financial management. course 8: financial mgmt2 introductions your name where you work your job...

Financial Management

Course 8: Financial Mgmt 2

Introductions Your name Where you work Your job responsibilities How long you have been in the

industry What you hope to get from this class

Course 8: Financial Mgmt 3

Agenda Investments Adding Value to the Investment Economic Analysis of a Property Budgets Property Valuation

Chapter 1: Investments

We will discuss:- What are investments and whether

to make them- Advantages and disadvantages of

investing in multifamily housing- Different types of ownership and

methods of financing

Course 8: Financial Management

Course 8: Financial Mgmt Chapter 1 5

Definition: Investment An investment is the use of funds to

earn a profit.

Module 8: Financial Mgmt Chapter 1 6

Four (4) Factors in Investment Risk – low risk = low return

high risk = high return Income – may depend on risk

involved Growth – means a potential to

increase in value >NOI = greater value

Liquidity - ability to convert to cash

Owner’s Objectives

Why is it important to know the owner’s investment objectives for the property you manage?

Performance Measures Rate of return on investment (ROI) Cash-on-cash return Capitalization rate Internal rate of return (IRR)

Rate of return on investment = percentage of return on each dollar invested

Cash flow/Investment = ROI

Module 8: Financial

Management 9

Capitalization Rate

NOI/Purchase Price = Cap Rate

NOI/Cap Rate = Value

Course 8: Financial Management

Exercise

We paid $7,000,000 for a property and the NOI is $500,000. What is the cap rate?

Divide NOI by 6%

Course 8: Financial Management 11

Remember

Lower cap rate = higher value

Higher cap rate = lower value

Advantages of Investments

Advantages include: Periodic cash payments Potential for increase in value Reduction in income taxes due to

depreciation Ability to invest using borrowed funds

Disadvantages of Investments

Disadvantages include: Real estate is not a liquid asset Active participation is often required Potential for risk (natural disasters,

changes in market conditions)

Forms of ownership Direct ownership Partnership Limited liability partnership Limited liability corporation S corporation Joint venture Real Estate Investment Trusts (REITs) Tenants in Common (TICs)

Types of mortgages Fixed rate Variable rate Balloon Bullet loan

Where to obtain a mortgage Commercial banks Finance companies Savings and loan institutions Insurance companies Pension funds Mutual funds Federal government (Freddie Mac,

Fannie Mae)

Skill Check #1

Chapter 1- Investments

Chapter 2

Adding Value to the Investment

Course 8:Financial Management 19

Adding Value: CAM Responsibilities

1. Generating and collecting as much income as possible

2. Controlling expenses3. Meeting the financial goals of the

investment

Additional ways to add value: Reduced staff turnover and lower

personnel costs Reduced resident turnover with better

customer service Aggressive rental rates set by unit type New income sources through resident

services Better collection of resident charges

Sources of Income Rent Administrative

Fees Parking/Garage

fees Pet fees Laundry

room/Vending

Late fees/collection fees

Clubhouse rental/video rental

Car wash Cable/Internet/

Types of Expenses Maintenance Administrative Salaries/Personnel Taxes

Insurance Utilities Contract services Advertising and

Marketing

3 Factors That Affect Rental Income Competitive rental rents Physical occupancy Collection percent or economic

occupancy

Concession Impact

Market rent = $700Concession = one month rent

What is the Effective Rent?

Law of Supply and Demand If the demand is high and the supply

is low, higher prices can be obtained.

If demand is low and the supply is high, rents must be made competitive to attract residents.

Economic conditions Population growth Household formation Job creation

Balancing rental rates and vacancies The goal is to maximize income not

occupancy Pricing too high may cause longer

vacancy Pricing too low means you are losing

money while the unit is occupied

Increasing rental rate

Market value = $800Raise rent 10% = $880Vacancy = 15 days

What is the cost of the vacancy?At the new rate, how long before yourecover the vacancy loss?

Lowering rental rate Market value = $800 Lower rent 10% = $720 Loss per month = $80 Loss per year = $960

What would you lose if you did notlower the price and the apartment sat vacant for a month?

