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Income Property Investing - The Cap Rate

For years, the Capitalization Rate of an income property has been the standard by which properties are analyzed and valued. However, the hypotheticals accompanying Cap Rates leave the door open for misguided investment; such misdirection may only enhance the bitter flavor of real estate succotash. Let's be thorough because to do so will build a divide between the successful and the bellyachers. Now, how have Cap Rates served as masks of profitability? How can investing be more appropriately assessed? Let's get started.

What is a Cap Rate? Cap Rate is assessed by taking the net operating income from a property and dividing by the value of said property.

CR = Net Operating Income / Property Value

Now, net operating income is, at best, an estimation and is supposed to be the income after fixed and variable costs are subtracted from the revenue (rent collected). However, these are often calculated poorly and do not represent the true net income on a property. In reality the Net Income is:

Rent Collected - (Loan Payments + Property Insurance + Maintenance Costs + Property Tax + Property Management Fees) = Pre Tax Income

Pre Tax Income - Income Tax = Net Income

One, or more, of these variables is typically left out and is not calculated with any income tax. Also, Loan Payments are not included in operating expenses; however, it is, in reality, the largest expense of owning and operating a business around income properties. Okay, let's get specific; unless an investor is purchasing the income property with all cash, s/he is placing a downpayment as a means to secure an asset and a liability. The asset is the equity in the building + the revenue stream, and the liability is the payable amount on your loan (your loan payments). It is extremely important to weigh the quality of your asset against the burden of your liability. This is something a Cap Rate is simply incapable of consistently accomplishing. Furthermore, the Cap Rate is based around the value of a home, but it never actually interprets your initial cash outlay as the basis of the investment. The initial cash outlay is the downpayment + any other purchasing expenses (loan origination, attorney fees etc.).

When is Cap Rate useful? Cap Rate can be an appropriate and comprehensive figure that truly asses an income property's strength, but typically in all cash purchases. That way, the figure is base around a true net income and a true cost (or value) of the property. What it still ignores is the effects of rent not collectable or late rent. Also, it assumes the asset is entirely liquid as if to judge it from an opportunity cost standpoint. I.E. the rate of return on the property as compared to a rate of return readily available elsewhere. However, most property is not purchased all cash, so the Cap Rate will have natural follies. Now, Cap Rates derived from your financing terms, initial equity investment, and loan amortization can provide a fair estimation of what the value of the property actually is to an individual investor. However, the figure still ignores variables such as tenant quality. So let's get a bit more comprehensive, while not getting too finance-ish.

How should I value property? I call it "Pro Forma Analysis," and essentially, it serves to encompass all financial variables, while observing the ramifications of deviating from what is expected as revenue. It is critical to know what financing terms are available to you in order to adequately approach this type of analysis, so get to a bank and figure that sucker out. Next, and this is a personal preference, I always base investment quality off of the amount of money in the pocket, meaning I include all forms of taxation into my estimations, never leaving my evaluation without considering after tax return. To the numbers:

You must know the exact initial cash outlay on the property, including downpayment on loan, legal fees, loan originations costs, and commissions paid. For example: A house purchased for $100,000 with a 20% downpayment, 1% loan origination fee, 1% legal fee, and a 5% commission that is split between buyer and seller.

Initial Cash Outlay = $20,000 + $1,000 + $1,000 +$2,500 = $24,500

Next, you must find out Cash Out-Flow which includes loan interest expense, property tax, association fees, prop management fees, maintenance, and insurance costs. The loan is interest-only at a 6% rate on an $80,000 loan, the property tax in the area is 1.5% of assessed value, the association fees are $300 annually, the maintenance is $1,200 annually, and the insurances total $300 annually.

Cash Out-Flow = $4,800 + $1,500 + $300 + $1,200 + $300 = $8,100 annual

Third, you must find your Cash Inflow at your estimated 100% occupancy/payments. This includes the rent income plus any other types of income the property may generate (parking etc.). In our example, the rent is estimated at $1,000/month.

