Wednesday, November 30, 2011

King-Kong Cap Rate

The Property Report in today’s Journal features the “King Kong,” Empire State building. The disclosed facts are that the building was appraised this summer at $1.65 billion, and secondly, that the net annual income is $63 million.

$63 million of revenue, relative to a property valued at $1.65B is a yield dancing around 3.82%. Not exactly the best way to define the ‘cap rate,’ because “net income” implies that interest deductions and various credits are netted out, but close enough! 

3.82%… (Yawn). Unless you don’t travel or eat food… this will barely outpace inflation.

However, this figure is actually within range of an edifice to most major metros: it is acknowledged that cap rates of 2-3% are really ‘the norm’.

But what does this mean for you? Sub-districts and managed personal-properties can find yields in the vicinity of 8-10%, and even higher if managed the right way! Sure, people most often anchor themselves to the nominal figure…$x-dollars…but a yield is the most objective, apples-to-apples comparison people can make when evaluating an actual investment. So, focus on the yield of an investment when determining its capital investment worthiness.  


Tuesday, November 22, 2011

Mortgage Mechanics

The value of mortgage paper is a function of how a product is structured around the cash flows. I want to take the time today to explain what a mortgage is, theoretically. In the future, I will look to explain how the mortgage transfers into structured bond-type products in the capital markets.

Examples are great ways to explain a concept. A $500,000 listed home purchased with 10% down results in a $450,000 loan. We will assume that the purchaser qualifies for terms of a “fixed” 4.5% APR loan, with a duration of 30 years. An amortization calculator will confirm that the annual payment for such a loan will be around $27,600 per year, or the equivalent of $2,300 per month. For the sake of explanation, let’s ignore taxes, fees, and any other overhead costs.

The result of paying $27,600/yr over 30 years comes out to an actual liability outlay of $828,000. This assumes, further, that there will be no refinancing or any modification to the terms of the loan. The topic quickly becomes controversial and a bit of a catch-22. The accounting number says that we bought a $500,000 value home, while the “economic” cost is, in this case, $828,000, a significantly higher sum. The market listed price really doesn’t reconcile with the real cost.

You better trust whomever it is you work with to explain concepts like this.

Back to the example. The $328,000 difference represents the total interest cost—compensation for the lender who is assuming the risk. Much more can be said on the topic of ‘risk'. Important to recognize is how increasing the time horizon or the interest rate can have a dramatic magnifying effect. In our example, if we increased the APR to 5%, a mere 50 basis point increase, the total interest outlay raises from $328k all the way to $379k, a difference of $51,000! Put another way, one-half of one-percent on a $450,000 loan is the equivalent of a 11% total increase in price ($51k / $450k) or a 6% increase in total cost ($51k / $828k) over thirty years!

More to come…

Monday, November 14, 2011

Importance of Agency & Client Representation

Every agency relationship has a principal, an agent and a third party.  In a real estate transaction, the principal (Buyer or Seller), agent (real estate broker) and third party (customer) are bound together in a legal relationship, with all the duties and rights that go with that connection.  Most frequently, the principal is a Seller who employs an agent to find a Buyer for his property.  Sometimes the principal is a Buyer who employs an agent to locate a property. 

Given the premise of agency, it is very important as a Buyer or Seller to identify an agent that you know has your best interests at heart.  Specifically, it is the agent’s fiduciary duty to place your objectives at the forefront and not compromise them in the slightest.  Buying and selling a home can be a very emotional and complex matter, which begs the employment of an agent who embraces confidentiality, loyalty and your utmost trust. 

As a Buyer looking to purchase a property, you need to identify an agent that upholds the following traits:
  • LISTENS and pays careful attention to you and your needs and wants
  • Gives advice and guidance with FACTS
  • Educates you along the home buying process (i.e. prepares comparable market analysis)
  • Has a strong rolodex of resources (i.e. painter, plumber, interior designer, lenders)
  • Strong negotiator & market savvy
  • Is ‘ahead of the curve’ on available property
  • Is respected professionally by other agents in the field
  • Strong problem solver and commitment to you after the deal closes – lifelong Realtor

As a Seller looking to sell your property, you need to identify an agent that upholds the following traits:
  • Cutting edge marketing platform with use of Internet and print mediums
  • Intimate market knowledge of value and future outlook
  • LISTENS to your goals and objectives in selling – caters accordingly
  • Strong negotiator in maximizing sale proceeds
  • Creates an over-arching allure of the property and what is has to offer to prospective buyers

The aforementioned outlines the high-level points to be mindful of when interviewing agents and finding someone who you feel most comfortable with. 

Lastly, there are cases where a real estate agent may represent both the Buyer and Seller, which is called Dual Agency.  In such a case the agent must act with extreme care because the agent owes fiduciary duties to both principals.  The cumbersome nature of working on behalf of both principals can be challenging; however, depending on the overall interest level of the property and market timing, it could work in everyone’s favor – so, such an option is worth investigating.  In the end, identifying an agent that you are comfortable with and listens to your objectives will prove most beneficial to getting the best deal possible. 

Monday, November 7, 2011

Tech and its Role in SF Real Estate

Forty technology companies are looking for two million square feet of office space in San Francisco, most of it South of Market, according to a report by Colliers International.  Most concede that the technology sector has been the culprit for property appreciation in San Francisco. But have you considered why that is exactly?  The industry’s boom-and-bust cycles has given its players a robust ability to earn large sums of income, which has a correlation with affordability and home prices.  Specifically, economists and laymen alike recognize that one of the main drivers in home ownership is having the financial bandwidth and confidence in making such a large purchase, which the Tech industry clearly affords its workers given the compensation packages offered.    

The Bay has experienced an influx of new ‘Techies’ entering the work force for companies such as Twitter, Facebook and LinkedIn.  One can internalize this phenomenon by merely observing the surge in rents.  Specifically, the occupancy rate in the City rose six percent between 2010 and 2011, while the average cost of all rentals went up from $2,214 to $2,422, a 9.3% increase, according to RealFacts data. A 3.3% differential multiplied by the population of SF (approximately 809,000) is a total of nearly 26,700 people that are scrapping to find a place to live, per year.  Increased hiring at tech companies indicates confidence by both niche and conglomerate companies.

With the Tech market heating-up again, and rents sky-rocketing – what are the implications for the prospects of out-right home ownership?  Historically, a swell in the rental market tends to spill over into a greater demand and thus increase in values for home ownership.  People vying for rentals quickly come to the realization that instead of ‘throwing money away’ via renting that it is better to make an investment in owning a piece of San Francisco real estate.  Real estate values are arguably at 2002 levels given the sales activity I am experiencing today; plus, interest rates are within a range not seen in the past 50 years. This is what I dub: the perfect storm for first time homebuyers and investors alike.  These sound indicators’ reminds me of an old adage, “It’s better to buy Bay Area real estate and wait, than to wait to buy Bay Area real estate” – this cannot be more true today. 

The takeaway: San Francisco remains and will continue to be the epicenter for the Tech Hub of the world.  Innovative people want to live here despite the concrete evidence that there is little remaining land to develop, (thus limited housing stock available) and in turn, continuous demand as evidenced by the data above.