Contents

	REALESTATE INVESTMENT FORUM
	"Real Estate Investment Manual & Field Reference Guide"   Copyright 2007.  All rights reserved.
	Preface  Whether you are buying a house for resale, or a multiple tenant commercial building you are an investor, and your success will be forever charged by your attitude, and the extent to which you embrace sound real estate investing principles. Furthermore, buying and selling properties in the wholesale markets should not be thought of as a life-long endeavour but, instead, a temporary business that will provide the financial foundation for long term investing. The wealth building benefits of ownership, cash flow, long term capital gain and tax shelter are the "magic" of real estate investment, and should be the objective of everyone reading this page.  Remember, too, that understanding the principles of real estate investing is not enough. You must, also, be able to properly apply these principles to resolving the issues that you will be faced with every day.  How do I find the right property?  If I do, will the price be right? How do I avoid the costly mistakes?  What are the best market conditions for resale, and how will I recognize them? What are the unforeseen property management problems?  Should I attempt to manage the property, or hire a professional? Where will the needed financing be obtained, and at what cost? Is this property really as good as it looks, and what have I missed?  Am I getting the right information from the agent, or property owner. How do I find the right property, in the right place at the right time. Finally, if I do make a serious mistake, how do I recover? You will discover very quickly that your knowledge of the principles will be useless if you do not know how to apply them.   So, before you attempt to apply the principles you find here, or any of those promoted by the "fast buck" gurus, ask yourself the most important question. "Should I get help?" But, don't be discouraged.  Millions of people have preceded you successfully.  And you will be successful, too. For the answer to all your questions become a member of the Forum's Mentor Project. Just click on the Subscriptions link at highnoi.com. Your Mentor will insure that you master the principles that every new investor must know, and the "Forum Workshop Live" will accelerate your success at light speed.   The "Real Estate Investment Manual & Field Reference Guide" unifies investment theory and the daily realities of the real estate industry with a detailed look at the structure of a successful real estate investment and the impact of clearly defined planning objectives that reach far beyond the first investment decision to build extraordinary wealth and cash flow benefits. You will be introduced to financing and analysis theory by surveying the unique components of a leveraged real estate investment as each relates to the primary objective of maximizing the return expectations due to the greater risk which this form of investment deserves. You will be shown how to easily understand the financing devices used almost exclusively by institutional investors, and then apply this knowledge to meet your particular financial objective by constructing your own detailed and comprehensive investment analysis models without the need for expensive real estate analysis software. From the very beginning you will be prepared to move ahead with more confidence regardless of your real estate investment experience because you will have created a purposeful plan with precise direction. But as you proceed, remember this. Successful real estate investment is not a "do it yourself" process. Those that think it is are probably doomed to failure, or at the very best mediocrity. The purpose here is to make you a knowledgeable consumer, better prepared to work with real estate and financing professionals, property managers, vendors, accountants and attorneys seasoned by years of experience and training, and who stand ready to assist you in reaching your particular wealth and income objective.  Although the Real Estate Investment Guide And Field Reference Manual focuses exclusively on residential investment, the principles, practice, theory and strategic models apply with very little exception to the information contained in the "Guide to Foreclosure, Probate And the Wholesale Markets" and the "Guide To Investing In The Small Commercial Property". Getting Started
THE FACTS	Cash Flow Programs  There are a great many real estate investment schemes being presented throughout the promotional industry today as "Cash Flow Programs". Virtually every infomercial and Internet program sells their program and Mentor schemes with the promise of fast and easy money.  The kind of thing that anyone can do, and promised as a fast track to incredible wealth. We do not intend to pass judgment here, and as a Member of the Forum you will be offered an entire menu of "no down", "no cash" and creative purchase techniques found in our newest program "Aggressive Purchase Strategies For The Twenty First Century".  However, some perspective is in order. We begin by making a few general observations, and with the assumption the property is not affected by some measure of economic and urban blight. There are no rules, or convention,  for properties suffering from these market conditions, and no place for a "rookie". First of all, quality property is not offered to people without money and very rarely sold on the court house steps as the result of a foreclosure sale. Next, almost all property purchased in foreclosure, or using "no down" techniques, is physically distressed and located in rural or poor economic markets. In many instances these properties are acquired with non-paying tenants that require eviction meaning certain misery for the uninitiated. And, finally, properties purchased using most of the aggressive strategy techniques will almost always require improvement capital, hard work and skillful management in order to return a profit. The Low Down On No Down  In spite of what you hear, and read, legitimate "no down" transactions are virtually nonexistent in urban and suburban America,, particularly if conventional financing is used.  Keep in mind that we are discussing non-owner occupied properties purchased for investment. The reason for this is very simple. While there are still a few conventional loans that may be taken "subject to" the existing terms and conditions they are very, very, rare. Actually, they are very, very, very, rare. Many conventional loans can be "assumed" (Note that we say assumed and not taken) subject to the existing terms, but the buyer must qualify pursuant to the lenders rules and pay an assumption fee. Whether a conventional loan is assumed or created as new the lender will never approve an application that does not include an equity contribution from the buyer unless that person has a special relationship with the bank. Any attempt by the buyer, or seller,  to circumvent these rules in the course of a loan application is fraud and both could be subject to prosecution. Some gurus promote the notion that loans taken will often be ignored if detected by the lender. While this is often true, any assumption technique which ignores the lenders assumption requirements, including those which we will recommend, risks immediate acceleration of the loan balance. Virtually all legitimate "no down" transaction occurs when the seller is willing to provide, or carry back, the financing on an unencumbered property, and where the buyer has no other obligation than to make the note payment. In other words, the seller owns the property "free and clear" and is willing to act as the lender. But you are still not off the hook. The fact that you propose, execute and close the transaction could cause you to be viewed, in the watchful eye of the law, as an "expert", raising the possibility of the seller returning with a cry of deception! declaring the transaction as predatory and fraudulent. If this happens, and you are an agent, there is no force in nature that will prevent you from being separated from your license by the real estate commissioner in your state. Therefore, with very little qualification, it is safe to say that a "no down" transaction involves the potential for defrauding the lender, the seller, or both. It is noteworthy that many of the so called no down techniques involve the "creation" of money for the purpose of meeting the down definition. This is not the true meaning of "no down". No down means no assets at risk. When you create money from credit cards, personal property, apply partnership proceeds, encumber property you own or pledge value taking any tangible form you are putting assets at risk. Creative financing, maybe. But it is not "no down". But, whether you are exercising an option, converting a lease or marrying a "moonshiners" daughter, if you attempt to do it without money you are at risk. Money Back At Close Of Escrow  There are a number of well known real estate investment guru's promoting techniques to receive cash back when purchasing property.  In other words, instead of the buyer paying the seller for the property,  The seller provides the buyer with title to the property and "arranges" to add cash to the buyer's side of the transaction.  It is almost impossible to complete this strategy without engaging in fraudulent activity. Consider the ways in which cash can be available to the buyer at close.  It is created either through a loan made by a conventional lender, The seller or a third party.  If we make the assumption that no seller in a correct state of mind would pay a buyer to take possession of the his property except in the most extreme circumstances it leads reasonably to the conclusion that this can only be accomplished by means of a financing "scheme".  A scheme intended to deceive the lender as to the intent of the parties. While there are variations on this theme the typical approach calls for the buyer and seller to agree on a value subject to financing to be obtained often on a higher, or inflated value of the property.  Here is an example of a typical transaction.   Seller Baker lives in condominium project that is in declining condition and the homeowner's association is under financed and in trouble. Baker's unit is worth $75,000 and the mortgage is $50.000.  Baker needs $12,500 to move his family to a new home he has found but can't get a sale.  Buyer Abel proposes to to purchase Seller Baker's property for $77,500 provided he can obtain an FHA home loan and Seller Baker agrees to credit him with $15,000 at the close of escrow.  Seller Baker quickly agrees since this solves his problem.  When the sale is completed it looks like this: Purchase Price $77,500 Able's Down Payment $  2,500 New Loan $75,000 Baker's  Mortgage $50,000 Net Proceeds From Sale $27,500 Baker's Net Cash Out $12,500 Able's Net Cash $15,000 Able's Down Payment $ 2,500 (Closing Costs) "Cash Back" To Able $12,500 Looks easy.  