members offer commercial brokerage services.

The National Association of Realtors^®, “The Voice for Real Estate,” is America’s largest trade association, representing 1.1 million members involved in all aspects of the residential and commercial real estate industries.

(1) The SIOR Commercial Real Estate Index, conducted by SIOR and analyzed by NAR Research, is a diffusion index based on market conditions as viewed by local SIOR experts. For more information contact Richard Hollander, SIOR, at 202/449-8200.

(2) Publication of additional analyses, including metropolitan data, will be posted under Economists’ Commentary in the Research area of Realtor.org in coming weeks.

The next commercial real estate forecast and quarterly market report will be released on August 26.

“The more I think about it, it seems that ” like kind ” property is a very loose term. I guess the ” character” of the property more important than it’s use. I mean if you have a duplex and you exchange it for an apartment building then that is clearly “like kind” . But if you exchange that duplex for say a property with a restaurant then that would not seem to be “Like kind”. Mostly it seems like this is used for exchange of rental or timber property but it must also apply to other businesses and I suppose it doesn’t really matter what the business is. Can we just cover it with a blanket called ” Investment property”?

So do we categorize properties? Business, trade, rental, timber, vacant land… I can’t really think of any others, manufacturing maybe. Or do we just do what “feels” like it would be a reasonable argument for ” like kind”?

Nelsonian Theory has the answer:

Like Kind:

1. Property held for long term investment (not income generating, but held for appreciation in value): e.g..: a lot, ten acres etc.
2. Property held for
   1. Productive use in trade or business; or,
   2. Generation of long term passive income (rental property).

Not Like Kind:

1. Personal use assets (personal use, not business use)
   1. Personal residence
   2. Second residence
2. Property acquired for resale to others (dealer status)
3. Personal property (REIT’s, appliances, cars, etc.
4. Partnership interests
5. Stock and bonds (secured or unsecured by real estate)

The real test: What was the intent of use at time of acquisition, and then how was it used after acquisition.

Tom Potiowsky, the State of Oregon Economist, recently presented his most current status of the Oregon economy to the Oregon SW Washington CCIM chapter. His presentation titled, “Oregon Economy: Up the Long, Long, Long Road to Recovery” aptly summarized his findings. The good news: the economy, which bottomed out last fall, is now growing again, although ever so slowly. Shown below are the top 10 facts I gleaned from Mr. Potiowsky’s presentation: 1. As of April 2010 the state’s unemployment rate is 10.6% compared to 9.9% nationally. 2. Job growth (-1.7%) ranks 41st for all states for April 2010 over April 2009 3. Total nonfarm employment dropped -3.0% year-over-year for the 1st quarter of 2010 4. The rate of decline in job losses has slowed from 10,000 a month for the first six months of 2009 to 875 per month for the first four months of 2010. Job losses are anticipated to continue through this quarter with only mild job growth the rest of the year. 5. Oregon exports increased 41% in the 1st quarter of 2010 compared to the same period last year but declined 23% when compared to 2008. 6. Personal income growth has almost stabilized at -0.1% for 4th quarter of 2009 over 4th quarter of 2008. 7. When compared to other states our unemployment rate is significantly better than Nevada and Arizona, about the same as Idaho and California and significantly worse than Utah and Washington. 8. From Oregon’s peak employment (which occurred in March 2008) it is estimated that it will take around 76 months (about 6+ years) to get state employment back to the same level. Only the 1980-82 recession took longer to recover from, that taking about 7 years. 9. U.S. employment is projected to take about 60 months to recover to the level it was prior to the recession. This is predicted to be the longest recovery period of the 10 recessions (by a wide margin) that has occurred since WWII. 10. Oregon’s Index of Leading Indicators is in positive territory for the first time since late 2007. The six-month annualized percent change is 3.3%. Nine of the 11 leading economic indicators are positive. So where we go from here depends on many factors. For example, on the upside other parts of the world could recover more quickly increasing the demand for our exports. On the downside, the potential for a real estate bubble in China or the affect of the Greek crisis on the Euro could adversely impact us and the rest of the world. Who knows? We can focus on the unknowns or those things out of our control or we can roll up our sleeves and focus on those things we can change. This reminds me of an old African proverb: Every morning in Africa, a gazelle wakes up. It knows it must run faster than the fastest lion or it will be killed. Every morning a lion wakes up. It knows it must outrun the slowest gazelle or it will starve to death. It doesn’t matter whether you are a lion or a gazelle. When the sun comes up, you better start running. Let’s all run in these difficult times as best we can to see another day!

