Ira Zlotowitz

hi this is Iris lottowitz founder and CEO of Japan C what we're going to accomplish today is to teach you how to underwrite a commercial real estate deal it might seem daunting at first but by the time you walk out of here you'll be able to underwrite a deal like a pro during my 25-year career in commercial real estate I was fortunate enough to train tens of thousands of people to enter and be successful in the commercial real estate space I have merited to have built the third most active commercial real estate mortgage brokerage firm in America as the saying goes a deal is only as good as the financing it gets in order to finance a deal properly you have to be able to underwrite a deal property there's one thing that I have an edge over almost all people in the business world and I'm not saying it to brag it's actually unfortunately humbling most people are lucky enough to have a business where people engage them you walk into a store you buy something you engage a service in my business we get nothing up front everything was on spec I hire someone they want me to Advance their money against commission we take on an assignment we spend money we have to whine and Don the client and if and when the deal closes we get paid and that's when we could split the profits at that time sitting in the seat as the president of the third most active commercial mortgage brokerage firm allowed me to see every deal from all perspectives how it works for the seller for the buyer for the broker for the tenant for the banker and see how it all comes together and what their perspectives are so this way when you know every perspective you could know early on that if there is going to be an issue what's the best way to solve it and what is each person's ulterior motive so I'm trained into one art to see what can go wrong and then be able to problem solve until the closing because if I could notice early on that this deal is not going to happen and I abort Mission today I'm not putting good time or good money after bad time or bad money then it's a very high probability I'll be able to take on another deal that can get to the closing table and be profitable so to me is asking those questions following the way the wind blows what nuances can I pick up that are going to allow me to realize hey this is going to go to the closing table and this won't unless the client is willing to move forward my goal today is to teach you how to look at a deal and be able to early on ascertain if it's worth your time to spend a minute an hour a dollar a nickel hundreds of dollars if you're going to take it to the closing table before we go down the path of actually underwriting a deal I want to tell you the four steps that you must follow so you don't waste your time and you maximize the best ability to be successful in the real estate game number one is find out how much money you have to play with first don't look at a deal first first go to your network see how much money will your network willing to give you to invest in a real estate deal can you put together a half a million dollars a million dollars 10 million dollars a hundred thousand and whatever number that is reverse engineer that number into how much of a building you could afford to buy keeping it simple without closing costs imagine you could only put together a half a million and banks will lend you 75 that means you could buy a two million dollar building you put up a half a million dollars of equity that's the money you're putting into the deal and you're borrowing the rest the million five forget about closing costs keep it simple you can't bid on a building for 2.1 million because you don't have money for that so therefore you want to first start with how much money do you have number two once you figure out how much money you have what kind of return does that money need what's the irr in today's market yesterday's market the future Market it doesn't make a difference what the past was what the future is going to be today the half a million that you just said you could get what irr does your money need and if your irr they need is an 18 irr you can't look at a deal that's thrown off only a 16 percent now that you get this start looking at deals the third piece is using the cap rate in relation to the noi to figure out the value then noi is the net operating income the cap rate is a numeric number I'll get into it later the details of it that tells you what the building is worth for now go to your Guru and ask your Guru what cap rate should you apply to a building so you take the noi apply the cap rate that has to work for that two million dollar number so you might have someone telling you they're selling your building for two million dollars throwing off 18 it works so far right but when you apply the cap rate that this person tells you then the building is selling for two million one then you obviously can't take that building fourth is once these first three things go well then you want to make sure that you confirm the numbers that got you to that noi you want to work through that noi you went to a number that the building has 200 000 of noi equivalent of two hundred thousand dollars of profit of the building but does it really maybe you start doing due diligence you're gonna realize hey there's an expense was left out hey this income is not going to be recurring next year you really only have 194. now reverse it at 194 does the cap rate still give the value less than 2 million does it still throw off the 18 return if yes you could reverse it and a pace to go forward I find so many people go the opposite let me first look for a good deal how do you know what a good deal is a good deal is based on your source of money and the returns of your source of money needs from a very very high level underwriting really boils down to two parts of the process is until you get to the noi that means you take the income you verify the income underwrite the income compare comps go to the expenses on the right expenses compare comps and figure out what the correct noi is the second part is once you have the noi making sure the business terms work what leverage can you get from the bank what loan to value what interest rate could you get what does it work out to get to the irr what are this partnership