Baker moves his family into new digs, and Able acquires Baker's property with a cool $10,000 bonus.  Every one  is happy. Every one, that is, except the lender and the title or escrow company. What Baker and Able did is a violation of the instructions that any lender would provide to the escrow holder.  While Able used an FHA "no down" purchase program needing only $2,500 to close escrow, under no circumstances known to us will a lender, institutional or private, qualify a purchaser for a loan with cash back at close and the lender's closing instructions would expressly prohibit such an agreement. Ask yourself, "Would I make a loan under those conditions".  Baker and Able most likely completed the cash transaction outside of escrow in order to hide their intent from both the lender and the escrow company.  Both defrauded the lender and are subject to civil penalties. And, since you have used government backed financing you are subject to criminal penalties as well. Ditto for financing secured through Federally insured institutions. If you employ this technique with any of the owner financed strategies you risk defrauding the seller leading to the possibility of a court ordered partition of your agreement and civil penalties. Take your chances, but you are looking for trouble.   To conclude there is the rare situation  in which a home builder will dispose of remaining inventory through a financing arrangement which offers prepaid profit to an investor.  If this is done with conventional financing the builder will always be responsible for the mortgage agreement between the bank and the investor, and will be secured with the builder's assets. The Truth About Options  An option to purchase anything whether it be a security, real property or any other asset, is defined as "The right, but not the obligation, to purchase at an agreed upon price within a specified period of time". An option contract is unique in that it is a unilateral agreement which obligates the seller but not the buyer. The seller benefits, however, since an option contract is accompanied by payment for the option that may, or may not, become part of the purchase price but is retained by the seller if the options is not exercised by the buyer prior to expiration. An option to purchase real property is almost always given by an owner to a person, or entity, that has a leasehold interest in the property. In other words such transactions are generally conducted between the landlord and the residential or commercial tenant. An option can be made a part of the lease, or originate as a separate agreement later. There are a great many reasons why the owner and tenant would enter into an option agreement, and virtually no reason why an owner would agree to option the property for an outright sale.  If the owner wanted an immediate sale that person would simply offer the property to the market in the conventional ways and sell for market value. This is not to say that there would not be a situation in which an owner would offer an option to effect an immediate or timely sale. Estate planning and tax strategy could motivate the use of a purchase option under certain circumstances, but these and other related considerations are very rare and unique. Fast profits form cheap options are the myths that promote expensive seminars, books and tapes. They are like snow in the Sahara Desert. Claims that it happens are accompanied by very few witnesses. Foreclosure & Probate  What applies to foreclosure generally applies to probate. Hopefully, the purists won't hold our feet to the fire. We are just trying to keep it simple. Good property never goes to foreclosure. (Never is a very strong word, but you are likely to become a believer if you chase this market.) Before that occurs it is offered to the market, and sold at market price thereby relieving the owner of the debt which initiated the process. There is also a procedure known as "deed in liu of foreclosure" in which the property is voluntarily surrendered to the lien holder. Many home owners choose this option when they must relocate and the property's debt exceeds the resale value. Owners of commercial property opt for this solution when they can no longer support the property due to insufficient income, or when overcome by management problems which exceed their ability to resolve. The residue of the foreclosure market winds up on the court house steps. If after the many hours of investigation, travel and inspection you wind up there too, you will not be alone. For standing beside the secured and unsecured creditors will be all the other foreclosure "trekies" that have been beating a wide path down the foreclosure trail. By the way, take cash, and plenty of it, because they do not accept American Express. Quick Turn, Flip & Fixers  These programs are old by the Gurus as a fast and easy way to make a quick buck in real estate. These properties are easy to find in distressed markets, but very difficult to find in a quality market. But, where ever you find them the plan is always the same. Gas up your truck (You don't have a truck? Better get one.) and load your tool box. (You don't have a tool box? Better get one.). Oh, be sure to fill it with lots of tools that you know how to use. Then be prepared to work your butt off because if you try to buy this process the contractors will take much of your profit. Guaranteed. There are benefits, however. The long list of building and material suppliers required will insure that you make new friends every day. While there is very good money in this market, very few investors have the energy to stay with this grind very long. However, if you know what to look for, and the techniques for creating profitable networks, this market can be quite lucrative. The Forum Mentors will show you how. Tax Certificates  If you like a good mystery you will be chasing tax certificates. Your first investment, however, will be a motor home. Be sure that it is large, comfortable and as economically efficient as possible since you will be spending most of your time in it. Purchasing a profitable tax certificate involves constant travel, detailed records search, endless property inspections and an intimate knowledge of the market in which the property is located. There are brokers that specialize in tax certificates, but you will find that they get most of the profit if there is any, and you will take all the risk. This applies to the search for "no down", cheap options and "quick buck" foreclosures as well.  But it is particularly true of the tax certificate market. Buying Property Below Market  Property of any kind is rarely bought below market. The circumstances under which it occurs involves an uninformed seller, or a sale suffering from some degree of stress related marketing. In other words the seller will settle with the first buyer just to get rid of a problem. If this sounds like a combination of  "no down" and foreclosure that's because it is. Every so often the nearby planets of our solar system line up in the evening sky. In order to see this event you either have to know in advance when it is going to happen, or be looking up at the right time. The odds of really buying property below market are probably about the same. The law of supply and demand, like the law of gravity, makes very few exceptions. In an orderly market every property will seek its value assuming properly informed principals. This also assumes that the property is offered to the market. If property is sold without market exposure the seller is uninformed, foolish, or both. Admittedly, the fortune seeker looking for this opportunity will get lucky. But it's hard work. The well meaning people in our universe who advocate the realistic potential for below market deals are usually refering to value added opportunities. Ways in which the property's value can be increased quickly and efficiently, and that have been overlooked, or ignored, by the seller. These opportunities are discovered through knowledge of the market, skillful financing strategy and the application of well developed management techniques. You will find acquiring the knowledge and development of  the needed skills much easier than turning over a lot of rocks in search of a seller waiting to be blindsided.  If you are interested in becoming an expert in this market, then  become a Member of the Forum. No Money  101, 1,001 or 1,000,001 ways to purchase property with no money down proclaim the purveyors of "easy money" programs.  No matter how ways you count they are all variations on one common and very simple idea stated in the memorable line from the film "Jerry McGuire" delivered by Cuba Gooding to express his frustration when informing a sport's agent played by Tom Cruise that he was tired of receiving nothing but promises for his success as a professional athlete. "Show me the money". No down purchase techniques use the money, or assets, belonging to someone else, and almost always involve some kind of promise for a future return to the seller. When you make these promises you are putting their money at risk while accepting very little on your own. Is this the act of a responsible person? Or, put another way, it should only be the act of a responsible person. Acquiring the needed knowledge and skills should be the first act of responsibility since no matter how you find yourself in the real estate investment business you must, at some point, return to solid investment fundamentals if you are to insure your success.  Remember, if you are slow, or fail to fulfill your promises to others when using their money or assets, it won't be long before you hear someone screaming, "Show me the money". If this sounds discouraging then our purpose has been served. So, can you make money in these markets? Absolutely! Can big money be made in these markets? Yes, for some. Then why do a few succeed where most fail, and what is their secret?  The answer is reduced to one word. RESOURCEFULNESS. All successful people are resourceful. They are not necessarily intelligent, educated or experienced. They are not identified by their race, color or creed.  The one thing they do have in common is there are no barriers to their objectives. They will find a way to go over, under or around any obstacle in their path because they are focused only on success. This is particularly true of real estate investors. You may find your place in the real estate business very quickly, or it may take considerable time. You may also discover that you are in the wrong place. The best way to find out, however, is to become a Member of the Forum's Mentor Project and learn how to properly apply the principles through the guidance of a seasoned professional working in these markets every day.