Cash Inflow = $1,000 x 12months = $12,000 annually

Now, the investor must find the annual pretax income = cash inflow - cash outflow

Annual Pre-Tax Income = $12,000 - $8,100 = $3,900

The pre-tax return can now be calculated in terms of the initial cash outlay by dividing the pre-tax income by the initial cash outlay.

Pre-Tax Return = $3,900 / $24,500 = 15.9%

If your income tax rate is 20% than you actually only keep 80% of the income for all intensive purposes, so now the after tax return can be calculated by taking 80% of the $3,900 income and dividing by the initial cash outlay.

After Tax Return = (.8 x $3,900) / $24,000 = 13%

You have found that at your expected revenue, you will return 13% on a perpetual basis, and for these purposes, the figure is representative of a perpetuity because when sold, it will be sold as a perpetuity to the next investor. Regardless, these revenue streams, though they may change are calculated with perpetual return, and sold/priced as such.

You must recalculate the return when the revenue stream changes. The stream could change for multiple reasons, mainly vacancy, but there might also be a rent adjustment. Vacancy will affect expenses by removing some (maintenance) and adding others (advertising, etc.). The effects of vacancy and occupancy on expenses are a different story told a different time - but maybe you are already familiar. It is important to note what expenses are fixed, regardless of occupancy; these are typically the largest cash outflows (Loan Interest, Property Tax); however, some things may dissipate, such as property management fees. You may mitigate your revenue by aligning different revenue streams next to one another. What are the effects if you are only able to secure 50% of the rent. If purchasing a single unit, and rent is not attainable at a given price, than you must lower the price in order to secure some type of income. Let's say only $500 is attainable in a given year, but there is no effect on the costs, as the unit is still occupied. This suggests a cash inflow of $6,000 and the same outflow of $8,100, rendering a loss: ($2,100). As a percentage it is a loss of 8.5% annually. Lets try 75% of expected rent: $9,000 revenue. This leads to an after tax return of $720 - a 2.9% annual return. In fact, you must seek rent at a minimum of $675 dollars in order to break even. Comparing these figures side by side show that the risk of loss due to vacancy is significant. So, it's a property that could potentially corrode your real estate portfolio, although initially it looked promising - 15.9% pre-tax return. How about this: the cap rate would have calculated out at just under 12%, as most agents would advertise. Sounds good at first, right? A cap-rate at 12% suggests the property is capable of "paying for itself", or capitalizing, in 8.33 years. Wow! That could be catastrophically misleading.

In our discussed case, it shows how the strength of the asset is compared to the burden of the liability. Though treading through such an example could be insufferable, it assists in showing the ramifications if risks are recognized in real-estate investing. It is important to take note of every variable affecting the income to you by assessing your debt obligations and how your revenue stream stacks up against them. Now, this is not a final, entirely comprehensive approach to real-estate investing as a whole. Things differ: the loan may not be interest-only, in which you would be required to amortize the principal payments on the loan and adjust the interest expense accordingly, but trading perpetuities within 10-year horizons, is the best way to remain sustainable. In such a manner, I typically suggest interest-only loans, if attainable, as I see income-property investment as a means to purchase a stream of cash flows more than purchasing an actual piece of property. In that way, I can observe the property objectively as a cash-flow investment (which is what it is in all reality), and base the value of the investment off the stream of cash I own. The property/structure/land is only a conduit by which I asses a cash-flow, hardly even considering it as owned wholly by the investor - cause it 'aint. Any sought after gain in value of the property will only increase property taxes, reduce liquidity, and sully the initial investment. Not to mention, the said "gain in value" would likely be corroded by capital gains tax and commission paid to the agent/broker. The "Pro Forma" approach is a more comprehensive one, allowing you to recognize the true value to you, while observing the consequences of deviating below your expectations from the property.