Before adjusting rent, analyze the 4 P’s:

PeopleProductPromotionPrice

Determining pricing Conduct a market analysis Use an automated revenue

management system

When to consider a rent increase When any floor plan remains 95% or more

occupied or that remains full even when the community turnover ratio averages below 55%

When rents fall below levels indicated by a comparative rent analysis

Anytime a community is full Upon owner request

Rental increases: Current residents Increase rent as leases expire, OR Increase rent selectively on expired

leases using a quantifiable, non-discriminatory standard (years of residence or number of previous renewals)

Consider a renewal rate that is slightly lower than the new market rate as an incentive to stay

Provide 60 days notice prior to the effective date of the increase

Managing Occupancy: Reports Occupancy reports Rent roll Delinquency report Deposit/Income reports Concession report Demographics report

Managing Occupancy: Methods Calculate occupancy trend Manage lease expirations Calculate turnover ratio

Expenses Fixed – property taxes, insurance Variable –utilities, turnover costs, etc. Capital- appliances, HVAC, etc. Replacement Reserve Account Debt service

Cost Benefit Analysis Potential Expense

Dollars Time Image

Potential Benefit Income Time Employee satisfaction Market position

Accounting Practices Budget control log Invoices Purchase discounts Check request or payment vouchers Petty cash Resident records Resident security deposit Collection of former resident accounts

Course 8 Financial Mgmt Chapter 2 40

Skill Check #2

Chapter 2: Adding Value to the Investment

Chapter 3

Economic Analysis of a Property

Economic Analysis

When analyzing a property, ask- How well has a property performed

over a specific time period?- Where does a property stand at a

given date in time?

Course 8: Financial Mgmt Chapter 2

Course 4: Fair Housing 44

Income Statement 12/31/2000

IncomeRental Income $19,450,000Other Income (Fees, Vending, Utilities) 1,815,000Vacancy & Collection Loss -97,500Effective Gross Income $21,362,500

Operating ExpensesFixed Expenses $1,268,000

Real Estate Taxes 97,600Insurance

Variable ExpensesPayroll 238,100Repair & Maintenance 598,800Utilities 1,636,000Contract Services 335,000Administrative & General 272,000Management Fee 102,000Advertising & Leasing 190,000

$4,737,500

Other ExpensesInterest 912,000Replacement Reserves 200,000

1,112,000

Total Expenses 5,849,500

Net Income 15,513,000

Accounting methods Accrual- records all income and

expenses in period they were earned or incurred, regardless of when received or paid

Cash- records all income and expenses when they are actually received or paid

Cash Flow The amount of money left after all

sources of income are collected and operating expenses, capital expenses and debt service have been paid

Often referred to as the operating statement

Gross Potential Rent (GPR) Current rent charged at 100%

occupancy- combines the sum of occupied units at current lease rents plus vacant units at market rents

100% of possible income All other income and expenses

measured and evaluated as % of GPR

Market Rent Total annual income received if

100% of all units were occupied and paying market rents

Loss to Lease Variance between market rent and

lease rent Market rent that is “lost” due to

lease rents at rates lower than the market rate

For many companies it is a separate line item on the operating statement

Loss to Lease Example Annual market rent of $1,375,025

with a loss to lease of $125,700 has a loss to lease of 9.1%

125,700/ 1,375,025= .0914 or 9.1% GPR of $1,249,325; market rent of

$1,375,025 less “loss of $125,700

Vacancy, Concession, and Collection Loss (VAC) Total value of rent loss from vacant

units, concessions given, collection losses from bad debt write-off, rent loss from non-revenue units

Standard for uncollectible/bad debt- 2% of GPR

VAC can be higher than10% of GPR

EFFECTIVE GROSS INCOME (EGI) GPR less vacancy, concessions, and

collection loss. Also called net rental revenue or total rental income

Represents all rent and only the rent income at the property

GPR-VAC= EGI

OTHER INCOME(OI) Income from items other than rent Laundry, cable, parking, amenity charges,

pet fees, application fees, administrative fees, lease premium fees, late fees

Fee policies established by owner or manager

Up to 10% of GPR- NAA survey in 2010 7.2% of GPR or $753 per unit

GROSS OPERATING INCOME (GOI) EGI + OI = GOI Property’s total revenue Available to pay property’s

operating expenses, capital improvements, and debt service

OPERATING EXPENSES(OE) All expenses fixed and variable

incurred in the course of managing the property

Controllable and uncontrollable expenses

Capital expenses and reserve for replacement costs are not typically considered operating expenses

