This Week's News Article

Analyzing Income Property (Part 2)

May 11, 2008

Last week we discussed the mathematical aspects of deciding whether buying an income property is a good deal or not. We looked at the Gross Rent Multiplier (GRM) and the Capitalization Rate (Cap Rate) as tools for measuring and comparing choices of property.

We also differentiated between properties having 4 or less units and those complexes having 5 or more units. The GRM was a tool of ‘comparison’, and the Cap Rate a professional accounting model expressing ‘return on investment’.

Let’s turn now to a completely different way of looking at your investment, but one that makes very good sense.

Cash on Cash Return: The Cash on Cash Return (CCR) tells you how much cash in pocket you will receive as a percentage of the cash you need upfront to acquire the property. The CCR makes a lot of simple sense to most people. If you have to find $60,000 total (including closing costs) to acquire your four-plex, and you will have a positive cash flow (before Income Tax) of $6,000 at the end of the year, you are making a 10% return, Cash on Cash.

It is easy to calculate your Cash Investment once you have seen your Lender and Realtor. Ad all the cash you will need to buy the property - Down-payment, Closing Costs, Inspection Fees etc. This is your ‘Cash In’.

Your Cash Flow (before Income Tax) is the Net Operating Income, previously discussed, less one other cash expenditure not included there - - - can you guess? You must further reduce the NOI by your repayments to the Bank!

Your Gross Income, less your Expenses, less your Debt Service Cost = your Net Cash Flow. The Cash on Cash Return (the Net Cash Flow as a percentage of the Cash In) really wants to be at least 10%. 15% is excellent, 20% is a no-brainer!

Warning: There are some Realtors and Sellers floating around who quote Cap Rates or CCR’s that are absolutely wrong! Persons improperly trained have no idea what these numbers mean. Numbers can also be miss-stated. A basic Real Estate Licensee has no training whatsoever in these analysis techniques.

A ‘CCIM’ designated Realtor should be able to help you with your investment decisions. You should also consult your CPA to discuss the Tax implications of your investments. Good Luck! I hope this has been helpful. If you missed Part 1 last week, drop me an email or view on my website at www.DaveWindsor.com.

Dear Dave: What exactly makes double-pane windows fog? Is it a sign that the insulation value is gone?

Answer: Double (or triple) paned windows fog when the seal around the edges fails. I have seen windows over 20 years old in perfectly good condition, while others fail in less than 5 years.

Poor construction of the window or faulty installation are the primary causes of early seal failure. An earthquake, or even a severe storm, can also jar the seal loose enough to open up space for the movement of air.

Once a seal allows the passage of air, moisture can creep in between the panes. Every time the windows heat up and cool down, the expansion and contraction force air in and out and, with it, moisture and other contaminating chemicals.

The problem with fogging windows is cosmetic. It looks ugly and prevents clear visibility. Insulation value of the window changes marginally.

If you are buying a house, and the home inspector notes a failed thermal seal, you should ask the seller to replace the window. However, you may face opposition from the seller because it is arguably a wear-and-tear item, consistent with the age of the home, as opposed to a material defect.

Dear Dave: I recently closed on a new home and, at the closing, the loan originator attended plus the Realtor, plus the closer of the Title Company. With my wife and two children the room was very congested. I didn’t think the Lender was usually present in a closing.

Answer: It is rare for a Lender to be present at the closing, and certainly unnecessary. The closing documents are prepared by the lender, executed by the closer with all parties’ signatures, and then returned to the lender for review before recording.

It is important for your Realtor to attend because you have a ‘representation’ relationship with them, and they have an obligation to follow through your transaction from start to finish. The lender, or loan originator, has no such relationship.

The closer at the Title Company is the designated third party who signs off buyer and seller. Their authority to proceed rests in your signing “Escrow Instructions,” and these should be the first point of discussion at the closing. The closing agent has no authority to proceed without your signed agreement to the terms of the “Escrow Instructions”.

Your 2 children should not be present. You cannot afford any distraction when finalizing the details of a major contractual obligation. Plan your closing ahead, with the help of your Realtor, and clarify who will be present.

In some States, buyer and seller appear together at closing but, in Alaska, these parties are brought in separately, since they have different papers to sign and different confidential interests which may need discussion at the closing.