Commercial Investment Real Estate is the magazine of the CCIM Institute, the leading provider of commercial real estate education. CIRE covers market trends, current developments, and business strategies within the commercial real estate field.
Issue link: http://cire.epubxp.com/i/649656
16 March | April | 2016 Commercial Investment Real Estate 1 6 Mar Mar Mar Mar Ma Mar Mar Mar Mar Mar Mar Ma M a Mar ar ar ch ch ch ch ch ch h ch h ch ch ch ch h ch ch | A A | A | A | A | A | A | A A | A A | A A | A A | A A A A | A | A A | A | A pr pr pri pr pri pr r pri pr pri pr ri r pri pr pri pri r pr pri pri p ri p r pr r pri p r pr pri r pr p ri pr r pr pri p l | l | l | | l | l | l | l | | l | l | l | l | l | 20 20 20 20 0 20 0 2 0 2 0 2 0 20 0 20 0 2 0 2 0 20 0 20 20 0 20 0 20 20 0 20 0 20 0 20 0 20 0 16 16 16 6 16 16 16 16 16 16 16 16 1 6 16 1 6 1 6 1 6 IN V E STMENT A N A LY S I S Capitalization rates for multifamily properties appear to have stabilized at very low levels after a veritable free-fall in major metropolitan markets since the end of the Great Recession. The drop in cap rates appears to be the result of low cost permanent fi nancing, the perceived long-term stability of apartments as an asset class, and a lack of yield in other industry segments. Test assumptions to make informed sale decisions. ing basic operating statements can be constructed from the bottom up. If NOI is capped at 6.0 per- cent, the value of each property is $16,666,666. Assuming a f rst mort- gage of $13,300,000 (80 percent of the purchase price) at 4.0 percent on a 30-year amortization schedule, the debt service coverage ratios for the properties are 1.31x and the debt yields are 7.52 percent in year one. Both acquisitions require cash equity contributions of $3,366,666 (without transaction costs). Assume that rents at Property A increase at 2.0 percent per annum and that expenses increase at 2.5 per- cent per annum over a 10-year hold- ing period. Also assume that rents at Property B increase at 2.0 percent per annum but that expenses increase at 3.0 percent per annum. T e 0.5 percent increase in annual expense escalations for Property B is an attempt to account for the higher uncertainty associated with the master-metered utilities at Property B. T e DSCR for Property A in year 11 is 1.56x and the debt yield on the outstanding principal balance at the end of year 10 is 11.34 percent. T e same metrics for Property B are 1.37x and 9.94 percent, respectively. Additionally, the value of Property performance of of ce and retail over the same period. It is not true that this assumed predictability lessens the need to analyze the performance of multifamily projects over a hold- ing period, especially when compar- ing apartment projects with varying operating expense structures. Two stabilized apartment projects may generate an identical net oper- ating income af er reserves, but it is the operating expense ratio and the potential volatility of certain operat- ing expenses that will make or break targeted returns. A Comparison For example, assume that two sta- bilized multifamily properties are 94 percent occupied and that each has an NOI of $1,000,000. Property A has an expense ratio of 33 percent (utilities sub-metered) and Property B has an expense ratio of 60 percent (utilities master-metered). Armed with this information, the follow- by David L. Church, CCIM Beyond Cap Rates Investors purchase apartment projects in major markets as soon as they are listed — or in some cases before they are listed. T e historically low interest rates provided by perma- nent lenders — Fannie Mae, Freddie Mac, conduits (until recently), and some local and regional banks — make acquisitions at high prices per unit and correspondingly low cap rates feasible. However, going-in cap rates tell only part of the story for long-term investors. Discounted Cash Flow Many rea l estate professiona ls eschew the use of 10-year discounted cash f ow models to value multifam- ily properties because income and expense growth is typically forecast at a steady pace and because replace- ment reserves are assumed to be f at through the holding period. It is true that it is simpler to forecast the 10-year performance of multifam- ily projects than it is to forecast the Ingram Publishing/Thinkstock