FAST START FUNDAMENTALS	The Real Estate Selection Process  Many important questions often go unanswered in the quest to enter an investment environment that continues to produce extraordinary wealth, and the process has become considerably more complicated. Structuring the transaction, establishing value and removing the confusion about the best available financing now requires expert professional guidance to stay ahead of the competition. The inexperienced real estate investor often finds this to be a daunting task, but an extraordinary opportunity is ahead for those willing to learn how the game is played. The exercises which immediately follow construct the Income & Expense Summary and a Decision Model for a 28 unit apartment building.  We often hear "Why do I need to know this stuff, I'm just going to buy and sell houses".  From this point forward it is important that you establish a new mind set. Whether it is the smallest house or the largest building in town, any property purchased for income and profit will require some, or all, of the purchase and management principles incorporated into these illustrations. This presentation will provide the foundation necessary to select the property that meets your purchase and management objective. Beginning with the fundamentals it moves ahead into relatively complex purchase, exchange and refinance modeling. Be patient as you proceed. Some of the ideas and theory will seem confusing at first. But it will become clear with time, practice and application. Be sure to complete the Field Exercises. Each will further enhance your understanding of the practice and theory. In time you will approach investment decisions with confidence and perspective.  You will know when that time comes because it will all seem so easy. Income Proforma Factors  The present and future value of an income producing property has little to do with the  conventional notion of appreciation. "Income properties are bought and sold based on the strength and durability of the current and future value of the "Net Operating Income". The Net Operating Income, or NOI, is the Gross Scheduled Income (GSI) after all operating expenses including vacancy and bad debt. Write this down. Read it every day. This is the linchpin in the real estate investment pendulum. Your grip on the driver. If you ever lose sight of this most critical fundamental it is essential that you step back, regrip and re-establish your target line with this concept, once again, firmly in mind. . . . . .let's begin.
FIELD EXERCISE	"A Property Management Primer"   The Income & Expense Summary  is the focal point for the analysis, valuation  and selection process. The principles contained in this illustration apply to any property you may be considering, and fundamental to investing in any market. Review this illustration and the construction in detail. The field explanations provide a solid foundation in the fundamentals of property selection and management. It is particularly important that you learn to skillfully prepare your own customized spreadsheet illustrations whether for an apartment building, or the quick turn "fixer". This skill is especially important if you are presenting data to purchase partners or any other third party, including a lender.. Begin by constructing an Income & Expense Summary using any standard spreadsheet program. If you are considering an apartment building or commercial property obtain the preliminary data from the owner, or owner's representative. The property owner's Schedule E, or C, filed with their federal tax return will help to validate the information. If you are working in the wholesale markets you will have to customize the presentation of your spreadsheet data in accordance with the objectives of the purchase.  Whether you plan to hold the property for a life time, fix it or flip it, you must always view the purchase as an investment decision. Build your own Summary using operating data from as many other sources as you can validate. Use the The Property (Loan) Presentation to assist you in assembling the data. Complete an independent market study of comparable rents in the area. Review the operating expenses for other buildings for which you can get data. Then compare your Summary with the statement offered by the broker, or owner. Is the Gross Scheduled Income (GSI) actual income, or is it based on market income, commonly referred to as effective rents. Pay particular attention to the representation of vacancy and maintenance expenses. Compute the Gross Rent Multiplier (GRM) of the offering price based on your Summary. Does your computed value compare favorably with the recent sale of comparable properties in the same market. Keep in mind that comparable means a similarity in condition, location and square footage of the rental units.  If you are working in the wholesale markets build your data base around market price, rents, repair, holding and resale costs.
FIELD EXERCISE	Building A Decision Model  The Income & Expense Summary provides the means of evaluating the data associated with the property's day-to-day performance. This data having been prepared and validated by the investor can then be inserted into a decision model for the purpose of creating a defined future expectation. The model can take any form necessary with respect to the investor's particular objective. Decision models can be created for such things as tax shelter analysis, evaluating  a competing investment, buy vs. lease, sale lease-back and real estate exchange planning to mention just a few. Most investors, however, are primarily interested in the future income stream and potential growth of their initial investment. The Cash Flow And Capital Gain Model  is a Decision Model created for a purchase decision based on cash flow and profit. Use this kind of model for any property you are considering.  It is very important to become familiar with this illustration since the analysis further refines the data fields of the Income & Expense Summary, and all the analysis that follows builds carefully on the principles contained in this model. Use the data from your Income & Expense Summary to construct a decision model for the property.  Build your own spreadsheet. You may have to brush up on some of the math required. Experiment with different kinds of data fields and their location. You will find this a particularly useful exercise for the development of more complex investment models later. When you are finished evaluate the outcome.  Is it more, or less, than your expectations for this property.  If it is less experiment with changes to price, down payment, expenses and financing parameters. Observe how changes in the data fields affect the Cash Flow And Capital Gain Projection. When you reach an outcome consistent with your expectations determine if you can realistically effect the needed changes in the data. If your requirements have certain tax implications it would be advisable to have your accountant assist in the construction of your model.. When your Income & Expense Summary and Decision Model directs you to purchase you will then be ready to create one of the most important business relationships in the real estate industry. For, unless you are paying all cash, you will probably need to take a partner. That partner will most likely be a mortgage lender, and you will find that a lending partner will evaluate your purchase decision in the most discriminate ways.
UNDERSTANDING INCOME	A Definition of Leverage   The concept of leverage will vary in terms of the more specific objectives of each investor, however, the following definition will generally  be accepted without regard to the degree of risk. "The process by which the return on investment is enhanced using borrowed purchase money for maximum asset acquisition with minimum equity subject to acceptable risk. Mathematically, leverage is the ratio of the loan balance to the value of the asset expressed as a percentage." Leverage is based, in part, by a lender's willingness to lend all, or some portion, of the investor's loan requirement. The process begins with an analysis of the mortgage lender's underwriting procedure and a detailed look at the elements of net operating income (NOI), debt coverage ratio (DCR) and the mortgage loan constant (LC). We will explore the subjective considerations that affect each of these factors, their particular importance to the loan process and how small changes in each can effect the leveraged position and ultimately the investor's return. The Federal Tax Code still offers exceptional incentives for real estate investment. However, by thoughtful preparation and the resourceful management of the qualitative and quantitative elements of the investment there exists extraordinary opportunities even without favorable tax consideration. The basis of a leveraged position begins with a lender's willingness to loan on all, or a portion, of an asset's value. Income property is generally evaluated on the basis of its ability to produce income over a specific period time. Of particular concern to the lender is the relationship between the net operating income (NOI) and the debt service that will be required by the lender's loan commitment. The lender will require a Income & Expense Proforma from which certain assumptions will be made regarding the amount of actual income available for the mortgage payment. It is for this reason we introduced the Income & Expense Summary first and asked that you become thoroughly familiar with its development and application. Loan-To-Value     Loan-To-Value (LTV) is an expression of the borrower's leverage measured as the ratio of the mortgage and the appraised value of the property expressed as a percentage. Mortgage/Appraised Value = Loan-To-Value(%) Most lenders have an underwriting policy which limits the LTV to a specified percentage. However, this is negotiable and will be covered later. Maximum Loan Amount    The maximum loan amount (LA) represents the largest loan a lender will approve based on the income proforma of the property, and will be covered extensively in this section. Net Operating Income Buildings are bought and sold based on the strength and durability of the current and future income stream. The Lender's underwriter, or correspondent (mortgage broker), starts by evaluating the data from the Income & Expense Summary. This information is usually provided by the borrower, therefore the underwriter will be subjective where the information is deemed to be incomplete, inaccurate, or unreliable. The process begins by adjusting the gross scheduled income (GSI) for anticipated losses due to vacancy and bad debt. The amount remaining is commonly referred to as the gross operating income (GOI). The GOI is then adjusted for operating expenses that can be reasonably expected from affective management and generally accepted operating costs. What remains is the net operating income, or NOI. The NOI may, or may not, be further adjusted to include concession income, an underwriting practice that varies as a matter of policy among lenders. Debt Coverage Ratio   The debt coverage ratio (DCR) is calculated to determine the lender's margin of safety relative to the borrower's loan request, and is a factor found by dividing the annual NOI by the annual debt service. NOI/Annual Debt Service = DCR A DCR of 1.00 indicates a break even cash flow.  A DCR of .99, or less, suggests the annual NOI will be insufficient to cover the mortgage requirement. A DCR of 1.01, or greater, should insure the lender of some margin of safety.  Most lenders will require a DCR of 1.00 to 1.25. Loan Constant  To determine the maximum loan amount the NOI and DCR are integrated with the loan constant. The loan constant (LC) is the ratio of the annual debt service (ADS) to the loan amount expressed as a decimal fraction. The loan constant can be determined without knowing the exact loan amount. You need only to determine the mortgage rate and term of the loan. For example: A loan amount of $1000 at 7.5% for 30 years requires an annual payment of $83.91, or $6.99 per month.  The loan constant is computed as follows: $83.91(ADS)/$1000 = .0839 (LC) Note: The loan constant is not the interest rate, but is the combined rate required to pay the interest at the indicated rate of 7.5% and amortize the principal balance over the term of the mortgage. The relationship of the rate and term remain constant for any loan amount. Determining Loan Value   The lender will use the net operating income, required debt coverage ratio and the loan constant to compute the maximum loan amount (LA) using the following formula: NOI/(LC)x(DCR)=(LA) Using the NOI from column 1 of the Cash Flow And Capital Gain Model , and assuming a DCR of 1.15,  we can compute the maximum loan amount. $120,120/(.0839)x(1.15)=$1,245,000 The maximum loan amount exceeds the $1,185,000 mortgage shown in field (6) which is based on an assumption that the lender will not loan more than 70% loan-to-value. However, the maximum loan amount would be insufficient if we were seeking a loan at 75% loan-to-value since the mortgage requirement would be $1,275,000.  Adding the concession income of $5040 to the NOI produces the following result: $125,160/(.0839)x(1.15)=$1,297,000 By adding the concession income we can meet the NOI requirements for the new loan amount. A quick method of finding the needed increase is to multiply the added amount of the loan, $30,000, by the loan constant and the debt coverage ratio. $30,000(.0839)x(1.15)=$2,900 Then $120,120+$2,900/(.8839)x(1.15)=$1,275,000 In this particular instance the concession income is more than enough for the higher loan amount. This is provided the lender will accept the concession income and loan 75% of value. Where the the LC, DCR and maximum loan-to-value (LTV) are known a constant known as the overall rate (OAR) can be computed. (LC)x(DCR)x(LTV)=OAR Or (.0839)x(1.15)x(.75)=.0724 The OAR can be used to compute the maximum value, or purchase price, of the building . NOI/OAR=Maximum Value Or $120,120+$2,900/.0724=$1,700,000 The Loan Value Mix A struggle over the value of the NOI occurs frequently between the lender and borrower. Additionally, the lender will not always provide a complete disclosure as to how a particular loan amount was computed. Since the loan constant can be computed from the preceding formula, and the loan amount will be disclosed, the assigned value of the NOI or the DCR can be determined provided one of these components is known by returning to the following expression: NOI/(DCR)x(LC)=Maximum Loan Amount Then (LA)x(LC)x(DCR)=NOI (NOI)/(LA)x(LC)=DCR To determine an interest rate required to support a given loan amount compute the LC using the following formula and extrapolate the interest rate. NOI/(LA)x(DCR)=LC Understanding these formulas is very important when negotiating a loan where any of these components is unresolved, or in dispute.