splits how much Equity do you come up with what's the max loan A bank's going to lend that's the second part what we're going to focus on this course here is the second part because the first part you should go into it like I said before assuming that the noi was accurate assuming that you got it it was correct and move forward now if the business terms work then and only then you say hey I checked the three boxes now go to box four work with someone as an expert that can help you you can't take an underwriting course in a minute in an hour and a day in a week it's a lifetime to master when you're ready to buy that deal at that time it's worth paying someone that's an expert to underwrite that deal and be able to go ahead and move forward so I'm going to teach you a high level of how all these numbers should work so you could appreciate what's going on but when you're really buying that complicated deal you should be able to then have someone that's going to work with you that's an expert underwriter to make sure that the noi is confirmed that's the correct noi now let's go so with every deal that you're probably going to underwrite somebody sent you the deal you could either be a buyer a GP a syndicator and you got a deal from a broker or you're an LP your limited partner and a GP a syndicator send you the deal you have what's called an offering memorandum the lingo is an OM now that you have that what do you do with it how do you make sense of it if you want to call up your Guru and to ask of certain assumptions how does this stop making sense to you so let's start here what I'm going to do now is while I'm talking to the camera if someone here with me that is going to be using the dependency calculator so if typically will start the property so you can do a search bring yourself to 520 South Second in Illinois that's the property you're looking at everything here is fictitious there's no real deal that we're talking about I'm going to use for illustration purposes numbers that you can imagine going through it so the first thing you're going to do is look at the OM what is the purchase price it says let's go in this case it's 10 million dollars so put 10 million dollars as the purchase price the next thing you're able to do is the noi the noi stands for net operating income in every single industry of the world they have different terminology which called profits in the accounting world this Gap that's the lingo when they want to get for the for the profits of business they use Gap it's an accepted practice that accounting practices in real estate noi means net operating income what's the income minus the expenses and assuming that you're using the regular underwriting guidelines how people on the right deals so for us right now really you could just take the number that you see in your document that says hey noi is a hundred thousand dollars 500 600 000 plug it in we are building out we have the ability to take the high level numbers that you see and there's typically three numbers that are very important so for right now you get the expansion by noi and the first thing you do after the expansion is is the revenue that's the potential gross income potential gross income is assuming that the whole entire building was fully rented what is the income of the building so if you have a building that has a 500 000 income let's say right now and there's enough space in the building to rent that another 700 000 worth of space the potential income is a million two but it's not fully rented so you'd have to underwrite and take away a vacancy a vacancy is another word for emptiness there's nothing there either actually nothing there or at a minimum apply a vacancy so let's go in a normal case with the deal you're looking at has potential gross income of 1.2 million dollars the vacancy is zero but no one buys a building assuming zero is going to be maybe a tenant not pay once maybe you're gonna have to have a collection loss you're gonna have to have a gap when your attendant leaves before you rent out to the lieutenant they always put a five percent vacancy so now plug in a five percent vacancy for the expenses you could put in a half a million dollars expenses of what are the operating expenses of the building is a half a million dollars but I want to go up in a little bit of a tangent here if you're really doing due diligence right now we're just trusting the numbers that you are sent in your om from the broker or from the GP assuming these numbers work at this level and you go to the end of the movie then you could come back to this page and really start spending a lot of time and effort to confirm and verify every part of the numbers so for right now you're going to plug this in and also with these numbers that they're coming and are really telling you what they expect in the first year when they've given you these numbers it's expected year one so you're able to plug in over here now What's called the t12. when you see in real estate the letter T it stands for trailing and the number if that is typically months so the trillion like 12 months you could put in right now the historical so you could see in this case for example the T12 was maybe a million dollars and the T12 had blanket expenses but for right now just to keep it there so reference point and now you're projecting so you notice hey now you want a million two is your projection I was taught be like a detective one second you have a million of income last year and you're expecting a million two of this year is that a big jump ask questions and if you have your own independent Guru you ask questions to say does that make sense and then you'll be able to see the beginning of the flag but once you type in these numbers quickly now you have on this building here it tells you that the noi for this building is 640 000 because you have a million two five percent vacancy of the million two 500 000 expenses give you a 6.4 cap that's the easy lingo cap rate is is the short form for capitalization rate which means if you bought this building for all cash he didn't take a mortgage you paid 10 million dollars and all you got back was 640 000 how much is your return what is your Capital return capital in equity in that money you put into the deal and money took out using the example we were saying