Investments
Better Analysis, Better Cash Flow, Better Results
Is it possible for every investment I make to be a GOOD investment?
All investing carries with it some risk. However, great performance and high risk don’t have to go hand in hand. With expert analysis and high quality, experienced Property Management, it’s not only possible to get a good investment every time, it’s actually quite probable.
Cash Flow
Cash Flow is a critical component to a solid investment strategy. Property values can fluctuate wildly due to national & world markets changes. Rental rates, however, are determined more by local demographic conditions and tend to have much less volatility. Cash Flow Investors, as a result, can ride out market ups and downs and make solid returns, even in the middle of a steep recession. Not to mention, strong cash flows provide great stability for personal events such as job loss, injury or retirement.
Investment Analysis
Many people perceive investing on par with gambling- sometimes you win, sometimes you lose. Anytime we say “risk” this implies that at some point, somebody will lose out. The more frequent the loser, the higher the correlated risk. Over the years we’ve learned however that most “loser” investments tend to result from poor analysis, rather than other outliers. The most frequent culprit- “the things we didn’t know”. Good analysis is critical to making good investment decisions. Axiom helps investors make good decisions every day.
Expert Advice
The word “Expert” is used way too widely these days. So when we say “expert” advice, this is what we mean: We have both a designated CCIM & CPM on staff. Much of our staff has received significant CCIM and IREM education. Our analysts work in our property management division, to keep a pulse on market and data adjustments. We have experience in management, acquisitions, dispositions, financing, 1031 Exchanges, etc. of a portfolio worth well over $150 Million & our reputation relies on the foundation that we provide good advice to our clients.
Free Analysis of your Real Estate Portfolio
Click here to get a comprehensive portfolio analysis. Our experts diagnose strengths and weaknesses and then contact you on how to improve.
What exactly is ROI?
The term ROI, which stands for “Return On Investment”, is most accurately defined in Real Estate by the Internal Rate of Return (IRR), which is comparable in calculation method to how the compound rate of return on a stock or CD investment works. Often investors will talk as though Cap Rate or Cash on Cash returns are synonymous with ROI. This is incorrect, but allow us to clarify further:
When investing in real estate, it’s important to realize there are two types of returns that are commonly used. The first and perhaps more common types are Property Level Returns. These ratios measure the performance of the specific property and do not require any assumptions specific to who’s investing in it.
Common Property Level Return measurements are Net Operating Income (NOI), Capitalization Rate (Cap Rate) & Gross Rents Multiplier(GRM). The GRM is used in a variety of ways- If you’ve ever heard somebody say they use a 1% rule, or any percent of the annual rents to calculate what they should pay for an investment- that’s a variation of the Gross Rents Multiplier.
Investor Level Returns incorporate data from the property performance of a real estate asset and then integrate Investor specific data such as $ invested, loans specifics such as LTV, Interest rates and amortizations, anticipated capital improvements, Cost Recovery schedules of real and personal properties, etc. The point is to be fully comprehensive so that we can calculate what our true Return on Investment is.
Common Investor Level Returns (which can be calculated before or after Tax) are: Cash on Cash (CC), Internal Rate of Return (IRR) and Net Present Value (NPV), the latter 2 which are Time Value of Money (TVM) calculations, require forecasting of future year operations in order to establish a rate of return. Because of the increased intricacy, inaccurate assumptions can create wild variances, resulting in very poor data from which to make decisions. We highly recommend seeking guidance from experts when running Time Value of Money calculations, where experience can be the difference between mediocre and fantastic investment returns.
Common Real Estate Investment Terms
Passive Income
Passive income is income earned by the investor without the investment of time.
As each investor’s valuation of time is different and subjective in nature, in order for an investment analysis to be accurate for all parties involved, any investment analyses should be done with the assumption that the investment is being made for purposes of establishing passive income and would not significantly differ based on who owns the property.
Net Operating Income (NOI)
Net Operating Income (NOI) is a property only calculation that is calculated:
Gross Potential Income + Other Income – Vacancy – Operating Expenses = NOI
NOI is used extensively and while not difficult to figure, is often miscalculated. NOI does not include mortgage payments, capital improvements, Income Taxes (though it does include property taxes) or administrative expenses arising out of owner preference. It is the net income of the “property”, meaning it should be the same regardless of ownership.
Note: NOI should always include the cost or alternative cost of property management (if owner managed) to calculate actual “net income”. Often owner’s won’t factor their time’s opportunity cost, created and above average “NOI”.
Gross Rents Multiplier (GRM)
Gross Rents Multiplier- Commonly used by county Assessors due to lack of operating (expense) data, is what we call a napkin test. It’s very easy to calculate and acts as a great filter for narrowing down investment options when confronted with too many properties to analyze in depth.
Calculation: Price/Annualized Gross Potential Rents = GRM. The answer is generally a number between 5-15, with the lower usually implying a higher probability of ability to cash flow.
Capitalization Rate (Cap Rate)
Capitalization Rate: Definitely the most popular Real Estate ratio used as it provides a more comprehensive look at how profitable the Property should be for the 1st year of ownership.
Calculation: NOI/Price = Cap Rate
Note: Cap Rates are only as accurate as the assumptions on income and expenses entered and because of such, results can vary widely by who does the analysis. Often cap rates fail to account for property management costs and deterioration of building systems. Whether a property is owner managed or professionally managed, the cost is either time or money. To be correct, even when self-managing- always account for the alternative cost of management as the only way to compare investments is to compare them as a passive income source.
Cash on Cash (CC)
Cash on Cash is used to annually determine the percentage of your investment returned in cash flow in a given year.
Cash flow is calculated as
Net Operating Income – Non-Operating Expenses (mortgages, etc.) = Cash Flow
Cash on Cash is calculated as
Cash Flow/Total $ Invested = Cash on Cash
It does not account for principal paid down on a loan or for appreciation on a real property.
Time Value of Money (TVM)
The concept of Time Value of Money (TVM) is not specific to real estate and indeed is used across all financial spectrums.
The Time Value of Money simply implies that the value of a sum of money changes over time according to factors such as the number of time periods involved (i.e.- your monthly mortgage payment), interest rates and future values. When given this data, we can compound (going forward in time) or discount (going backward in time) to determine to establish values such as loan payments, yield returns on investments, the longevity of income streams, or future and present values of investment options.
Internal Rate of Return (IRR)
Internal Rate of Return (IRR)- the closest comparable measurement in real estate to a compound rate of return which is used heavily throughout the rest of the financial world.
The difference between an internal rate of return and a compound rate of return is that an internal rate of return is assuming multiple disbursements (cash flows) that are pulled out at different times throughout the life of the investment. I.e.- if you receive monthly cash flows on real estate, then once you get those back, those funds can no longer be considered invested for compounding purposes.
The internal rate of return is the most comprehensive return however in that it accounts for all cash flows disbursed, principal paid down on the loan and appreciation on the property being analyzed, in other words- all aspects of income derived from the investment. In addition, it can be calculated both pre and after income tax to determine the impact of different tax brackets and savings from the investment in real estate.
Net Present Value
Net Present Value is the value of a future series of cash flows, discounted back to a value in today’s dollars after accounting for the investor’s discount rate.
Discount Rate
A discount rate is often referred to as the Investor’s desired rate of return (IRR) or in the corporate world, as the rate readily available via other mediums should they place the money elsewhere. It is primarily used in determining what an investor can afford to pay for any given investment, by establishing the Net Present Value of a future series of cash flows.