LENDER & BORROWER - A PARTNERSHIP	The stakes can be high for the investor seeking to maximize leverage. Therefore, it is important to unite the lender's need for protection with the an investor's attempt to stretch the limits in seeking a specific leverage objective. In a changing market the dynamics of the NOI, LC and DCR will have a significant impact on the competing objectives of borrower and lender. Timing  Although timing is rarely the deciding factor, any attempt to create a safely leveraged investment could be defeated by the inability to obtain an interest rate, or combination of rates if more than one loan is required. Also, such factors as demographics, government policy, trends in development and changing consumer preference will affect the borrower's options due to their influence on vacancy, income and resale potential. Risk vs. Cash Flow   The merits of leverage need to be balanced by the disadvantages, or risk. It is inevitable that the actual performance of the building will vary from the proforma projections. The variance is the measure of risk that the investor will be required to assess when deciding the amount of leverage desired. As previously mentioned, certain outside factors can be expected to effect this variance, often measurably. While the expectation of enhanced returns might encourage the acceptance of an inordinate degree of risk by the borrower, it may be viewed as unacceptable by the lender. A resourceful investor will find that a knowledge of these risk bearing considerations will be helpful if there should be difference of opinion regarding certain factors relating to the net operating income and the resulting effect which these differences may have on the loan value of the property. It should be apparent by now that the NOI can be very arbitrary and small changes can result in a significant reduction of the loan amount. The same risks can be extended to the borrower as regards the DCR. The lender may not dispute the value of the NOI, but the financial strength of the investor may raise concern. The lender will also look upon the potential effect of the borrower's experience, distance from the property and any demonstrated skills in property management as offering strength, or weakness, to the loan. Any concerns are often resolved by an increase in the debt coverage ratio in order to insure that should the NOI decline precipitously the mortgage will continue to be protected with an added margin of safety, particularly if there is any financial weakness exhibited by the borrower. Property Qualification   The importance of location is known to all. However, agreement as to the quality of certain locations is less than universal. While the lender is prohibited by law from establishing discriminating lending practices based on location, it is still a dominate practice in certain areas. Although lenders will never deny a loan for stated reasons relating to location they will discriminate through analysis of the income and expense data. This form of discrimination, known as "red lining", is normally concentrated in a core city environment suffering from some measure of "urban blight". While the beginning investor should avoid this kind of property these locations are of special interest to certain experienced investors seeking to take advantage of the lower sales prices and more flexible terms often associated with properties in these areas. Remember, too, discrimination not withstanding, all lenders have very strong preferences regarding location, therefore it is wise to be prepared for this kind of resistance if the property is located in a marginal area. Lender Qualification  All lenders have specific income goals which are determined by the average yield of their lending instruments. The borrower stands an improved chance of obtaining the desired loan if there exists an understanding of the relative importance of the loan request within the context of the lender's profit objective. But, first, the borrower must establish that the lender is seriously interested in the property for which the loan is sought, and that the property is clearly within the scope of the lenders's underwriting practice. Satisfied of the lender's intent, the next step is determining the availability of a leverage enhancing mortgage instrument. Lenders making commercial real estate loans tend to specialize in a certain class of property such as apartments, retail, office or industrial. Each offers the standard laundry list of mortgage products in a variety of fixed and adjustable rates. A fixed rate loan is a poor mortgage product for investment purposes for two very important reasons. This type of mortgage is almost always offered at a higher interest rate, therefore having a larger loan constant and lower loan amount. Additionally, the higher interest rate increases the debt service requirement and usually results in diminished pre tax cash flow. For these reasons many commercial lenders do not make fixed loans available except in special cases. Within the basic mortgage inventory there are a number of leverage and cash flow enhancing mortgages that may be available, or customized, upon request. Examples would include: Rollover Mortgage   Any mortgage for which the rate and term is subject to determinant, or indeterminant change. Open End Mortgage   A loan that may be recast in order to allow the borrower to finance a larger loan balance made possible by the increased loan value of the property. AIMS   Alternative mortgage instruments.  A loan that is created to meet borrower or lender objectives. Participation Loans   Certain very specialized loans such as shared equity and income participation loans in which the lender shares in the the equity and/or income stream of the property. Negotiating The Loan   Always negotiate the loan. Particularly in a financing market where the lenders are known to be competing for mortgages. But, whether they are, or they are not, always negotiate the loan. It is very important to understand that a loan from the perspective of a lender is merely one of many loans blended as a package, or portfolio, to produce a balanced yield for an institutional investor. Although the rate and terms quoted by the lender are intended to meet specific yield expectations, each can vary according to a variety of circumstances, not the least of which is a strong buyer combined with an attractive property. Banks and savings & loan associations make real estate loans from money on deposit.  The high cost of property in many developing areas of the country creates a demand for real estate loans which exceeds deposits, and the money loaned needs to be replaced in order to maintain the required reserves and operating capital. Most mortgage money is made available by large institutional investors and include large banks, pension funds, mortgage REIT's and publicly traded investment pools such as Fannie Mae, Ginnie Mae and Fredie Mac. These investors demand a guaranteed yield and timely placement of their investment. The guarantee is provided  in the form of a "commitment" by participating banks and S & L's, also known as correspondents.  Each commitment promises the delivery of a package of loans in a specific amount and having a defined average yield and maturity. In exchange for the commitment the correspondent will recover the money loaned and profit from fees and other costs charged to the borrower.  Each loan in the package must be underwritten in accordance with strict guidelines and delivered by a specific date. Failure to deliver the commitment, or late delivery, results in severe financial penalties along with the risk of being removed as an approved correspondent. In a dynamic financial market there are two driving and competitive forces. The need to lend and the demand for the money. The rate and terms for this money are usually determined by the point at which these forces are at equilibrium. Should a lender make a commitment to an institutional investor that exceeds the current demand there could exist a situation not unlike water building behind a dam. As the pressure builds the lender will seek relief by making some loans at below market terms, then later combining these loans with a package that includes loans at a higher rate giving the investor the required yield. Most lenders attempt to avoid this financial high wire act by regulating their commitments so that they fall just short of borrower demand. A borrower should seek to take advantage of these opportunities and probe for the soft underbelly of the commitment process. While these opportunities are not always visible, or available when needed, the astute real estate investor working with knowledgeable professionals can score a hugh financing victory by locating the lender who needs the loan. Variations On The Theme   If you know the variations possible with the loan correspondents, and the institutional lenders they represent, you can increase the chances of creating the financial leverage you need. By understanding the symbiotic relationship that exists between the borrower and lender you level the playing field in a complex financial game. Any lender will look more favorably upon a loan application that demonstrates a clear command of the data presented with a clear plan for implementation, particularly if viewed to be profitable with minimal risk. Even if the borrower's is not within the lender's sphere of influence, or authority, it may form the basis of a profitable relationship with little change in the proposed financing. Just as the real estate investor is affected by outside market dynamics the lending industry, more than most any other business group, is at the mercy of government politics and changing monetary policy. A borrower 's proposal no matter how unique, or demanding, may prove to be acceptable since all lenders are continuously reinventing and repositioning their mortgage products to meet the demands of a dynamic and competitive marketplace. New and innovative ideas are moving across traditional barriers faster than ever in the new pardigam of computer technology. Alternative financing techniques are no longer confined to the realm of conventional wisdom but instead driven by the lender's competitive need to creatively meet the demands of their customers. Therefore, always negotiate the loan with a plan that meets your investment objective.