before about a half if you have a half a million dollars to invest if you put in 10 million no mortgage not a half a million and you took out 640 it's 6.4 percent at this point the only thing you have to know about capric is two things what does the formula work for six point four percent and then have your Lifeline have your Guru Mr Guru I'm buying this building in Illinois what's the cap rate I should buy this building for how low of a return should I be willing to make in effect is another word what's the cap rate what is the lowest cap rate I should buy this building for that's all you got to know forget about getting off on a tangent it's complicated cap rates you just want to Simply take the noi and apply a cap rate and if in this case your Guru says you don't buy a building in that area less than a 6.9 so you know what you do click on the tab which says captured and then just change it from 6.4 to 6.9 and instantly that second it's going to say that if you had to buy this building with a 640 and a y but you can't pay less than a 6.9 cap that means you're not willing to make less than 6.9 you know much about this building for 9 million two before you spend another minute on this deal a nickel a penny anything you pick up the phone to the person who called you up let's go with this case from now on your GP got this deal from a broker you call up the broker and say Mr broker I started through the underwriting I know it could only get worse as I go down the line but I can tell you now there is no way that I could pay more than 9 million too is this still an option if he says no way I have ton of bids higher irrelevant to you because your Guru is telling you it's not worth it if the broker says nine two this is what to work with we could talk to then depending on how you read that wind decide to go to the next step so now at this point right now the next step is closing costs so the full due diligence really would allow you on this hair to open up the closing course and see a whole list of every single possible closing cost that could exist on a transaction the appraisal that's the person is going to come down to an appraisal to figure out to tell you what the value is an appraisal is not a a scientific answer it's an it's an opinion of value that's an appraisal list then you could have is there any environmental reports that have to be done do you have to go to check is there any environmental issues on the building because if there are you don't want to buy a building that has environmental issues so the person buying a building is want to make sure that they're covered if there's environmental issues there's expenses there there's engineering maybe the structure the building has an issue and then you could have the borrowers legal you have legal fees to close the transaction then you can have a Banks legal then you can have other fees on the transaction you could have the mortgage brokers fees you could have the sales broker if you if the bar is paying for it title refers to Title Insurance title insurance is regulated on the price every single state has a regulation of how title works every bank is going to require Title Insurance title insurance is actually the only insurance that goes on the pass not in the future when you have life insurance car insurance fire Insurance theft Insurance it's what if something happens in the future title insurance is saying is that this title you're buying the building today and you're being told that at the closing no one has any claims to it what happens if someone knocks any door the next morning and says hey I really own this building or I'm owed 100 000 in this building title insurance company does searches and then they ensure the results that if someone makes a claim later then they can't make a claim to this property and they're going to cover it if there's a problem you could have all different expenses they're going to go on to a transaction that potentially could go in so sometimes to go into the nuanced details of it I don't want to keep going here because what ends up really happening in most cases most people have this rule of thumb and the rule of thumb is I buy a building let's use three percent so whether you use three percent whether you use two percent with four percent you have your Guru you work with it's called your assumptions what assumptions do you use plug in the Assumption in this case let's plug in three percent when I came into this business there was no strings of value-added deal person bought a piece of real estate and they worked it today everything's very scientific as you'll see and in this world most deals in this Marketplace have what's called a capex capital expenditures how much money are you putting into this deal right after you buy it so we have now 10 million dollar purchase or in this case we're down to nine two nine two million purchase plus we have three percent closing costs on the 9 million two plus I expect to do X number of dollars in renovations so you could easily plug it in right here for the example we're using today I'm not going to plug it in but I want to tell you the power of the calculator is that when you do plug it in it's going to automatically now add it to the three percent and the capex number so it's very easy if you do back at envelope because you could take three percent and the lingo using is capex and also it's going to trigger that later on in this presentation when you're going to have a deal and you want to calculate what the cash flow in the future is going to look like it's going to know to ask you hey you put in capex so what is the stabilized year you have a million to your projected income what year is that going to be right because that's when I'm buying a building you say hey I'm buying a building for this price I plan on putting money in what's the year sometimes it stabilizer is year one sometimes it might be year two or year three so to help you calculate it this way it's not that complicated you can just plug in a number later on and answer that number but I want to go with a straightforward deal with outward capex in it and then go ahead and keep moving forward the next thing we're going to put in is the mortgage so in a case like this you could call up your mortgage broker one of the free tools that your parents