NET OPERATING INCOME(NOI) GOI-OE=NOI Applying cap rate to NOI allows you

to determine property value using the income approach

OPERATING EXPENSE RATIO Expense to income ratio Evaluation tool to measure property

performance and expense control % of GPR used to pay operating expenses Ratio depends on age, location, property

type, and expense classification OE/GPR= operating expense ratio 2010 NAA survey showed national OE

ratio of 40%

CAPITAL Expenses (CE) Also called capital improvements Includes non recurring expenditures

like appliances, roofing, carpet replacement, etc. intended to add to the life of the property and its fixtures

Tax benefits, depreciation, cost

DEBT SERVICE Mortgage or loan payment- principal

and interest payment Fixed rate mortgages usually have

level monthly payments that amortize the loan

Break-even Occupancy Ratio

(OE + DS) ÷ GOI

1,803,800 +1,278,000= 3,081,800

3,081,800 ÷ 4,359,000 = 71%

Break-even rent per sq. ft.

(OE + DS) ÷ total square feet

$1,803,800 + $1,278,000= $3,081,800

$3,081,800 ÷ 760,000 = $4.05

CASH FLOW CALCULATION Gross Potential Rent (GPR) -Vacancy, Concessions, collection losses (VAC) = Effective Gross Income (EGI) + Other Income (OI) = Gross Operating Income (GOI) - Operating Expenses (OE) = Net Operating Income (NOI) - Capital Expenses (CE), Reserve Payments (RR),

and Debt Service (DS) = CASH FLOW

Activity #1: Cash Flow

Calculate the cash flow of the NAA Apartments

The General Ledger Provides more detail of major

financial statements Chart of Accounts Know cut-off date for invoices to be

submitted

Skill Check #3

Chapter 3: Economic Analysis of a Property

Chapter 4

Budgets

Purpose of a budget

1. To estimate expected income and expenses to determine what occupancy levels will be needed to cover expenses and provide a return on investment

2. To monitor the property’s performance

3. To evaluate performance of personnel

Lease-up Budget Special attention paid to activities

and costs associated with attracting residents, signing leases and generating income

Information used for projecting expenses depends on your and your supervisor’s previous experience

Modernization Budget Reflects larger allocations for capital

expenses and labor Must be flexible if the work is dependent

on contractors schedules and vendors supplies

May include periods of no rental income while work is being done in part or all of the building

May be prepared separately from the operating budget of a property and be for a short time only

Stabilized Operating Budget Reflects varying expenses from month to

Examples: Utilities for heating would be higher in winter

months Utilities for cooling would be higher in summer

months Snow removal would be posted only for winter

months

Tips for developing budgets Use round numbers Use current figures Prepare early Seek input Extrapolation/Annualization

CAM Responsibilities Managing the budget Analyzing variances Explaining variances Recommending action

Skill Check #4

Chapter 4: Budgets

Chapter 5

Property Valuation

Property Valuation Is the process of determining the

value of a property in order to make financial decisions regarding the property

The Cost Approach Estimates the current cost of

reproducing or replacing the improvements, minus the loss in value from depreciation due to age, condition or obsolescence, plus land value

Important when there is no market activity and a sales approach cannot be used to value a property

The Sales Comparison Approach In this approach, the market value of

a property is directly related to the prices of comparable competitive properties

Most useful when there are several similar properties in the local market that have been recently sold or are currently for sale

The Income Capitalization Approach This approach uses methods,

techniques and math procedures to analyze a property’s ability to generate

income and convert future earnings to present-day

dollars

Direct Capitalization

Value = NOI/Overall capitalization rate

Course 8: Financial

Management 79

Skill Check #5

Chapter 5: Property Valuation

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