Tony Salloum

Tony is the Director of Business Development for RentPost http://rentpost.com, an online property management software company that leverages its software as a resource to assist with the issues Tony writes about. To experience how Tony and RentPost simplify the worlds of real estate investors, property managers, landlords, and tenants, he invites you to visit http://rentpost.com.

Residual Income - A Real Life Example

Ah, residual income - easy money. Well, not quite, unless you look at the long view. It can take a lot of effort to create streams of residual income. But since this is income which continues to come in long after your work has ended, it might be considered easy for the amount you make.

A little over years ago I decided to make a web site about removing stains from carpet. Not knowing that much about the subject, I bought lunch for the owner of a carpet cleaning company. In return, he gave me some tips on how to remove various stains, and how to care for carpet in general. I asked questions and took notes throughout lunch. I later made a fifteen-page web site from those notes.

It took a week to build the site initially. Twice over the last couple years I have spent a few hours updating it, so I might have 50 hours into the whole project. I have left the site untouched for as much as nine months at a time, and as I write this, I can't remember the last time I even looked at it online.

The result was a site that still generates about $200 most months, from automated advertising and affiliate programs that don't require any attention. This is residual income at its best. I put in the effort up front, but still paid every month years later. When my wife and I visit family in Ecuador, the income keeps coming. Some of our web sites do much better, but this is a great example of residual income, because it requires virtually no attention. Wouldn't you love to have a couple dozen web sites like this?

Residual Income - Other Examples

The idea is income that continues after your efforts are done, and without much if any additional effort on your part. You may not like the idea of making web sites, so what are the other ways that people do this? Here are a few examples of others who receive residual income.

Real Estate Investors - Buy a strip mall, hire management, and have the cash flow deposited into your account - a classic form of residual income. Apartment buildings and rental condos are other possibilities. But be sure there will be enough income to cover management fees. If you have to manage it yourself, you just bought yourself another job.

Inventors - This could be a difficult, but fun one. Inventions are often licensed to companies, which means that as long as they keep selling, the inventor has regular royalty fees.

Writers - Authors typically get about 5% of the retail price of a book, and those checks could keep coming for decades. Sell e-books from your own web site, and you can keep 90% of each sale, with nothing to ship. Have a processor handle the orders (that's where most of that other 10% goes), and you'll just have to answer an occasional e-mail.

Musicians - Create a hit song, and you'll get royalties as long as people still want to hear it. Don't sing? Song writers get royalties as well.

Insurance Agents - When you sell a policy, you normally get a commission every year when the customer renews. Insurance agents have been known to retire young with a healthy stream of residual income.

What do you do when that stream of income slows down? Find another! That's another great thing about residual income. It leaves you with time to look for more opportunities.

Copyright Steve Gillman. To learn more Ways To Make Money and how you can get free e-courses and e-books, visit his website:
http://www.UnusualWaysToMakeMoney.com

How to Blog For an Income - Understand How You Can Blog to Create Income

Not that long ago there was no such thing as a blog, and now we hear of people making small fortunes from them. Not surprisingly, many people do not understand how this is possible. No-one has to pay to read a blog, so how on earth can anyone make money by doing it? It is actually very simple when you understand the mechanics. The principles are the same whether in relation to a blog or an information website. Neither one needs to sell anything to make money.

Any blog or website can feature adverts on its pages and when anyone visiting your site clicks on one of these adverts you get some money. One of the easiest ways to do this is through Google AdSense, where you simply enter a bit of code onto your page, and Google do the rest. What happens is that Google automatically assess the content of each page, and serve adverts which are relevant to that topic. The benefit of this is that because the adverts are directly related to the subject your visitors are interested in, they are more likely to click on an advert.

The number of people who click on adverts will only ever be a small proportion of the total number of visitors. The rate at which people click on adverts compared to the total number of pages viewed is known as a 'click through rate'. This varies a lot, but typically you might expect it to be between one and four percent. In other words, for every hundred pages looked at by visitors, you might get on average two or three clicks on adverts. 