has is right here be able to tell you what rates could you expect what property type and what Market the rate she had will tell you the rate let's save just for keep it simple let's assume the rate is six percent just type in six percent let's go now if you want to talk about the loan amount so this primarily three different ways that you want to use a loan amount for the back of the envelope type of assumption loan amount number one is just you know there's an amount the money you're borrowing number two which is the more common one starts with a percent of the purchase price so you're buying this building for nine million too I'm getting the bank is willing to lend you 75 of 9 million too and then we'll calculate for you what the loan amount is sometimes it's about capitalization it's not about just the loan amount it's about the total cost I have a lender because I'm putting a lot of work into it similar to a construction loan right a construction loan is is basically capex on steroids but it's really that's you're doing a ton of work on it in that case many lenders focus on a percent of the total capitalization which means the total cost of this deal and in that case you could do the same thing you do with toggle here so under the 75 you do 70 of the purchase price or 75 of a capitalization one of the things I plan to build future into it is for those that have heavy capitalization and sometimes different types of deals where it's a split calculation where you put in I get 75 of the purchase price and 90 of capex but 95 to 100 of deals that are typically going down obviously say 99 typically it's just one metric either or then we have What's called the long terms when you're doing a loan with a bank there's no such a thing I shouldn't say no such a thing but very rare maybe a Hud loan where you're taking a loan like for 30 years and fixed for 30 years that's a home mortgage but when it comes to commercial real estate Banks and many borrowers don't want to lock in a long-term rate because when it comes to commercial there is no government protecting you when it comes to a homeowner the government wants to protect the person buying a home this person could be a genius mathematician a genius doctor a teacher they know they bought a house they want to take a mortgage and pay the same payment for the next 30 Years but if you think about it look what happened now interest rates spiked up could you imagine all those lenders that made loans at two percent and our rates are up at four percent or six percent or eight percent and goes up and down people could lose a lot of money just from that for the next 30 years they have to honor that rate when it comes to commercial real estate most loans are like adjustable rate mortgages but even worse and it's called it has a balloon payment you take a loan today at let's say a 10-year loan at the end of the 10 years they don't have an option to continue for the next 30 years you have to stop at 10 to 10 years so the way I describe it is is that there's a 30-year mortgage but after the year 10 of the 30 that's when you have to refinance so the loan term means that interest rate that we just discussed that's six percent for how long is the bank committing to stay with you for how many years that's typically what this lingo means sometimes it could be I have a rate I have a loan for 10-year commitment but the rate may change after year five we're going to assume that the interest rate which is the most common time the interest rate matches the long term so in this case let's put out a 10-year term and we'll put out then amortization 30-year amortization so I want to talk about amortization amortization is the simplest way to to think about it is is that it averages the payments that you should be paying over the 30 years so your payments becomes even that by the end of the 30 years assuming it wasn't a 10-year loan a fixed rate it was you had a 30-year fixed rate if you made the same payment consistent payments for those 30 years what would your balance be really what should happen in a holistic simple example is is that if I would lend you a million dollars and I would charge you 10 interest for 10 years you know what should happen at the end of the first year you owe me one hundred thousand dollars which is one tenth of a million to pay back one tenth plus you owe me a hundred thousand dollars in interest to year two you owe me a hundred thousand again plus only ninety thousand because ten percent interest on the nine hundred thousand dollars that you have for mine that's ninety thousand your payments are 190 then 180 then 170 and keeps going down but that's crazy the biggest payment that year one think about it when you buy real estate you talk about deal a ton of upside if there's upside I want the lowest payment the year one and then as time goes up I want to get higher the people who got in trouble in the last Market you know everyone is trash talking to them you didn't think it was coming let me tell you something even a broken clock is right twice a day so the for 20 years people are going rates are going down and staying low for the most part and people are taking floating rates let me buy this building take a lower rate now because the bank's not it's not pricing in that it might go higher and then I'll refinance and put it to sleep for a longer term and I'm done all of a sudden the rate spiked up comes the Monday Morning Quarterback and says hey I can't believe you did that is there a level where some people just doing crazy things of course but for the most part that was the accepted business that people doing in a normal case were taking floaters they bought caps they bought different things to protect themselves but it went so crazy so fast no one thinks about these things when he's trying to do different stress tests I'm gonna hit a debate that Pro a con but that's just the background the mindset so going back to amortization amortization is taking that and saying his I can't afford to go from 190 down what would happen take all my payments and average it out what's my single constant payment that by the end of the 30 years will be totally finished what we offer here on the calculator to the right side a little bit is the amortization schedule so you can add actually see what the amortization