The delinquency rate on CMBS conduit and fusion loans increased by more than 50 basis points in January,bringing the total rate to 5.42%. The total delinquent balance is now more than $36 billion, a $3 billion increase over the month before. By dollar and basis points, this is the largest increase in the delinquency rate thus far in the downturn, as measured by the Moody’s Delinquency Tracker (DQT). …The retail delinquency rate rose 72 basis points and currently stands at 5.24%. The 72 basis point increase was more than 1.5 times higher than any increase in the history of the retail DQT …

Read the rest of the story.

Cap Rates – A Hot Topic: For apartment investors and apartment brokers, the subject of cap rates is critical right now.

Why Now: Cap rates are starting to change at a pretty good rate in  response to the current recession and changes in apartment financing interest rates.

First – Some Background Information

What does a “Cap Rate” tell you? The cap rate is one of the best indicators of investment productivity for an income producing rental property.

The Technique Name: The term “Cap Rate” is the main ingredient of the mathematical formula of “Capitalization Rate of Net Operating Income”.

How is the Cap Rate Used?

Note from Reader to Self: “Is this stuff worth learning?                                 Restated “What is in it for me, if I learn this stuff?”

Proper Answer: If you don’t learn about it and how to use it properly, then you had better hire someone like Bob Nelson, CCIM, then hang your financial well-being on his ability to “think properly for you”.

Restated: Learn what the prudent investor must know to protect and advance your own position.

While it certainly would be wise to hire “The Guru”, it would also be equally wise to understand what guides his thinking, in case he gets run over by a bus!!

CAP RATE APPLICATIONS

The cap rate has a number of very valuable uses, depending upon its user.

1. Owners: An owner could use the cap rate to determine the productivity of the various properties owned.
   1. Rule: The higher the cap rate, the more productive is the property’s capacity to generate cash flow relative to the value that the owner assigns to that property. .
   2. b. Rule: The higher the cap rate, the higher the property’s return
   3. c. Rule: Use the cap rate and the current available interest rate to forecast the potential benefit of increased yield that would result from refinancing the property today.
   4. d. Rule: When it comes to portfolio adjustment time, use the cap rate to identify the “runt of the litter” (worst performer), then exchange that one into a more productive property.

1. 2. Buyers: A buyer can use the cap rate to determine the relative appeal of several properties being considered.
   1. a. Rule: All other features considered equal, chase the property that offers the highest cap rate, and kick the low performer to the curb.
   2. b. Rule: If the indicated cap rate at the asking price is too low, then offer a lower price.
      1. i. Force the offer price to generate the cap rate that is your minimum purchasing criteria for investments of comparable risk, similar location, and similar physical characteristic.
      2. ii. This may not work for the seller, but you can make wise decisions using the cap rate selection criteria.

1. 3. Sellers: A seller can forecast with a high degree of accuracy what a reasonable asking price should be for each property that they own.
   1. a. Rule: Apply the “current” market generated cap rate to the NOI of each property to forecast how a qualified buyer would probably respond given a particular asking price.
   2. b. Rule: Use the cap rate and the current available interest rate to forecast the potential benefit of an increased yield that would result from refinancing the property today.

WHAT IS NET OPERATING INCOME?

The Net Operating Income (“NOI”) is the annual cash flow that you would receive if you own the property free and clear of debt and before paying your income taxs on the received cash flow (“cash flow before debt service and before person income taxes”).