The amount of money you get from each click can vary enormously too, depending on the subject of your site. The amount you receive depends on how competitive the topic is for advertisers and how profitable that particular market is. Each click could earn you anything from less than a cent to several dollars. Usually you are only getting a few cents per click, so you can quickly see that it does not look like an easy way to get rich quickly. As the number of advert clicks will only ever be a small proportion of your total visitors, you are not going to make any serious money unless you have a serious number of visitors.

There is another part to the financial equation with regard to making money from blogs. In addition to advertiser income, the other possible source of income is from referrals of products sold on other websites. The way this works is that you find good products that you believe your visitors will be interested in and recommend them on your website. If your visitors follow the link from your site to the product site and make a purchase, you receive a commission on that sale. For this to work properly you need to be referring good quality products that you genuinely believe in, and which your visitors are actually looking for. If you get this right, and have enough traffic, the commissions can certainly be substantial.

You can now see that there is clearly an income to be made from blogging, but money from adverts and referrals will be tiny unless you have lots of traffic on your blog. A few individuals do manage to hit luck and get fantastically busy blogs, but realistically, that is not something the vast majority of us can do by design. If you understand the process, it is relatively easy to create a blog and get a reasonable supply of traffic, but that is never going to earn you a worthwhile income on its own. The way people manage to make serious money blogging, and this is the really important part of this article, is by creating lots of different blogs. Even if you only get a few dollars a day from each blog, that becomes a healthy income if you multiply it by a few dozen or more.

That leads onto how you manage to actually generate good quality blogs in the kind of number you need to in order to earn good money. If that sounds like a lot of work, it is, unless you use blog creation software, which is the only way to manage blogs on that kind of scale. What a good blog creation tool will do for you is automate as many aspects of the creation and promotion of blogs as possible. The work is just not physically possible without such a tool.

Take care not to opt for anything which only looks at the physical creation of blogs. Having a blog is not enough on its own - it has to have traffic. No blog or website will get traffic unless it is created in the right way and promoted properly for search engine ranking. Unless your blogs show up in search engine results, they will have no visitors, and therefore no income.

Find recommendations on the best blog creation software here. Keith Garrow is an artist whose website now offers detailed advice and guidance on many web related subjects, including web host reviews, search engine optimization and how to create a website.

How to Use a Debt Management Plan to Deal With Christmas Spending

Many callers to the free help with debt helpline are looking for a debt solution as they have overspent at Christmas. It is very easy to go overboard at Christmas and spend on items that you suddenly realise when the account is rendered, you cannot afford to pay for.

It may not be until January or February when the accounts first appear, that you understand that minimum payments cannot be made.

It can be quite a shock when this first happens, and it may be the case that those affected do not know where to turn. That is why we are building a presence on the internet, and free resource for those in need of help and advice.

Debt Management

We are very happy to explain what a debt management plan is, where it can be obtained and the effects of entering into an arrangement.

The debt management plan can be effected in a matter of days. It commences with a simple telephone interview which will determine the amount of income and expenditure and hence the available disposable income. It is this disposable income that will form the basis of the offer to the creditors.

The debt management company will inform creditors of the amount of debt held and the amount of disposable income. This results in an offer to each creditor based upon the level of debt. They are free to accept or reject the offer.

In current times, as long as an offer is reasonable nearly every creditor will be happy to accept what is proposed. This is because a creditor will be pleased to get a regular payment albeit less than they could expect monthly in accordance with the terms of their agreements.

It is a costly exercise for a creditor to have to chase a debtor for a payment each month. Therefore they are likely not only to accept what is on offer but also suspend interest and charges.

The debt management plan can be stopped at any time as it is an informal arrangement. By entering a debt management plan however, it will affect your credit rating and so you must be sure that you have a debt problem that needs attendance.