schedule looks like on this transaction if you click it you will see how much is your payment it's consistent and then how much of that is going towards the bank's interest and how much that is going towards the bank's principal and then at the end of that that month what is your balance go to payment number two payment number three if you notice it's the same payment but the amount that's being allocated changes so I want to tell you one pro tip that I've learned when it comes to amortization and the mistake that people make I meet people who say most of the interest is paid up front so I don't want to refinance my home on the last few years of my mortgage even though it's a higher rate than today because most at interest already paid the interest in the beginning now I'm not paying interest you make a mistake it's not that most of the interest is paid in the beginning in the beginning most of your payment is going towards interest but as it comes towards the end if you scroll down to the last year it's just the opposite the latest payment is just the opposite almost all the payment is paying down principle but that actual year in the last year if your balance of your mortgage is eighty two thousand dollars if you last year and you're paying a 14 interest and without any cost you can refinance for six you're saving eight percent on that difference so that's like a little bit off to the side but I wanted to share the sentiment with you now let's go back to the the the general underwriting today most deals come with what's called interest only IO is the lingo for it I'm buying a deal going the same theme tell the lender listen I know you have amortization you want me every month to pay back principal and interest I'm going to pay back my principal money towards the loan balance and interest is your profits but I have such a good deal here it's gonna be amazing I'm putting money in I'm working this deal I don't I want to have a lower payment is it possible that you could give me one year two years three years four years five years today's probably more common along the range of Max about two years today but let's go with right now you want to do two years of i o which means that the first two years of this deal is gonna be an interest-only payment the next thing onto this I'm just going to show it to you but it's not relevant for most of the deals let's not focus on it is what happens if you have a deal that also has other financings with it so for example you have secondary financing at the same time you might want to take a mezzanine or you want to take a preferred equity on these scenarios just put in the amount that you're getting in there it will use the same amortization same schedule on top and give you the total loan and the Blended rate what is a mezzanine loan a mezzanine loan is Banks don't really allow a second mortgage so a mezzanine loan is like if you ever go into a theater so you have the box seats at the bottom and then you have the upstairs but then there's this Gap in the middle it's called mezzanine it's not the second and it's not the bottom most loans are made to the property you're lending money to the property the first position on the property a mezzanine loan is made to the LLC when you buy a piece of real estate you don't buy it as your name I'm not buying as iris lottowitz is buying this building I'm buying it as one two three main street LLC in that case I go out the bank wants to lend me in this case 75 but I want 80 so I come back to the bank and I tell the bank listen could you go above it they say no so I find someone who's willing to lend me five percent to my LLC the first bank bank is fine they're letting 75 of the purchase price the borrower me I'm coming to the table 25 my own Equity 20 of it and five percent someone lent me to my entity so that's called the mezzanine loan the other type of loans was called preferred Equity I go to some and say do you want to invest with me I think I'm getting myself a great deal a lot of upside we call Value ads and I don't want to take a partner for life have a partner so I find someone who says I'll tell you what Ira you have to put up two million dollars in your deal you're buying this deal I'll tell you what I'll lend you I'll become your partner I'll give you a million dollars as Equity I'm called preferred Equity you know why because I get my money back first meaning that you bought this building for 10 million let's say you have loans for eight you're short two million I'll tell you what I'll give you a million I won't take half the deal I'll take less than much less than half the deal but I get my money back first so I look at a whale I can now in my top million and we'll see later on how all these splits work out I only have to put a million dollars out of my pocket and I keep all the excess profit it allows me to leverage leverage up like I think if on a car jack you jacking up a car every time you get leverage every time you get someone willing to take less money than the buildings throwing off if a building is is thrown off six percent and then I'm paying a mortgage to the bank of three percent the money I put in gets my regular six percent what the building's throwing off plus the profit the difference between what the bank is taking and what the building is throwing off Blended interest rate is assuming you have a first mortgage a mezzanine preferred Equity or any other mortgages to sum it up into one number what is that number and then what does that works is an overall percent of a deal before the craziness of this last cycle banks used to have certain rules the most leverage in total they don't care what you want to call it they wanted to make sure that the GP the general partner the syndicator had a certain amount of skin in the game that they're buying a building X percent of the money needed came from their pocket and then you could go out to different sources at that time so this is more on the sophisticated side of things but this calculator allows you to plug those numbers in now if you notice that as you plug all these numbers in on the right side of the screen and again you could actually use this from a phone and then just what's on the right side is at the bottom but the right side of the screen now while you were typing any number