Real Estate 100 LTV : May 2019

Due diligence is a comprehensive, complex, and critical stage in any commercial real estate acquisition. You don’t want to leave any stone uncovered, and you want the most time available to review all documents and look for any and all possible red flags with the property, title, tenant relationships, and numerous other considerations.

That’s why we’ve created the checklist below, which outlines many of the key documents, records, and financial information needed for a full and complete due diligence on a prospective property acquisition.

In many transactions, we typically urge clients to incorporate this checklist into the sale contract and require that the specified due diligence period will not commence until the date that the seller produces the last of each of these deliverables.

Simply put, when you’re the potential buyer of a property, you deserve to have all the necessary documentation in your hands before you start the intensive due diligence process.

Whether you’re a growing business looking for your first independent location, or a developer with an experienced deal team conducting diligence on multiple acquisitions simultaneously, we hope this checklist will serve as a helpful guide for the items you’ll need to make the most informed decision possible on your next real estate acquisition.

THE BUYER & SELLERS CONTRACT!

The most recent title policy or title commitment on the property in the possession or control of seller together with all related documents.
The most recent ALTA survey and topographic study for the property and a copy of the construction blueprints, engineering plans and as-built drawings in the possession or control of seller.
Legal description of the property.
Zoning Compliance Certificate for the property and all zoning approvals (including variances and any pending applications).
Declaration of covenants, conditions, restrictions, reservations and easements for the property.
Seller’s third-party engineering, environmental reports (including but not limited to Phase I and Phase II reports, NFR letters, mold abatement reports and underground storage tank testing and closure reports), appraisals, soil tests, boring reports, foundation reports (logs of pilings), termite or radon studies.
A true, correct and complete copy of each written lease and each guaranty (together with any amendments), and a certification that there are no oral leases or oral understandings, if any. Rent Roll with list of leases and dates they are up for renewal with occupancy status.
An accounting of all rent and other income, common area maintenance, security deposits and real estate tax contributions paid by any tenant at the property, including, without limitation, a certified rent roll, showing current rent, previous rent if applicable, delinquencies, security deposits, years of occupancy, lease commencement date and lease termination date.
All security deposits and any other amounts to which any tenant, vendor, or any other party may be entitled.
A copy of the last three years’ real estate tax bills, including special assessments or incentives, copies of all tax protests, related correspondence and protest results for the property and copies of the prior two years’ utility bills for the property.
A true, correct and complete copy of each written service contract (together with amendments thereto, if any) and a true, correct and complete written summary of each oral service contract, together with copies of any and all other contracts and agreements relating to the operation, maintenance and repair of the property.
An accounting of all income and expenses related to the property, including collection reports and tax statements for the last three years.
A list of all personal property, if any, owned by the seller, located at the property, and used or useful in connection with its operation and maintenance.
A list of all permits, partial certificates of occupancy, certificates of occupancy, warranties, government notices, special assessments, code violations and unexpired guaranties and copies of same in seller’s possession or control.
A copy of existing insurance policies and certificates and any pending claims against the property.
A schedule of pending litigation, if any, affecting the property or seller’s ability to convey the property.
Any and all other matters as purchaser may deem reasonably necessary to satisfy itself, in its sole discretion, concerning the property and the status of the property’s title.

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All formulations are annualized based off of ANNUAL AMOUNTS.

Basic Formula's

1. Gross Scheduled Income (GSI)

GSI is the annual rental income a property would generate if 100% of all space were rented and all rents collected. If vacant units do exist at the time of your real estate analysis then include them at their reasonable market rent.

Rental Income (actual)
plus Vacant Units (at market rent)
= Gross Scheduled Income

2. Gross Operating Income (GOI)

GOI is gross scheduled income less vacancy and credit loss plus income derived from other sources such as coin-operated laundry facilities. Consider GOI as the amount of rental income the real estate investor actually collects to service the rental property.

Gross Scheduled Income
less Vacancy and Credit Loss
plus Other Income
= Gross Operating Income

3. Operating Expenses

Operating expenses include those costs associated with keeping a property operational and in service. These include property taxes, insurance, utilities, and routine maintenance. They do not include payments made for mortgages, capital expenditures or income taxes.

4. Net Operating Income (NOI)

NOI is a property's income after being reduced by vacancy and credit loss and all operating expenses. NOI is one of the most important calculations to any real estate investment because it represents the income stream that subsequently determines the property's market value – that is, the price a real estate investor is willing to pay for that income stream.

Gross Operating Income
less Operating Expenses
= Net Operating Income

5. Cash Flow Before Tax (CFBT)

CFBT is the number of dollars a property generates in a given year after all expenses but in turn still subject to the real estate investor's income tax liability.

Net Operating Income
less Debt Service
less Capital Expenditures
= Cash Flow Before Tax

6. Gross Rent Multiplier (GRM)

GRM is a simple method used by analysts to determine a rental income property's market value based upon its gross scheduled income. You would first calculate the GRM using the market value at which other properties sold, and then apply that GRM to determine the market value for your own property.

Market Value
÷ Gross Scheduled Income
= Gross Rent Multiplier

Then,

Gross Scheduled Income
x Gross Rent Multiplier
= Market Value

7. Cap Rate

This popular return expresses the ratio between a rental property's value and its net operating income. The cap rate formula commonly serves two useful real estate investing purposes: To calculate a property's cap rate, or by transposing the formula, to calculate a property's reasonable estimate of value.