If you feel that you may benefit from a debt management plan please do not hesitate to contact us.

Information provided by Steve Thatcher of Help With Debt (UK) Limited and total debt solutions company.
For all further reading see http://www.helpwithdebtuk.com
For personal contact email sthatcher@helpwithdebtuk.com

For Steve's thoughts see http://steves-debt.blogspot.com

If you have any debt problem whatsoever either personal or corporate make Steve your first call all advice is free. Finally if in the UK and you need a friend to speak to call 01162171406

Free Debt Management UK - Wipe Out Your Debts

It is very common to have debts, the reason being immaterial. Debt management is a service which helps you to manage and clear your debts in an easier and quick way. If you are suffering from single or multiple debts and you are having less income as compared to those debts then free debt management UK service is here to help you to come out of this problem.

As the name suggests, this is a free service and it is only for UK citizens. There is no fee for forms or monthly consultancy fee, it is completely free. Here you find many financial experts to solve your debt problem. They give suggestions to manage your debt and clear it soon with your available resources of income. It gives you suggestions on how to consolidate your debts and lower interest rates. Now we have many different free services like - debt management service, debt consolidation advice, instant debt management advice and so on.

How free debt management UK helps you

This first tracks your entire income sources to estimate how much you are capable to repay for month excluding your routine expenses. Then they analyze all your debts, their amounts, interest rates and repayment time. Then they decide on preferences like which loan has to be cleared first i.e. debts with low time period and high interest. If you are having small amounts with high interest rates then they suggest you for debt consolidation loan with low interest. But they suggest for consolidations only if it is beneficial. And they give clues to reduce your interest by taking new low interest rate loans to clear high interest ones.

All that you have to do is to find free debt management UK services on Internet and fill the form they provided without any dues. Give actual figures of all debts and your income sources for best results.

Alec Reece has a way with dealing with loans for a long time. Writing articles is just a way to extend this to consumers and provide empowerment through information. All you have to do is read. To find bad debt management, advice debt management consolidation, free debt management UK, debt management uk, credit card debt management visit http://www.ezdebtmanagement.co.uk

Risk Management and Change - Using Those Special Pair of Glasses to See the Big Picture

The more you review a risk plan and absorb it, the more risk you will mitigate. Now that you have reviewed your current plan, developed some type of spreadsheet or software for governance, and possess a reference to prior plans. Now that you have taken three months to take a good hard look at your business and now you will know what your additional risks are.

The second quarter is great time to either bring someone in or to have one of your staff research tax nexus issues.

So what is tax nexus?

Public Law 86 272, 15 U.S.C. 381 384, restricts a state from imposing a net income tax on income derived within its borders from interstate commerce if the only business activity of the company within the state consists of the solicitation of orders for sales of tangible personal property, which orders are to be sent outside the state for acceptance or rejection, and, if accepted, are filled by shipment or delivery from a point outside the state.

The term "net income tax" includes a franchise tax measured by net income. If any sales are made into a state which is precluded by P.L. 86 272 from taxing the income of the seller, such sales remain subject to throwback to the appropriate state which does have jurisdiction to impose its net income tax upon the income derived from those sales.

Tax nexus changes as tax laws in states change, 86-272 is not written in stone and therefore there are many states that have created laws that circumvent or are written to state that 86-272 is not applicable under certain circumstances. This creates tax and penalty risk. Legislatures have become creative with statutes and the failure to monitor this can be costly.

Some of these circumstances are:

You had a salesperson entering the state or in some instances cross state lines.




Third party performing warranty repairs in the state.




Third party installation or repair of a product.

As you can see your "nexus" is contingent on your current circumstances and business practices. Relevance to current business practices related to tax statutes must be reviewed at least yearly if not more often, this becomes forgotten in day to day operations and that is when penalties ensue. Laws change and states are constantly looking for creative ways to increase revenue. Take a look and mitigate compliance risks.