instantly it was running the calculations let's go with the first numbers total capitalization how much in total are you putting into a deal in the case where you have capex you have three metrics going in the purchase price capex and your closing costs and then it says based on how much you're borrowing how much Equity do you need that's how much money I got to come to the table with That's My Equity need over here the 2 million and change then I have principal interest what are the payments based on principle interest so it shows me the payments monthly versus yearly and then it shows me that service coverage a 1.28 that service coverage dscr stands for is that service coverage ratio debt is another word for Mortgage Service after service the debt coverage ratio what is the ratio this building has an noi and has a mortgage payment how much after the mortgage payment am I left with as a ratio to the mortgage payment in this case it's 1.28 again you don't have to know how we calculated it but what it really is telling us that for every dollar you're giving the bank I have 28 cents that's left above that if you look now on the i o period where it's interest only where I'm not paying any principal down you look my debt service is 1.53 because the payments are much less so this same deal in the first two years I have a lot of extra money why because I want to do it to put my money back into the building you have to think about it this way if I didn't get this i o period right because from 417 thousand five hundred thousand dollars is the difference in payments if I needed three hundred thousand dollars worth of capex into this deal and a bank wouldn't give me i o think about this I have to come with three hundred thousand dollars but if the bank is willing to give me I O I only have to come up with two hundred twenty thousand dollars approximately because during the first year of an extra eighty thousand thousand cash flow to put back into the deal so I have to put up less money affects my return and my splits and everything else so that's why to see these numbers side by side but here's the biggest mistake that most people make and that's why we have it here the max loan from that service coverage so when you're going to go back to right above the loan amount you're gonna be able to put in what is the minimum that service coverage ratio that a bank requires so I just showed you this example over here of 1.28 if a bank comes back and you put the number and says the minimum debt service we need is not 28 you have to have 1.3 30 buffer it will tell you on the right side here next to it say uh during the this period you can't borrow this amount of money you have to borrow a little bit less a lot of mistakes that people are doing they're taking out loans and the underwriting is that oh they run the numbers very quickly and they say oh it's 75 I spoke to him at the rate is this I could borrow blank dollars they find out later based on underwriting they missed this point they find out too late so here this sticks out in front of you find out what the bank's minimum debt service coverage is so you'll know while you're doing your underwriting if it works similar to when you went to the top of this this is a very important feature when we started if I showed you a 6.4 cap and then you will but my Guru says 6.9 right away before you went further you realize don't pay more than 9 million too same scenario is you're not going to borrow more money than this now we'll keep going down to a few more totals that it gives you on the right side of the screen as we go down to the bottom corner maturity balance means is like we said before there's a 10-year term there's a third year amortization what happens what is the balance of the loan going to be at the end of the 10 years so the maturity balance when this loan matures you have to pay it down what is the balance going to be the reason why this is important is because later on we want to calculate different types of you know profits when you sell the building you want to know at the time you sell the building what the balance is if you sell the building later on for 12 million how much will your balance be so you have 12 million the sale price minus closing costs minus the payoff maturity balance so you have now the payments and now you want to see what are the totals that you have first year cash flow do you have your noi and you have your payments what is your cash flow afterward the second thing is what does it work out to the first year cash on cash if you're putting in that capitalization that Equity required on top and you're profiting 222 000 that's an 8.5 cash on cash return cash on cash is the simplest number to use on the first year it's very simple how much should I put in cash how much did I take out when all is said and done you wrote a check for this amount and you pulled out this amount works out the 8.57 bank debt yield is another number that's important when you're talking to Banks it's the same equivalent as a cap rate but instead of going from the noi to the purchase price what's the relationship between the noi and the loan amount that the bank is giving and the banks could have different metrics to go forward from here this is the first round when most deals are left to die by the time you get past this page is when you realize most of the deals shouldn't continue these are the tweaks these are the questions to ask but if you take it past this now you want to say okay the numbers look right the price looks right assuming the nois is accurate now let's go to the investment returns now we're coming into an area where almost all real estate professionals have no idea themselves how to make these calculations they rely on complicated models they rely on a senior analyst to get these numbers for them what I'm providing here is not going to replace any of those people just like I always say with chat GPT it's not replacing me and you but if each of us uses chat gbt we can do a lot more quicker look how quickly we're able to get through these numbers so the idea over here is not to get it down to perfect ideas to get it close enough that you could calculate that other step that irr can you calculate what is the internal rate of return going to be irr which stands for internal rate of return means