The “NOI” Formula  -   For Apartments:

Scheduled Gross Rental Income (at current rental rates)

-   Vacancy and Credit Loss loss from vacant units and no-pay tenants

Effective Gross Rental Income

+   Other Dependable Income such as:

Tenant Deposits (while not “income”, it offsets expenses later)

Sub-metered Utility Income (if units are sub-metered)

Vending Income (laundry income, etc.)

Effective Annual Income

-     Fixed Expenses: (expenses that do not vary with occupancy)

Property Taxes

Property Insurance

-          Variable Expenses: (expenses that vary with occupancy)

Property Management

Advertising

Legal and Accounting

Utilities (provided by the owner)

Trash Removal

Maintenance and Repairs

Supplies

Grounds Maintenance

Reserve For Replacement of Short Lived Assets

Net Operating Income  “NOI”

Again, Net Operating Income “NOI” is the amount of annual cash flow that you would receive if you:

1. 1. receive all of the income that is reasonably available from a well managed property;
2. 2. own the property free and clear of debt; and,
3. 3. prior to paying income tax on incomes received from the property

If you think about it, that is a very sensible way to measure the true productivity of the property.

1. 1. The mortgage payment is not a function of property productivity.

It is a function of property ownership.

Restated: the property doesn’t come with a mortgage. I may have to put a large mortgage on the property in order to own it. While you could own the property free and clear of debt. For both of us, the property will produce the same NOI.

• A very large portion of that NOI will have to be used to service my large mortgage loan.
• You get to keep what I paid as mortgage payment as your cash flow since you have no mortgage.

What Is NOT Included In NOI?

As previously stated, the mortgage payment and your personal income taxes are not considered in the calculation of  Net Operating Income “NOI”.

There are other expenditures that would be incurred periodically, but those expenditures are not part of NOI.

Example: A Capital Improvement – those improvements that not be recurring annual expenditures that would extend the useful life of the property.

Example:  New Roof. While a new roof is necessary to protect the asset and its ability to attract and retain tenants, the cost of the new roof would not be included in the calculation of NOI.

Why: The cost of the new roof is not a recurring annual expense. You don’t pay to put a new roof on every year… unless the property is located in Tornado Ally…

CALCULATING THE CAP RATE

The mathematic relationship that calculates a “Cap Rate” is demonstrated below in a circle diagram.

Cover the component you wish to calculate, and the formula for its calculation is demonstrated by the circle diagram

NOI  =   Net Operating Income (of a comparable property)

R    =   Cap Rate (derived from the market)

IV   =   Investment Value (or Sale Price of a comparable property)

USE: To calculate Cap Rate “R”, then cover the “R” and it shows you that you take the NOI of the property and divide it by its Sale Price.

Typical and Common Cap Rates in the Pacific Northwest:

Rental Houses:                4% to 5% cap rate

Duplexes                         5% to 6% cap rate

Larger Apartments           7% to 9% varies with location and condition

R =  NOI / Value It is a market derived percentage that reflects what a specific type of highly similar properties are selling for relative to the NOI that those properties generated at time of sale

PART TWO:  BEYOND THE BASICS

Assuming that you have a reasonable understanding of Net Operating Income “NOI” and Cap Rate “R” let’s consider what such knowledge can do for an informed investor

FOR APARTMENT COMPLEXES

IN THE

PACIFIC NORTHWEST

CAP RATES HAVE INCREASED RECENTLY

Starting about mid-January, 2010, cap rates for apartment complexes have increased noticeably.

2009 to 2010:

6.5% on attractive well located apartment complexes

6.75% to 7.0% for older but well located complexes

7.0% to 7.5% for older “so-so” maintained complexes

Mid-January 2010 to present mid-March 2010:

7.0% on attractive well located apartment complexes

7.25% to 7.75% for older but well located complexes

8.0% to 8.5% for older “so-so” maintained complexes

Preliminary Market Observation: Cap Rates of mid-sized apartment complexes have risen about ½% from, early January 2010 through mid-March 2010.

