Analyzing
the debt Repayment ability of
Income Producing
Property
In order to give you an idea of
the analysis that Banks do for Income Producing Property,
take a look at the following cash flow analysis example:
Gross
Rental Income |
$139,260 |
(Less
Vacancies) |
($6,963) |
Net
Rental Income |
$132,297 |
|
|
Less
Operating Expenses: |
|
Taxes
(from 1996 tax return) |
($24,178) |
Insurance
(from 1996 tax return) |
($8,040) |
Utilities
(from 1996 tax return) |
($3,744) |
Maintenance
(from 1996 tax ret. and estimate) |
($2,500) |
LandScape
(from 1996 tax returns) |
($1,380) |
| Net
Operating Income: |
$92,455 |
Annual debt burden (assume
$6250/month) $75,000
Debt Repayment Ratio: 1.23x (sufficient)
The most important number in the above analysis
is the Debt Repayment Ratio ( Net Operating Income
/ Total Annual Debt Burden ). A smart borrower will
know what kind of a debt repayment his property can
carry in order to obtain the most money from the
Bank. To calculate the maximum loan amount you need
to know the answers to the following questions.
1 ) Your Net Operating Income?
2) The interest rate that the Bank will charge?
3) The lowest debt-repayment ratio that the institution
will accept (this is usually 1:20X)
4) What kind of an amortization schedule is used
for the type of facility.
Let's use the above information to find out the
amount of money that can be borrowed.
a) The bank charges Prime + 1% for this type of
facilities when it is secured by a first mortgage,
and Prime + 2% when it is secured by a second mortgage.
b) The Bank tries to approve loans with a debt
repayment of ratio of 1:25X, but some credit policies
allow a low of 1:20X.
c) The Bank uses various amortization
schedules but the most favorable ones for this type
of facility are based on a twenty-five (25) year
amortization with a seven (7) year balloon. Armed
with that information you do some math:
$92,455 / 1.20 = 77,045 <====
Maximum Debt Burden.
Using an amortization table $734,000 at 9.5% (Prime+1%
as of July 1998) is the maximum debt based on a twenty-five
(25) year amortization.
With those numbers you could go to the
Bank and ask for a 1st Mortgage in the amount of
$734,000.
Finding out the Market Value of Income Producing
Property
Obtaining a loan without an appraisal is very difficult,
expect to have to pay for one (most commercial appraisals
are at least $1,000 with the average being $1,500)
A professionally prepared appraisal will use all
three methods to come up with an estimated value
for the property.
There are three methods of estimating a market
value for a property.
1.)
The Cost Approach: This approach adds the
cost of constructing the building, deducts the
depreciation, adds the value of the land, and adds
the value of the improvements. It is used mostly
for newer buildings since there would be very little
depreciation.
Example:
This
is the Cost of building |
$600,000 |
You
add the A/C system & Other improvements |
$100,000 |
You
deduct depreciation |
($50,000) |
You
add any tax or impact fee |
$50,000 |
Your
reproduction cost is |
$700,000 |
You
add the land value |
$300,000 |
This
is your value |
$1,000,000 |
2.)
The Sales Comparison approach: Self-explanatory!
The appraiser will go around looking for comparable
sales, it will assign a certain modifier to each
in accordance to how much they resemble the property
to be appraise and come up with an average.
3.)
The Income Capitalization approach: which
is the one that concerns you as an investor of
Commercial Real Estate is calculated the following
way:
You obtain the Net Operating Income for the Property
in this case is $92,455. After that you obtain the
capitalization rate which is a combination of the
interest that you will pay the Bank, and the required
rate of return that you demand for your investment.
You might only pay 9.5% interest on the Bank Loan,
but you might require that your investment pays you
10%. You would calculate the Capitalization rate
as follows:
9.5% X .75% = 7.13
10% X .25% = 2.50
Cap. Rate 7.13 + 2.50 = 9.63%
Then it is a simple matter of dividing your Net
Operating Income by your capitalization rate:
$92,455 divided by 9.63% = $960,072
This is the value of the building, and it is the
most you should pay for it in order to obtain a 10%
rate of return on your investment.
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