what did my money earn me assuming that based on when I got the money back it's not just taking the average like if I made eight percent year one and 10 year two and twelve percent year three I average ten percent that's average cash on cash that doesn't really mean much irr takes into account not just what I got back but when I sell the building later and I get that one lump sum payment of the net proceeds of the sale plus present valuing when I got the money back so a deal that pays me eight percent year one ten percent year two or twelve percent year three average day out to ten percent a deal to pay zero zero thirty also averages out to ten percent but when it comes to irr and turn of rate of return depending on when and how fast you got that money back that is going to be the difference in how it calculates the irr of the deal present value you don't have to know all these sophisticated things you just have to know based on we're going to show you here what converts that irr so go with confidence that's in the 90 percentile at least close enough once you get this like I said you're taking a deal serious that one deal you take serious it's worth it to get that expert so I meet a lot of people when it comes to confirming numbers and underwriting they said I can't afford a top tier whatever top tier means to you because I do it once a week but if you're only doing once a month could you afford a top tier yeah I use the example of uber when Uber first came out people used to say how could be an Uber driver it makes so much less money I used to get a hundred dollars to go to the airport now I only get 75 but when you took a dry run to the airport got paid one way a hundred dollars and you came back how much did you make 100 now you get 75 there 75 back same thing over here you could afford to upgrade to a much higher caliber person because you only have to use them once a month so even if you even if you pay double the pay to get someone that double the pay was bottom line half the price of what you're paying on a monthly basis and along the way you have much more insights into the deals you're working on so this is what the wow factor really comes in on the calculations here so now let's go here for the holding period holding period means how long do you anticipate holding on to the property you're buying the property most people that buy a deal buy with intention to keep it for a year two years three years seven years to ten most times is seven to ten years an interesting point the reason why it's seven to ten years and there's a number is because how long before you're gonna have to spruce up this building remember you did capex and you're putting money in to Spruce it up in the hopes you're going to raise the rents seven years later or ten years later it needs that again but at that point you don't want to like stop taking money out of the deal and reinvesting every dollar back so most people say no something I brought it to here these are my returns seven years let me sell it the next person will add capex when they buy it I'll take this money and start again somewhere else you could debate this from today to tomorrow wanting to take it from the beginning of the movie to the end but yet I found interesting there are people who have niches and steps in the process that's they want to deal with you have people who buy rural land and they say I'm going to spend the time and energy to get it rezoned but the minute they get it rezoned they sell it I'm gonna get someone's gonna parcel a bunch of land together I'm gonna go ahead and just do the construction I'll just do the the lease up I'm gonna do and the other people take it from zero to the end yes but for the most part people become experts in their space step by step by step of what they want so let's go back here and underwriting the deal let's assume again you're holding it for seven years so you take a seven year hold again we're doing a deal without capex if it was capex you'd be able to go and use the transaction and say what year should be stabilized now the next question are assumptions we just pre put in that what do you think the rent is going to grow by every single year going forward for right now we're assuming three percent for the expenses we're assuming two percent we're assuming the vacancy factor is going to stay at five percent the reason why we plug out the vacancy in the calculator is because of many real estate deals many people don't put vacancy on this in the OM so just put vanoi incoming expenses and you know hey you're missing vacancy if I didn't break it out you'd have to go into the numbers calculate under the hood to get this number but since we see in most cases there's always going to be income growth expense growth let the vacants be a standalone number what percent you want with this number it calculates now for you what the the noi growth rate is going to be compounded year over year so if you're going if you're growing at three percent income two percent expensive the five percent vacancy it's 3.7 percent works out to be the growth rate now then it tells you what the projected noi is at closing so we have an noi on when the year we started that was the first tab we did but now it's telling us hey if you're holding the building for seven years you're noi at the end of the seven years is gonna be 800 000 and change so this gives you a snapshot what's going on but before we go forward what was very cool and take a lot of pride in this thing was built out is that you can now go into the projected growth rate where the income is going to grow and click on the expansion and say but in year number three I'm not growing by three percent every year you're right I'm going by three percent so how this sheet looks is that you have the T12 first that was the base year before you started you put in what you expect the first Year's Revenue to be and then it keeps growing by three percent every year two percent you only going to change one year you're number three from three percent let's change it out to ten percent and all you did is that little change you hit done hit done again because now it brought you back if you want the screen and done again to close out this whole screen and now you're sitting here and we're calculated for you you just brought up that the