WHAT CAUSES CAP RATES TO CHANGE?

1. 1. Availability of qualified buyers willing to purchase
   1. a. In my opinion, there are more cash-heavy buyers looking to purchase in mid-March 2010 than existed in September, 2010.
   2. b. I sense that cash heavy investors have been sitting on the side-lines “waiting for the bottom of the income property market” in the current recessive market.
   3. c. They are tired of receiving 1.5% on their savings accounts, and are attracted by the 8% yields that could be had on a free and clear apartment complex.

1. 2. Some fairly desperate sellers needing to sell
   1. a. I sense that there are a number of apartment complex owners that have felt the bite of the recession, and have decided that they need to sell one or more of their portfolio assets in order to develop liquidity to protect the balance of their net worth
   2. b. More desperate sellers will accept lower prices, thus causing a higher cap rate for the property that they are selling.
   3. c. As the cash heavy buyers see increasing cap rates, those rates on other competing complexes will be applied to all other properties on the open market.
   4. d. A limited feeding frenzy could develop as investors move to acquire attractively price apartment complexes with low fixed interest rates. It simply makes sense to buy now. The moon and stars are in alignment for the perfect buying season.

1. 3. Lenders that typically finance apartment complexes are become more and more conservative in their lending practices.
   1. a. They will instruct commercial appraisers to be more conservative with their appraisal reports. They will have more conservative estimated of the property’s NOI, and the “Overall Rate of Return” (effectively the “Cap Rate” used by the appraiser) will be increased with each increasing market cap rate observed in the market.
   2. b. The lender will use a more conservative Debt Coverage Ratio “DCR” when determining the amount of money that will be loaned relative to the property’s capacity to service the debt.

PROBABLY FUTURE ACTIONS

Nelsonian Wild-Eyed Philosophizing:

1. 1. Concerning Cap Rates: Cap rates for apartment complexes will increase slightly, but will stabilize until such time when interest rates increase significantly. Then, cap rates will parallel the increase in interest rates.

1. 2. Concerning Investor Greed:

1. a. Investors who get too greedy (insist on using too high of a cap rate) will be snubbed by apartment complex owners who are not desperate to sell.
2. b. Those investors who are more moderate in “throwing their purchasing weight around”  (e.g.  will accept “market rate” cap rates) will be in an excellent position to acquire the BEST ASSET TYPE WITH THE HIGHEST OVERALL PROBABILITY OF SURVIVING THE CURRENT RECESSION
3. c. Restated: The greedy will become the needy

[1,833 words to here]

STAY TUNED FOR MORE EDITORIAL COMMENT,

AS I OBSERVE CHANGE IN OUR MARKET PLACE

Thank you for your attention

Bob Nelson, CCIM

Real Estate Investment Broker

“The 1031 Guru”

Pacwest Real Estate Investments, LLC

711 Country Club Road

and

3130 Beech Street

Eugene, Oregon 97405-4344

(541) 485-8100

bob@1031guru.co

www.1031guru.com

1. “Attractive”:

a. general “curb appeal” (important to tenants and buyers)

b. overall security for tenants

c. income generating capacity that would support the asking price Why: Nelsonian Theory has it that “Before you buy, figure out how to get out of the property later”

Ask yourself this question: “If I were offering this property for sale today, will I get interested qualified buyers at this price?

2. “Strong pride of ownership”

a. Can it be made to reflect a “price of ownership” consistent with the level of rents that I target? Again: Think resale.

b. Long term tenants appreciate pride of occupancy, and will pay decent rent for a safe and clean place to call home.

3. “Well maintained property”

a. Did the prior owner do a good job in maintaining it?

b. If not, there will be a price penalty.

The Financing Decision: The lender will require certain information with the application. The most important information is the operating history of the property.

