Financial Management
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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
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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
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Definition: Investment An investment is the use of funds to
earn a profit.
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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?
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Performance Measures Rate of return on investment (ROI) Cash-on-cash return Capitalization rate Internal rate of return (IRR)
ROI
Rate of return on investment = percentage of return on each dollar invested
Cash flow/Investment = ROI
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Capitalization Rate
NOI/Purchase Price = Cap Rate
NOI/Cap Rate = Value
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Exercise
We paid $7,000,000 for a property and the NOI is $500,000. What is the cap rate?
Divide NOI by 6%
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Remember
Lower cap rate = higher value
Higher cap rate = lower value
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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
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Disadvantages of Investments
Disadvantages include: Real estate is not a liquid asset Active participation is often required Potential for risk (natural disasters,
changes in market conditions)
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Forms of ownership Direct ownership Partnership Limited liability partnership Limited liability corporation S corporation Joint venture Real Estate Investment Trusts (REITs) Tenants in Common (TICs)
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Types of mortgages Fixed rate Variable rate Balloon Bullet loan
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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)
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Skill Check #1
Chapter 1- Investments
Chapter 2
Adding Value to the Investment
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Adding Value: CAM Responsibilities
1. Generating and collecting as much income as possible
2. Controlling expenses3. Meeting the financial goals of the
investment
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Additional ways to add value: Reduced staff turnover and lower
personnel costs Reduced resident turnover with better
customer service Aggressive rental rates set by unit type New income sources through resident
services Better collection of resident charges
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Sources of Income Rent Administrative
Fees Parking/Garage
fees Pet fees Laundry
room/Vending
Late fees/collection fees
Clubhouse rental/video rental
Car wash Cable/Internet/
Phone
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Types of Expenses Maintenance Administrative Salaries/Personnel Taxes
Insurance Utilities Contract services Advertising and
Marketing
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3 Factors That Affect Rental Income Competitive rental rents Physical occupancy Collection percent or economic
occupancy
Concession Impact
Market rent = $700Concession = one month rent
What is the Effective Rent?
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Law of Supply and Demand If the demand is high and the supply
is low, higher prices can be obtained.
If demand is low and the supply is high, rents must be made competitive to attract residents.
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Economic conditions Population growth Household formation Job creation
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Balancing rental rates and vacancies The goal is to maximize income not
occupancy Pricing too high may cause longer
vacancy Pricing too low means you are losing
money while the unit is occupied
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?
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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?
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Before adjusting rent, analyze the 4 P’s:
PeopleProductPromotionPrice
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Determining pricing Conduct a market analysis Use an automated revenue
management system
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When to consider a rent increase When any floor plan remains 95% or more
occupied or that remains full even when the community turnover ratio averages below 55%
When rents fall below levels indicated by a comparative rent analysis
Anytime a community is full Upon owner request
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Rental increases: Current residents Increase rent as leases expire, OR Increase rent selectively on expired
leases using a quantifiable, non-discriminatory standard (years of residence or number of previous renewals)
Consider a renewal rate that is slightly lower than the new market rate as an incentive to stay
Provide 60 days notice prior to the effective date of the increase
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Managing Occupancy: Reports Occupancy reports Rent roll Delinquency report Deposit/Income reports Concession report Demographics report
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Managing Occupancy: Methods Calculate occupancy trend Manage lease expirations Calculate turnover ratio
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Expenses Fixed – property taxes, insurance Variable –utilities, turnover costs, etc. Capital- appliances, HVAC, etc. Replacement Reserve Account Debt service
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Cost Benefit Analysis Potential Expense
Dollars Time Image
Potential Benefit Income Time Employee satisfaction Market position
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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
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Skill Check #2
Chapter 2: Adding Value to the Investment
Chapter 3
Economic Analysis of a Property
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Economic Analysis
When analyzing a property, ask- How well has a property performed
over a specific time period?- Where does a property stand at a
given date in time?
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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
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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
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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
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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
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Market Rent Total annual income received if
100% of all units were occupied and paying market rents
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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
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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
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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
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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
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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
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GROSS OPERATING INCOME (GOI) EGI + OI = GOI Property’s total revenue Available to pay property’s
operating expenses, capital improvements, and debt service
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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
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NET OPERATING INCOME(NOI) GOI-OE=NOI Applying cap rate to NOI allows you
to determine property value using the income approach
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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%
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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
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DEBT SERVICE Mortgage or loan payment- principal
and interest payment Fixed rate mortgages usually have
level monthly payments that amortize the loan
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Break-even Occupancy Ratio
(OE + DS) ÷ GOI
1,803,800 +1,278,000= 3,081,800
3,081,800 ÷ 4,359,000 = 71%
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Break-even rent per sq. ft.
(OE + DS) ÷ total square feet
$1,803,800 + $1,278,000= $3,081,800
$3,081,800 ÷ 760,000 = $4.05
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CASH FLOW CALCULATION 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
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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
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Skill Check #3
Chapter 3: Economic Analysis of a Property
Chapter 4
Budgets
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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
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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
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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
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Stabilized Operating Budget Reflects varying expenses from month to
month
Examples: Utilities for heating would be higher in winter
months Utilities for cooling would be higher in summer
months Snow removal would be posted only for winter
months
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Tips for developing budgets Use round numbers Use current figures Prepare early Seek input Extrapolation/Annualization
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CAM Responsibilities Managing the budget Analyzing variances Explaining variances Recommending action
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Skill Check #4
Chapter 4: Budgets
Chapter 5
Property Valuation
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Property Valuation Is the process of determining the
value of a property in order to make financial decisions regarding the property
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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
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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
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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
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Skill Check #5
Chapter 5: Property Valuation