FIELD EXERCISE	Construct a Property Presentation using the Income & Expense Summary and Decision Model to demonstrate your command of the market data. Promote lender confidence by customizing the flow chart detail to enhance the accuracy of your presentation while at the same time providing the appraiser with added information upon which to establish the value you are seeking.  Computerize the presentation by placing it on disc. Or, better yet, if the property is for sale develop a personal web page which efficiently and professionally  transmits the information to your market without  the need for paper and postage thereby saving valuable administration and handling time.
MAXIMIZING LEVERAGE	The Expanded Cash Flow & Capital Gain Model Model calls for critical insight into the effect of small changes in the NOI, DCR and LC. This illustration also examines leverage enhancements that are created by recognizing the difference between scheduled and market income, as well as the changing dynamics of the GRM. Note how cash flow and capital gain is added through thoughtful management of each of these components. This should sound a little like the Field Exercise recommended for your Decision Model, except then it was for the purpose of evaluating some fundamental expectations. Now we will apply the principles that separate real estate investors from those that merely own investment property. This illustration will be the basis for your business plan, and your strategic actions Market Income  There is often a significant difference between the Current (C) income which is computed on current rents, and the Market (M) income rent which is based on an accurate survey of comparable units in the same, or similar market. Often the Current rents are found to be below Market. Therefore, it is extremely important that both Current and Market rents be compared in order to properly evaluate the future income stream and capital gain potential of the investment. It is common for a seller to inflate the offering price based on unsecured, or unsubstantiated market rents. An astute investor will never pay a price based on this form of data. It is important to remember that value must be earned before it can be offered as a benefit of the purchase. Therefore, if a seller has not worked to establish the building on higher rents then the higher value has not been earned. Conversely, a buyer needs to insure the rent scheduled has not been recently inflated to promote the sale and can be maintained in a competitive market. The Interest Rate   Remember that the interest rate is the rate at which the return to the lender is computed and the Loan Constant (LC) is the amortized rate at which the interest and return of principal is computed. Any change in the interest rate will have a corresponding effect on the LC for the purpose of computing the loan value, however as the LC decreases cash flow increases and the rate at which the principal balance is amortized accelerates. Referring to column 3 of the illustration the mortgage rate is reduced to 7%. The 5 Year Summary shows a cash flow improvement of $24880, increased principal reduction of $5720, combining for an added return of $30600, or $6120 for each of the first 5 years. This represents an additional return on the equity (ROE) of 1.2%, and while this may not seem like much it is considered very significant in the financial markets. Additionally, it is acquired without any added capital, or management. Expenses    Column 4 demonstrates the importance of properly estimating and managing expenses.  For each dollar of expenses saved there is an added dollar of NOI. A reduction of 5% results in an added $11,260 to the first year cash flow, 2.18% to the ROE and $126,170 to the 10 Year Summary. Recalling there is often disagreement between borrower and lender over the value of the NOI a history of successful property management can be an important negotiating point in favor of the investor seeking to improve leverage with a higher loan-to-value mortgage. The Power Of Leverage   Column 5 reflects the extraordinary impact of leverage.   An increase of 5% in the loan amount produces a 15% increase in Return/$1000 Of Beginning Equity field (30) even though there is a large reduction in cash flow for both the 5 and 10 Year Summary. This is an important demonstration of the power of leverage as the single most important contributing component of return on investment, and suggests that for maximum return cash flow will generally have to be sacrificed for leverage. An assumption, however, which provides that the property will enjoy a capital gain resulting from an increase in value. Gross Rent Multiplier or Capitalization Rate There are some excellent real estate professionals that insist on dismissing the use of the Gross Rent Multiplier as elementary in preference for Capitalization as the appropriate means for establishing value. While use of the capitalization method, or CAP rate, is essential in certain situations, the GRM is an exceptionally valuable analysis tool if properly understood and applied correctly. This is particularly true for residential income investments in which the dynamics associated with the net operating income (NOI) can change quickly, and often, during the holding period of the investment, and where most of the total cash received from the investment  is derived at sale Return to the Cash Flow And Capital Gain Model and Click on Capitalization Rate Field (17).The CAP rate is extremely important to the investor when evaluating a net income stream because the cash flow is going to be the return on investment for the term of the lease, or leases, which could be a long time. Often 10,15 and 20 years for regional and national tenants. If the Capitalization rate applies at all to an apartment building it would only be for the first year of operation. Furthermore, the accuracy of the CAP rate depends entirely on the reliability of the NOI which in turn is dependent on the operating expenses Field (12), and derived from the operating statement, or the Income And Expense Proforma. Since this data is highly subjective using a first year CAP rate to project the future performance of an apartment building would be speculative at best. The most frequently used method for the preliminary valuation of apartment buildings is still the Gross Rent Multiplier, or GRM.  Click on Field (3) of the Cash Flow And Capital Gain Model  and review the definition. While the GRM is not used to capitalize the value of an income stream it is an excellent tool to discriminate among competing properties offered for sale, or recently sold. A CAP rate is merely a number having some relative meaning for each investor, but a Gross Rent Multiplier can be much more revealing for the experienced observer. CAP rates and GRM's tend to move up and down together and generally reflect upon the condition, location and income strength of the property. While the GRM does not offer direct NOI details, experienced professionals and knowledgeable investors know the GRM has probably been increased, or discounted, based on the relative strength of the property in the market place, and often provides accurate intuitive information about the quality of the income and operating conditions of the building. Many real estate brokers can approximate the location of a property within their community with no more knowledge than the selling price and GRM. Compared to the NOI, and resulting CAP rate for a particular property, the GRM as a relative strength indicator, tends to remain more predictable over time. It is for this reason, and because it is does not involve the extended calculations required by the CAP rate, that we have chosen to use the GRM to project future value in our spreadsheet illustrations.The CAP rate and GRM are both important tools. There will always be a difference of opinion regarding the comparative value. We suggest they be placed in the investor's tool kit, and that each can be used skillfully together, separately or interchangeably. The GRM is a number abstracted from the market place based on the relative features and benefits of sold properties. The GRM of comparable properties is found by dividing the selling price by the gross scheduled income. The result is then applied to the gross scheduled income of the featured property and expressed as: GRM x GSI = Estimate of Value The difference in Capital Gain Year 5 shown in field (25) increases by the amount of $99,700 between column 5 and  6 as the result of  a relatively small change of .39 in the GRM. Many properties have sold on a GRM increase of 1.0, or more, due to effective purchase strategy, or appreciation through skilled management. Reminder:  "Income properties are bought and sold based on the strength and durability of the current and future value of the "Net Operating Income" Appreciation is the result of added value without added income. The process, sometimes referred to as "sweat equity", is often accomplished by removing obsolescent features, adding improvements or by whatever means restoring a substandard property to market condition. Experienced investors will attempt to position a property for sale on a GRM higher than it was at purchase. Summary  This illustration establishes a clear relationship between the contributing components of leverage and the return on investment. While, individually, these factors may not be completely within the investor's influence at the same time, It has been shown that effective management of just a few will reap extraordinary benefits.