1. “Schedule E’s / Form 8824’s” and “Year-End Reports”:

a. The lender will require the last three years of the owner’s operating performance from filed tax returns, and manager’s Year-End Reports.

b. The lender and the lender’s appraiser will use this information to establish a baseline of rents and expenses.

c. The Target: a normalized Net Operating Income (“NOI”) which is the annual cash flow if owned free and clear of debt and before personal income tax considerations)

d. The lender’s allowed Debt Coverage Ratio (“DCR”) when divided into the normalized Net Operating Income (“NOI”) will define the lender’s opinion of the maximum annual principal and interest payment that the property can safely support.

i. Today’s DCR for apartment complexes: 1.25 to 1.30

ii. FYI: That has increased from 1.15 two years ago

e. The amount of annualized debt service (P&I) when divided by 12 will define the maximum allowed monthly debt service (P&I only) that the lender would permit for the property.

f. When the monthly maximum debt service is applied to the lender’s interest rate (6% to 7% today) and maximum allowed loan term (25 to 30 years today), this will define the maximum amount of loan that the lender will permit for the property.

g. There is no mystery involved. If you can define the normalized NOI and can obtain the Debt Coverage Ratio (DCR) that the lender will use, then you can determinate in advance the maximum available financing for the property. A good commercial – investment broker will do this prior to bringing a property onto the market.

SIDE-BAR COMMENTS  AND  STRATEGIC OPINIONS  FROM “THE GURU”….

1. DCR-based Calculations can be misleading.

a. Recently I made such a calculation for a 72 unit apartment complex that I was marketing. Using current lender standards (1.30 DCR, 6% interest rate, and a 30 year term), the calculation inferred that the lender should be willing to make an 84% Loan to Value Ratio (“LVR” or “LTV”) loan. My observation: Fat Chance!!

b. Lenders still feel edgy about going past a 75% LVR, even when the “financial moon and stars” are in perfect alignment. However, do not abandon the information presented above.

2. Interest Rates change quickly. Never trust old information

a. There are several really good and dependable lenders that I look to for current and accurate information. I may be able to help.

b. There is nothing that will ruin your day more than tying up a really good property, then finding out that something has changed, and you have to sheepishly step politely out of the “Winner’s Circle”. Again, maybe I can help IF I AM BROUGHT INTO THE GAME EARLY ENOUGH TO BE ABLE TO MAKE A SUBSTANTIAL IMPACT.

3. Use FIXED RATE LONG TERM Financing.

a. I will try to remain “Politically Neutral” here (I am a registered “Independent” and have been since 1964), but in my opinion what the current administration is doing will lead to super inflation in the fairly near future.

i. Super inflation leads to super interest rates.

ii. You can’t just leave the printing press on at the Treasury without having someone notice…Gee, maybe there is a downside to “too much money”.

b. Absolutely avoid a variable rate loan.

i. You will become the custodian of the apartment complex for the lender as the variable rate loan indices start to climb.

ii. With a variable rate loan, the lender would have passed the inflation risk through to you.

3. Use the LONGEST AMORTIZATION TERM AVAILABLE.

a. This would require the lowest monthly PI payment.

i. You can always add more to the payment if cash flow is available

ii. But you can back off to the lowest required payment if cash flow turns negative for a period.

4. These are times that build wealth and character!

a. Be cautious, but keep moving forward!

i. Interest rate are MEGA-CHEAP

1. The last “Great Recession” (1980-86) first mortgage price was 21.5%!!

2. Today’s “Mother of Recessions” has first mortgage prime at around 6%.

3. We have never seen a recession where prices are “right” and money rates at “right” too.

a. But borrow with an interest rate that can not be adjusted for at least 5 years and preferrabley10 years. You can thank me later.

ii. Prices and investment yields are getting “more right” every day.

1. If you can borrow at 6% and invest at 8%, you are making money on money you don’t even have. WHAT A COUNTRY WE LIVE IN!!!

Contact me if you:

1. have questions about this information; or,

2. are looking to purchase or sell an apartment complex.

I know my “stuff” and can buffer you from certain dangers.

Bob Nelson, CCIM

The 1031 Guru

41 years of commercial – investment brokerage expertise

(541) 485-8100

bob@1031guru.com

www.1031guru.com