Let's take a close look at some of the other items to mitigate risk and continue the risk management and change process.

1.Perception. Take a good look at every employee that is part of your business and you probably have an idea of their strengths and weaknesses are don't you? Now, I am going to let you in on a little secret you don't. Want to know what I see when consulting. Try this!!

What happens is companies take a stereotypical view of employees. They Perceive! Most managers think employees that complain are problems, to be ignored or dealt with. Unfortunately, this is just the personality type you need to increase production, repair poor business practices or eliminate other risk related concerns in your business.

The complainers (something we avoid like the plague) are the real associates that can be the greatest factor of change in your business. Not all of them, but most of them. When consulting I hear complaints from employees all the time. They are not't heard, taken seriously, they are dismissed, but don't just dismiss them.

Take a different approach, try this, ask them why they are complaining, give them autonomy to open up and honestly tell you what is happening in their departments, listen take a subjective look.

Then, do some surveillance of your own. Take a look and see for yourself, we always perceive these associates as a nuisance; they are actually a force for change. I will bet that you will find these concerns, repair them and you will see their real worth and really do care. Stop the perception, start opening up, change the way you think before you competition gets the edge on you!

2. Dynamic, Your Dynamic is marked by continuous and productive activity or change. Now you need to take a look at the physical parts. Performance, Operations and Documentation. Yes, there are stories of those companies that did not build their infrastructure properly to handle an explosive growth then are struggling or have failed. Or took advantage of an opportunity and thus failed. I assure you there are far more stories of companies building cost structures for the future, for growth that never materializes. Surely there are companies that did not downsize because they consistently underestimated the potential size of the downturn. So now do you know how your business is growing? Honestly steady is better. Why? Because growth too fast means that the little things get overlooked hiring is to fast and lacks training and that's a reaction to growth not action toward growth. Are you able to currently handle the growth? Hampered by a poor credit market? These are items that can change your dynamic, your market power; please take a long hard look to keep it in balance.

This is also a great time to take a look at Internal Controls, Sarbanes-Oxley and take a look at opportunities for acquiring companies. Why, because if you feel after taking a look that all the other factors are in place now, you know in comfort you can perform all these at one time. Risk is also confidence; once you learn to accept change it becomes easier to mitigate change.

3. Stability, is a key look at your business vs. your competition, compared to how well you are performing and what are you performing well at. What new and differing metrics would you like to see, need to see? Measurement is key to stability; you can't see what you do not measure. Remember technology today is only good for six to nine months your product cycles are fading out faster and faster. Something new and better is bound to come along. Will it be from you or your competition? Are you ready if its you? Business performance management software may be the answer. Dashboards are another option and in some cases more so, management can retrieve real time data anywhere at any time right from the web instead of having to ask for the information. These are items help you monitor your stability, your market standing so you can maintain balance.

Above all remember time is of the essence, not being prepared for these situations costs hard payroll dollars. Heightened costs and reduces productivity. It may even put you on the road to Chapter 11; look at all the airlines in the past month.

Look also to eliminate some items to take on new ones, eliminate that one report, or find a new way to generate them, tailor a process to lessen time, or don't send that email, but make a change build a relationship ask questions in person this time, for the associate and yourself. All these items cost your organization productivity. How? It takes focus off the way that productivity and creativity can be improved, puts it on an unneeded task, that this time could be better used to prepare for future growth. Hope these ideas have sparked a new vigor in you one for change!

Carl Ashton MBA, CMA is a Consultant / Interim CFO / Controller for Acsys Inc and a member of the Gerson Lehman group of Subject matter experts. Also writes for Service Business Solution LLC A South East Accounting Firm, Franchise Accounting Solution LLC (A Franchisee only Division of Service Business Solutions), Corporate Payment Solution LLC (Electronic payment and Payroll Division of Service Business Solutions) carl.ashton@franchiseaccountingsolution.com