MEASURING RETURN	There are several generally accepted methods used to measure growth and return on the Capital invested. Any calculation, regardless of the method, measures the combined influence of cash flow, equity growth and the return of capital. The two most often used and discussed are the Internal Rate of Return (IRR) and the Financial Management Rate of Return (FMRR). The principles related to each method are the same, with only the presumptive difference regarding the reinvestment of the cash flows (CF) that provide a slightly different result between the two. Since virtually all of the financial return associated with most real estate investments for all but the very long hold results from the capital gain at the time of sale, the presumed difference between the individual cash flow contributions becomes virtually insignificant at the time of sale. The use, and importance, of analytical tools among real estate investors spans the full spectrum ranging from disinterest among the more lackadaisical investors to mandatory for the institutional portfolio managers. This treatment is intended to provide the investor with some financial analysis perspective, and offered as a means of comparing a real estate investment with other investment alternatives. But, remember this. Financial analysis, or "crunching the numbers" is merely a precursor to a smart and profitable real estate investment, and by no means assures success. But, if you understand your market, your property's place in the market and manage the investment decision with a disciplined plan dedicated to maintaining the property's integrity with quality service to the tenant, the numbers will generally take care of themselves. Internal Rate of Return   The IRR is used most by lenders and institutional real estate managers for the purpose of estimating a yield which is the measured return on capital. Aside from the arithmetic involved, the important difference between the IRR and the FMRR is that the IRR presumes the cash flows are reinvested at the same rate as the IRR itself. Whereas, the FMRR assumes the cash flows are reinvested at a specified rate. Another important difference between the two methods is the reciprocal treatment of the individual cash flows. The IRR discounts future cash flows to a present value based on a discount rate. Think of it as compounding in reverse. For example: $1000 received annually for 5 years and compounded at the rate of 7% = $1417. Discounted, it's simply the reverse. $1417 to be received in equal annual installments of $1,000 for 5 years and discounted at 7% has a net present value, or NPV, of $1,000. Yield computed as the IRR is returned as a percentage and assumes that all the cash flows were reinvested at that rate. Another way of determining value is by adding the discounted cash flows to the loan amount. (CF) + (LA) = Value Or ($50,000)+($1,000,000)=$1,050,000 Financial Management Rate of Return   The FMRR is often the method of choice because it is somewhat easier to understand, and because of the more flexible assumptions regarding the reinvestment of the cash flows. Assuming the cash flows from column 3 of the Cash Flow And Capital Gain Model were reinvested in a very conservative money market instrument at 5%, the fifth year values of each cash flow would look like this: Year 1 2 3 4 5 1 $34290             2 $36004 $37770          3 $37804 $39658 $42110       4 $39694 $41641 $44215 $44980    5 $41679 $43723 $46426 $47229 $48730 Band of Investment The Band of Investment measures the return attributed to the separate components of debt and equity. This method is often used by an investor to establish value based on a certain cash return and the terms of available financing. We can construct a return using the Band of Investment with the application of some previously defined terms. The Net Operating Income (NOI), Loan Constant (LC) and the Over All Rate (OAR). We can then combine these factors with the relative percentage of debt and equity to form the Band of Investment using the following computation:. The Loan-to-Value percentage, or ratio, (LTV) is multiplied by the Loan Constant (LC) to obtain the Return on the Loan (ROL). The Equity-to-Loan percentage, or ratio, is multiplied by the known, or expected first year cash-on-cash return to obtain the return on the equity. Cash-on-cash is the Net Operating Income (NOI) after debt service. Remember, also, that if the loan-to-value is 70%, the the equity-to-value is 30%. LTV and ETV must always combine for 100%.The (ROL) is then added to the (ROE) to obtain the Overall Rate of Return (OAR). (LTV) x (LC) = (ROL) (ETV) x (CR) = (ROE) OAR = (ROL) + (ROE) From the Current column of the Cash Flow and Capital Gain Model we can use the Band of Investment to construct a OAR. (.70) x .08391 Field (9) = .05874 (.30) x 04971 Field (19) = .01491 OAR = .07365 Based on the Current OAR the property is slightly over valued at $1,700,000. However, by employing leverage building components within the Decision Model the outcome could easily change.
LEVERAGE MAINTENANCE	Diminishing Returns  From the definition of leverage . . . . . . "Mathematically, leverage is the ratio of the loan balance to the value of the property expressed as a percentage." The value at the time of purchase is assumed to be the cost. That amount sandwiched between the value and the loan balance is the equity. Assuming the property does not loose value for some reason, the investor's equity begins to increase from the first payment to the mortgage due to the effect principal reduction. Each mortgage installment includes the interest due on the note with the remaining portion applied to the mortgage balance. As the mortgage ages the amount of interest due decreases with more of the payment applied to the loan balance to the extent that the last payment retires the loan with only a very small amount of the payment applied to the remaining interest. This is the principal of amortization. Equal monthly payments for a specified period of time which results in the mortgage pay-off with the correct application to principal and interest when the last payment is made. The effects of loan amortization and the increasing value of the property have the potential of creating equity growth at an extraordinary rate. We know the equity is the difference between the market value of the building and the underlying loan. The Return On equity (ROI) for consecutive years may be computed using the formula: Where Y1 is the previous year and Y2 is the current year the (ROI) is found by dividing the total equity (TE) for (Y1) by the projected equity growth (EG) for (Y2) plus the principal reduction (PR) and projected cash flow (CF)for (Y2) ROI=(TE)Y1/(EG)Y2+(PR)Y2+(CF)Y2 The ROE is much easier to compute than ROI and a very useful analytical tool as we will se in a moment. Return On Equity vs. Return On Investment The properly leveraged real estate investment is perhaps more difficult to maintain than it is to create. For the serious investor it involves constant re-evaluation based on the investment objective. This section deals with the cause and effect of those factors the investor may want to consider as the leveraged position diminishes due to increasing equity. The theory and application of the Internal Rate of Return and The Financial Management Rate of Return have been reviewed in detail as the commonly accepted methods of computing return on investment. Both methods compute a return based on the original investment. The use of the IRR and FMRR are excellent tools for for projecting the Return On Investment (ROI) provided that each is based on reasonably predictable income and equity growth data. In total, the validity of both are well regarded. Both, however, given their reinvestment assumptions, offer a rather abstract view of the ROI since they do not reflect the reality of how the average investor treats the income stream. In fact, most investors do not reinvest the cash flow but, instead, spend it. While it may be the investor's intent to reinvest some of the cash flow there is no way of predicting how variations in reinvestment practice will skew the relative calculations. It needs to be noted, as well, that the calculated result for both of these methods will declining over time. That is to say, the calculated result for the IRR, or FMRR will be higher in the earlier years and declining during the intermediate and long term for any investment provided the income stream and equity growth is projected to be uniform and without change . The IRR is particularly sensitive to the timing and magnitude of the income stream and future dollars will contribute proportionally less to the ROI causing the IRR to, in some cases, decline precipitously as the investment ages. This is particularly true if the projected income stream intends to capture the unscheduled difference between current and market income, reduce expenses or make improvements that will result in accelerated income growth during the early years. Any of these factors working separately, or together, could result in higher than average income in the early years then leveling off during the remainder of the holding period. The later cash flows will not only be smaller, each will be discounted over a greater number of years, thus diluting the overall IRR. Where this occurs the optimum rate of return on investment will occur early in the early years of the investment and there is a relatively simple way to identify the timing through a comparison of the relative change in IRR and ROE . Main Street  is the first in a series of spread sheet illustrations intended to demonstrate the profound importance of leverage maintenance.Fields 23 through 27 demonstrate the unique relationship that exists between the IRR and the ROE. Field (23) computes the IRR and ROE at the end of Year 1. Note they are the same. Technically The IRR should be slightly higher since the cash flows are received monthly. they have been annualized here for simplicity. ROE and *IRR have been computed for consecutive years 9-10, 19-20 and 29-30. They are also the same. This relationship remains constant through the term of the investment. Therefore, to determine the rate at which the IRR is declining, or its relative performance, one needs only to compute the projected ROE for any given year. This is a very valuable tool for the investor seeking to use a specified ROE as the decision point for sale or exchange.