Net Operating Income
÷ Market Value
= Cap Rate

Or,

Net Operating Income
÷ Cap rate
= Market Value

The cap rate formula is simple:
Net Operating Income / Value = Cap Rate

You can also turn this formula around to calculate any of the other variables.

Want to know what you should pay for a property?
Net Operating Income / Cap Rate = Value

Curious what your net income will be?
Value x Cap Rate = Net Operating Income

8. Cash on Cash Return (CoC)

CoC is the ratio between a property's cash flow in a given year and the amount of initial capital investment required to make the acquisition (e.g., mortgage down payment and closing costs). Most investors usually look at cash-on-cash as it relates to cash flow before taxes during the first year of ownership.

Cash Flow Before Taxes
÷ Initial Capital Investment
= Cash on Cash Return

9. Operating Expense Ratio (OER)

OER expresses the ratio (as a percentage) between a real estate investment's total operating expenses dollar amount to its gross operating income dollar amount.

Operating Expenses
÷ Gross Operating Income
= Operating Expense Ratio

10. Debt Coverage Ratio (DCR)

DCR is a ratio that expresses the number of times annual net operating income exceeds debt service (i.e., total loan payment, including both principal and interest).

Net Operating Income
÷ Debt Service
= Debt Coverage Ratio

DCR results:

Less than 1.0 - not enough NOI to cover the debt
Exactly 1.0 - just enough NOI to cover the debt
Greater than 1.0 - more than enough NOI to cover the debt

11. Break-Even Ratio (BER)

BER is a ratio some lenders calculate to gauge the proportion between the money going out to the money coming so they can estimate how vulnerable a property is to defaulting on its debt if rental income declines. BER reveals the percent of income consumed by the estimated expenses.

(Operating Expense + Debt Service)
÷ Gross Operating Income
= Break-Even Ratio

BER results:

Less than 100% - expenses consuming less than available income
Greater than 100% - expenses consuming more than available income

12. Loan to Value (LTV)

LTV measures what percentage of a property's appraised value or selling price (whichever is less) is attributable to financing. A higher LTV benefits real estate investors with greater leverage, whereas lenders regard a higher LTV as a greater financial risk.

Loan Amount
÷ Lesser of Appraised Value or Selling Price
= Loan to Value

Advanced Formula's

13. Annual Depreciation Allowance

Annual depreciation allowance is the amount of tax deduction allowed by the tax code that investment property owners may take each year until the entire depreciable asset is written off.

To calculate, you must first determine the depreciable basis by computing the portion of the asset allotted to improvements (land is not depreciable), and then amortizing that amount over the asset's useful life as specified in the tax code: Currently 27.5 years for residential property and 39 years for nonresidential.

Property Value
x Percent Allotted to Improvements
= Depreciable Basis

Then,

Depreciable Basis
÷ Useful Life
= Annual Depreciation Allowance

14. Mid-Month Convention

This adjusts the depreciation allowance in whatever month the asset is placed into service and whatever month it is disposed. The current tax code only allows one-half of the depreciation normally allowed for these particular months.

For instance, if you buy in January, you will only get to write off 11.5 months of depreciation for that first year of ownership. Likewise, say you sell in January, then you will only get to writeoff half-month depreciation for that final year of ownership.

15. Taxable Income

Taxable income is the amount of revenue produced by a rental on which the owner must pay Federal income tax. Once calculated, that amount is multiplied by the investor's marginal tax rate (i.e., state and federal combined) to arrive at the owner's tax liability.

Net Operating Income
less Mortgage Interest
less Depreciation, Real Property
less Depreciation, Capital Additions
less Amortization, Points and Closing Costs
plus Interest Earned (e.g., property bank or mortgage escrow accounts)
= Taxable Income

Then,

Taxable Income
x Marginal Tax Rate
= Tax Liability

16. Cash Flow After Tax (CFAT)

CFAT is the amount of spendable cash that the real estate investor makes from the investment after satisfying all required tax obligations.

Cash Flow Before Tax
less Tax Liability
= Cash Flow After Tax

17. Time Value of Money

Time value of money is the underlying assumption that money, over time, will change value. It's an important element in real estate investing because it could suggest that the timing of receipts from the investment might be more important than the amount received.

18. Present Value (PV)

PV shows what a cash flow or series of cash flows available in the future is worth in today's dollars. PV is calculated by "discounting" future cash flows back in time using a given "discount rate".

19. Future Value (FV)

FV shows what a cash flow or series of cash flows will be worth at a specified time in the future. FV is calculated by "compounding" the original principal sum forward in time at a given "compound rate".

20. Net Present Value (NPV)

NPV shows the dollar amount difference between the present value of all future cash flows using a particular discount rate – your required rate of return – and the initial cash invested to purchase those cash flows.

Present Value of all Future Cash Flows
less Initial Cash Investment
= Net Present Value

NPV results:

Negative - the required return is not met
Zero - the required return is perfectly met
Positive - the required return is met with room to spare

21. Internal Rate of Return (IRR)

This popular model creates a single discount rate whereby all future cash flows can be discounted until they equal the investor's initial cash investment. In other words, when a series of all future cash flows is discounted at IRR that present value amount will equal the actual cash investment amount.

Get All Info To Get Rich, Learn Stocks, Learn How To Build Credit, Buy BIG Real Estate with No MONEY Down, Buy & Start Business' & to How to Build Wealth.

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