Posted by Zee on March 30, 2000 at 03:11:31:
Maurice,
Good luck with this. I, too, am making my first deal (flipping a building lot, posted above), so, I am in sympathy with your desire to win.
I’ll share a practical thought process from “The Real Estate Game”, by William J. Poorvu, of the Harvard Business School:
It’s called “Back of the Envelope” analysis. It’s a quick & dirty financial analysis to help see if you want to take any further interest in a prospective deal.
Year 1 (based on selling price and existing rents p.s.f.)
Cash Flow from operations (CFO) $_________
Mortgage Payment (interest & principal) $_________
Cash Flow after financing (CFAF) $_________
Return on Assets(ROA): CFO/Purchase Price = __. %
Financing cost (FC): Payment/Amt. financed = __. %
Return on Equity (ROE): CFAF/cash invested = __. %
Glossary of BOE (back of envelope) Terms:
p.s.f. (or rents psf): per square foot. For comparing costs between copmarable properties in your market
net operating income (NOI): net property revenues less building operating expenses.
cash clow from operations (CFO): NOI less capital expeditures or reserves for such items as tenant improvements (TI’s), leasing commissions, and structural reserves.
financing costs (FC): dept or mortgage payments of principal and interet, often in the form of a constant payment that amortizes the loan over a given time.
cash flow after financing (CFAF): CFO-FC
return on assets (ROA): CFO/puchase price
return on equity (ROI): CFAF/cash invested or cash on cash
So, now you have a “set up”, that is, a snapshot of a property’s financial performance at a given point in time. It’s focus is cash flow (not financial accounting). Cash flow not only reflects what an investor can actually spend, but untimately will determine that you can borrow or sell properties for.
Use the set up to monitor performance of properties already owned, or to evaluate the financial feasibility of a potential acquistion.
Plug in your numbers, but read the book for an emplanation.