PRESERVING EQUITY	Tax Avoidance Principles  Of The Tax Deferred Exchange The nontaxable real estate exchange creates exceptional profit opportunities through the preservation of equity that would otherwise be lost in a conventional sale. In fact, refinement of the exchange rules in recent years has made the entire process almost as easy as a routine sale and purchase. One needs only to observe a few simple rules. Title and escrow companies around the country will generally oversee an exchange to the extent it meets their liability requirements. However, it is recommended the taxpayer obtain the services of a real estate professional, or intermediary that specializes in exchange services to insure the tax deferred benefits are preserved. These professionals are easy to locate, and the cost of the service is generally quite reasonable. For a complete review of IRC 1031 please review A Procedure Manual For The Tax Deferred Exchange. Understanding exchange options is also very important for real estate professionals interested in business development and for businesses seeking maximum property performance. By using the exchange properly you can meet a broad range of business and investment objectives. The Exchange lists some of the ways an exchange can be used.   You can be certain, however, that there is an exchange solution for every need. The Exchange Summary  is not as complex as it first appears. The process is initiated by exchanging the equity from Main Street based on the data from Fields (1) thru (8). The illustration then follows the equity exchange at 5 year intervals for the next 25 years. The equity, shown as Exchange Proceeds Field (26), is exchanged out at the end of each 5 year interval and becomes the Equity Field (12) for the newly acquired property. The Cost Field (8) is determined by the leverage assumptions Field (13).   The GSI of the new property Field (10) is projected by dividing the Cost by the assumed GRM Field (9). A new income stream is created until the property is exchanged at the end of the holding period based on the income growth and the new equity assumptions. At the end of year 30 the property is sold and the Profit Adjusted For Taxes Field (27) is computed.
FIELD EXERCISE	Observe the extraordinary value and future income stream created by the exchange process and compare the results with Main Street for the same period of time. The numbers may seem inordinately large, but remember that you are looking 30 years into the future. This kind of income and profit can only be generated through the equity preservation process of the tax deferred exchange. Build your own Exchange Summary. Construct your projection from data that accurately reflects the current market conditions in your area with reasonable assumptions about the future. Expect to discover that the hypothetical results of this illustration are not unique, but common to your community and many thousands of real estate investors who now enjoy this kind ownership benefit.
FIELD EXERCISE	The Refinance Summary differs from the Exchange Summary in that it assumes the property is refinanced instead of exchanged at 5 year intervals. The Cash Flow Summary for Year 1 thru 5 recaps the income and then extrapolates a Market Value, $1,285,200, Field (19) computed from the GRM, 8.0, Field (18). The Market Value is then inserted into Field (1) for Year 6 as the Loan Value. The new Mortgage, $899,600, Field (7) is computed based on the Leverage assumption, Field (8).  The net loan proceeds is computed by subtracting the mortgage balance Year 1 and the Amortization, or principal reduction, Field (19) of $58,700 from the new Mortgage Year 6. This amount, $394,900, is then inserted as the Loan Proceeds Field (21) Year 1. Now, construct a Refinance Model model for your properties, or those you are considering.
TRIPLE SINGLE FAMILY RETURN	Inflating Single Family Strategy   Appreciation is thought by many people to be an important measurement of the return on investment. And, indeed, it can be. Recalling that appreciation is the process of adding value to an asset based on some conscious contribution. Often without adding income. Inflation, however, is really nothing more than a transitory measurement of an increase in the market driven value of any commodity whether it be precious metals, market equities consumer products, collectables, etc., and establishes the present worth without regard for future value. While income producing properties are bought and sold for the present value of the future income stream, the cost and return can be affected by both inflation and appreciation. The single family residence is an investment enigma in that it is expected to perform like a real estate investment which depends upon the property's rental income to at least meet the operating expenses and, with the exception of factors relating to appreciation, relies upon inflation for any future value. Many first time investors are attracted to the single family residence due to the smaller investment requirement. A suitable property can usually be located near the investor's home which helps to reduce the risk and management burden. This investment should always include the appropriate mortgage and maintenance reserves since it is usually well leveraged and accompanied by varying degrees of negative cash flow in the early years. Real property values have increased in most urban and suburban markets across the United States at a rate somewhat greater than the average annual rate of inflation since 1950. While many residential markets have enjoyed severe inflationary spikes during this time, the same markets have experienced periodic depression as well. In general, it is safe to say that the return on investment made in single family properties, including the rich economic markets of Northern and Southern California, the Southwest, Southeast and Northeast, has been in the range of 10% annually over the long term. This is a very modest return, particularly in view of the cost and management risk associated with this type of investment.  The residential markets will continue to be cyclic and the expectation of future performance compared to inflation should not reasonably be expected to change. As we know an investment grade property relies entirely on the quality and quantity of the income to establish present and future worth. Good property with strong income, even during the worst of times, will enjoy strong economic value. A single family investment, often with weak or insufficient income, depends on continued inflation for a return on investment and, therefore, should be regarded as speculative.
FIELD EXERCISE	Spruce Street is a single family investment model that attempts to construct a balanced view of this kind of investment. The rents and equity are assumed to be increasing at the rate of 5% a year. This is an aggressive assumption believed to be justified based on teh current economy. Study this Model carefully. You will discover the success of this kind of real estate investment is tied inextricably to tenant selection and vacancy management since, unlike an apartment building, there is only one rental unit to support cash flow and debt service.Review the Field comments in detail, particularly Expenses (%), Field (8). Construct a model for your properties, or those you are considering with an eye on the unique risk bearing considerations associated with single family ownership. The Single Family Mortgage & Pyramid Summary provides a model which seeks to illuminate most of the management and cash flow risk associated with single family investment by creating a reinvestment plan which diversifies equity growth and dramatically expands the potential for cash flow and profit. This Model demonstrates the value of spreading vacancy and management risk across a multiple property matrix.
BALANCING INVESTMENT OPTIONS	The Delicate Balance of Investment Options Experience has shown that many real estate investors are poorly informed, or care little about, the benefits of leverage alternatives. Hopefully, the presentation provides the platform and the tools for both the new and experienced investor to plan more effectively for the final outcome based on the first dollar invested. The Exchange and Refinance Summaries demonstrate different plans, each with with different outcome.
FIELD EXERCISE	The Exchange Summary places the emphasis on future income and capital growth. The Refinance Summary demonstrates the power of liberating equity for early reinvestment. Another option would be a plan seeking greater diversification. By reinvesting the proceeds from LOAN PROCEEDS, Field (19) of the Refinance Summary in another building we can project the outcome of each for the remaining years using the Exchange Summary model. At the end of the same thirty year period the investor would have 6 buildings, an annual cash flow of approximately $1,400,000, equity of $32,000,000 and total assets valued at approximately $54,000,000. There are many options which lay between the principals developed by these illustrations. Work out a plan that meets your objective for cash flow and capital growth. Construct a model for your properties, or those you are considering .
FINAL OBSERVATION	Millions of people hand billions of dollars each year to stock brokers and investment advisors with the hope that their trust will be validated by safe passage through the turbulent waters of the financial markets. However, it seems the real estate industry has failed to promote the same level of confidence. This is probably because the industry is highly fragmented and controlled by local authority with no centralized governing and regulatory means of promoting consumer confidence and professional recognition. There are, however, many industry professionals and competent specialists prepared to help balance the risk with the capital requirements of a real estate investment. These professionals are also prepared to suggest alternative investment options when it becomes clear that the investor's needs would be better served in areas other than real property. In fact, most people are poorly suited for the tolerance requirements of real estate investment and would be better served with more predictable management free options. But, if you still plan to build your future on a foundation of real property select a team of competent advisors and don't leave home without them.
CONTRACTS & FORMS	As a real estate investor you will need more than just property knowledge and management skill to be successful. You will need an inventory of contracts and forms, and you will need to be adept in their use. Unfortunately many people in this industry view the paperwork as a necessary evil. So much "psychobabble" to satisfy the suits sitting in the state capitol, or as a means of protection from the attorneys downtown with their hand poised on the meter. Much of this attitude has been precipitated by laws throughout the country deemed to be particularly pro tenant. While this is probably true, even in your area, it has come about primarily as the result landlord abuse. And like any suppressed minority tenants formed unions and associations to protect their rights.   But remember, the same law that protects the tenant also provides the property owner with strict and predictable management guidelines. And, if you choose to view your legally mandated requirements as the first step towards positive tenant relations you will find, believe it or not, that it will add real value to your property.   Forms Management There are a great many forms used in the course of day-to-day course of business and investment activities. There is no shortage of vendors claiming to have all the forms you will need. There is no way, however, they can support this claim since the contractual forms they supply be current and meet the statutory requirements of the state in which they are used. No one can realistically maintain and distribute such an extensive inventory of properly formatted documents. You can, however, obtain all the required documents you need from your local Board of Realtors. These contracts and forms have been prepared and approved by the State Association's attorneys, and made available in the office of the local board for their members and the public. The Purchase Offer And Strategy You have found a property you would like to buy. You have worked out an Income & Expense Summary and constructed a Decision Model. Hopefully, you have also done some forward planning with a simple Refinance and Exchange Summary.  Now you are ready to write the Purchase Offer.  During the many years of our experience one observation remains consistent. Prospective Buyers and Sellers often alienate the offering and acceptance process in an attempt to maintain an edge. Control the high ground. The Offer, instead should be thought of as the beginning of a relationship not unlike the first date, or a job interview. This is not the time to become defensive, Nor, for that matter, is there ever a time to be overcome by self doubt and insecurity. Instead, this is the perfect time to humanize the process and the principals. This could, in fact, be one of the most important business relationships you will ever create. The Seller may have a large portfolio of properties that he might be willing to share with you in the future. He, or she, may be needed to provide transition assistance after the close of escrow. The brokers offer valuable marketing services, investment insight and control virtually all the property information in the investment market. These are not people with whom you want an adversarial relationship. Instead, seek to create an environment based on courtesy, trust and mutual respect.   Contingencies  control the pace and outcome of the transaction. The typical purchase offer will include a broad range of contingencies. Generally, however they refer to three primary considerations. Financing, inspections and close of escrow.      Financing  Most of the preparation for the removal of this contingency can be done prior to the offer. It is important that as the buyer you determine the primary sources of apartment and commercial financing. There will not be that many competitive sources located in any geographical area. While there may be a large number of mortgage brokers specializing in commercial financing you will soon discover that each is corresponding with the same core group of lenders. The only difference among the brokers will be there fee and experience. Each lender will have an array schedule of financing programs with varying terms. Each will have certain underwriting practices. And each will be more, or less, competitive at any particular point in time depending upon budget, commitment and reserve requirements. If this doesn't sound familiar return to Lender & Borrower - A Partnership and review this section . It is important that you contact these lenders while in the process of developing the Income & Expense Summary and Decision Model. They can complete much of the work associated with qualifying you and the property during this process. Be sure you understand the principles of  Income Performance because you will be hearing such terms as maximum loan amount, loan-to-value, debt coverage ratio and loan constant. Then, when preparing the Purchase Offer any prequalification can be included so that the time required to remove this contingency can be shortened. This will add exceptional credibility to the offer both from the standpoint of the Seller and the Lender. It will also provide a distinct advantage should there be competing offers that are not as well prepared. This will be your first opportunity to establish respect for your knowledge and preparation in the minds of all the principals.      Inspections  Needed or required inspections are too numerous to mention. The usual inspection contingencies are contained in the sample Offer. Others arise from local practice and law. It is particularly important that all inspections requiring a vendor's service be ordered immediately after acceptance, or upon recognition of the need. Unfortunately vendors have a reputation for being slow, and notoriously unresponsive and independent when busy. Inspection reports may also need to be supplemented either by the reporting vendor, or with a second party vendor. Be absolutely sure that your Purchase Offer provides for the time required to complete any supplementary or added contingencies based o n the requirement to obtain additional reports. This is also the time to begin building a vendor list for property management. Start with the property owner's list. A dependable vendor that provides quality work and competitive pricing is hard to find and often difficult to maintain. Start your list early and maintain it carefully. You will need more than just a few vendors. Consider this list as essential, and be prepared to add more. Perhaps you are beginning to suspect that good property management begins with sound Purchase Offer strategy.      Close Of Escrow (COE)  You may not get to the close of escrow if you fail to comply with the contingency requirements of the Purchase Offer. Each Offer will specify the manner by which the contingency related provisions will be removed and acknowledged. Be sure that you understand the methods agreed upon. Many a Seller has pulled the rug from under an unsuspecting Buyer in favor of a better backup offer for failing to remove a contingency in the time required, or in the manner agreed upon. Many Purchase Offers provide for either active or passive removal of contingencies. We recommend the active option. This helps to insure that you remain focused on the details, thereby keeping the rubber on the road. In accordance with the Purchase Offer the close of escrow occurs not later than a specified date, or on a date pursuant to a specified event. Good strategy dictates that you attempt to create the COE as a contingency as well. Contingent upon the removal of all other contingencies made a part of the Offer. It is sometimes difficult to get agreement on this provision. Generally, however the escrow is extended automatically if there remains unsatisfied conditions and both parties are in compliance. If you are in an exchange your facilitator will provide closing instruction that will protect you in the event your exchange property is closing later than expected. Finally be certain that your broker, or a third party, is granted the authority to extend the close of escrow in the event you are unavailable on the date agreed upon. The Lease Agreement  The tenant lease is a contract in which the property owner actually conveys, or transfers, certain property rights to the tenant in the form of a leasehold. This is a particularly sensitive document due to the nature of the landlord/tenant relationship refered to earlier, and should always be constructed based on current local law. A generic form should never be used. As a property owner it is imperative that you be thoroughly familiar with the landlord/tenant laws in your state. These laws are generally found in the Civil and Business and Professions codes, and may be easily located on your state's web site. We strongly recommend that all forms and contracts related to tenant management be obtained from your local board of realtors. Most Realtor Associations provide the property management forms that have been written and approved by the Associations attorney's for compliance with current law. Use them. Lease Strategy  The lease is not only an important legal document it forms the basis of your future relationship with the tenant. Other than the initial interview and the date of installation, the lease forms the most lasting impression of your management style and commitment. Consider the following supplements to your lease. If your state prohibits a late fee, provide an incentive for early payment and establish a date. Provide the tenant with addressed and stamped envelopes. Require that routine communication be by FAX or E-mail. Provide an emergency phone number assigned to a pager, or cell phone. Never give the tenant your home phone, or address. Provide a list of emergency vendors for times that you are away. Or, arrange for reciprocal property management with a neighboring property owner. Schedule periodic safety inspections. This serves more than one purpose. It enables you to identify unreported maintenance problems before they become serious, and to discover lifestyle issues that may create a property hazard or pose risk to other tenants. Provide a clearly stated policy converting payment options to cash, money order or certified check in the event of chronic late payment or a written notice to pay. Never customize a payment plan to suit the tenant, or as a solution for the tenant's cash flow problems. State a committed policy for an unlawful detainer action.(eviction) Once initiated it will not be terminated. Better to be wrong than uncertain. Once the tenant has been lost to eviction it rarely pays to chase the debt.   Getting The Good Tenant      Property Preparation Resist the temptation to minimize vacancy by showing the property before it has been vacated, or properly prepared. Never show a property before it is ready for occupancy. Prep each unit as though it is for sale. Your preparation effort will live and die with the condition of window and floor covering. Paint all units the same color. If your property is energy efficient use it as a selling point.      Marketing Comprehensive newspaper ads create the largest pool of prospective tenants and reduces the time required to introduce the property. Do not make appointments to show property. Schedule a day and time the property will be available for preview and include this information in the ad. Do not promote questionable features and benefits. Avoid puff and your honesty will be rewarded in the savings of time and appropriate applicants.      Tenant Application        The Tenant Application can take any form. The basic rule is get as much information as you can. Construct your own and revise as you gain experience. The important elements include Personal information, former residence, employment (current and previous), banking and automobile information. Never approve an application without a credit check, employment verification and a reference from a previous landlord. You cannot discriminate based on race, or national origin. You can discriminate based on financial considerations relating to your opinion of the applicant's ability to pay the rent, or in preference to another applicant. Be very, very careful if there are no other applicants at the time of a denial, and use a form letter approved by your attorney. Most states will allow a non-refundable application fee. It's your call. We suggest you retain the fee with application to the first months rent if approved. Then, when the tenant is approved, and the lease is signed, get all the money the law will allow. Recommended Forms These forms are offered as illustrations only. If you choose to use any of them be sure they are in compliance with your laws. Statement Of Condition Notice To Pay Or Quit Notice Of Termination Please use the Discussion Group to share your property management experience with other subscribers. Good luck to all.