noi growth rate went up slightly higher because at one year difference of who you're moving towards now let's go a little bit further down I'm going to talk about the same questions we asked before regarding what is the projected cap rate at sale you put a cap rate when you bought this building at 6.4 what camper do you want to put at sale do you think you're gonna later on you get a lower cap rate the same cap rate higher that's for conversation purposes let's just put 6.4 the same exact cap rate that you have in the beginning closing costs at sale at this point you don't have capex at this point it's the opposite way just I don't know I assume three percent let's put the same three percent and right now what happens over here at this point is it shows you all the calculation results of what's Happening Here when you close this deal what what's happening the capital sale what's happening to the money at the sale so first it's going to tell you the net sale proceeds if you're selling this building with the noi that it's showing at a 6.4 cap minus the way the closing costs there is how much you're going to get after closing cost then you have the unpaid mortgage so then we have net distribution from the sale by just subtracting those numbers then you have the Total distribution prior to the sale during these last seven years based on all these calculations how much was distributed and now you have the grand total distributions so going back before if you want to just take cash on cash in theory that's an easier number just averaging it out which we have here 52 average cash on cash if you look at the bottom result that it has there but the normal order what's what people care about today the intro is is irr what is the irr for this deal this deal has a 23.81 irr and then it could have then you could put in there what is the equity multiplier an equity multiplier is telling you that if I put money into this deal out of pocket a hundred thousand dollars let's say and I got back three hundred thousand dollars My Equity multiplier I in effect I multiplied My Equity from a hundred thousand to three hundred thousand is a three x this metric is used by many big investment funds but the more accurate one is irr the reason is because irr takes in the time it takes to get there if I tripled my money in a year wow that's amazing if I trip my money off of 80 years that's a terrible return irr Blends those numbers together but different people want to see different numbers easy to them and that's why we have that calculation that's built in it shows you the ROI is a return on investment Roi is basically taking the total amount of money that you invested divided by the total return that you made and that's that's the number not based on a yearly it's it's in the aggregate one big number pulling it all together yield on cost is assuming you take all your costs in the deal purchase price closing costs everything and you take your return out for the time that was there what is the return work out to and the average cash on cash is taking those proceeds I said before the net proceeds the total proceeds that you got during the life of this investment dividing it by the years is basically telling you what it works out to an average cash in cash these aren't really metrics that are common today we still have it from different times that people look at it the most important one today is going to be cash and cash for year one and irr as you're going forward so here's a very important other piece of the puzzle many times people are buying a deal and during these seven years especially if this capex is a value add this upside they might not be going straight from today until the end of the seven years they may be during these seven years either refinancing the building cashing out some money so how does that affect the irr or they could do what's called a supplemental where it's like a second mortgage but from the same bank so Fannie Mae Freddie Mac the agencies typically allow for supplemental if you come back to them for the high level a supplemental has terms day one that when you take out this loan the bank will give you the more conservative of appraised value the more conservative the debt service coverage we discussed before so let's go for example as it goes here so the first number is what you at the end of what year do you want to do the supplemental here's another example I'm saying before if you might be doing it halfway through the year and in that case you know I'm not giving those calculations that's what you need the perfected calculations later on but it gives you pretty close to what you need so let's assuming you're doing it at the end of the third year then what cap rate do you want to use for that time you want to use a 6.2 cap you think the deal is getting a little bit better then you want to say what is the maximum loan to value the bank is giving you then what is the minimum debt service coverage the bank is going to let you have similar to what I spoke about before 1.25 let's say now is what they want for the amendment that service coverage period and then what's the interest rate for that reigning period let's assume it's a higher rate let's assume seven percent you could say rates are going to go down but typically it's higher than the initial rates and then the amortization is 30 years so now you see the maximum loan is 7.7 your balance at that time is like six million and change and you're getting out several hundred thousand dollars in the supplemental the closing costs to the same assumption that there's not gonna be the same three percent because you're not selling the building let's call it two percent again just the number we're making up over here and then it shows you the property value of the capital event now if you go back and you close this out go back to the tool okay scroll back up you'll see the irr in this deal went from 23 before the supplemental up to 25 so sometimes you could say is it worth all these costs to do it you don't have to guess anymore plug the numbers in and look at it hey this is a 25 irr versus 23 irr let's go back to the beginning of this whole course if you went to someone says I'm only investing in a deal with a 25 irr they'll invest in this deal now two minutes ago before the supplemental they wouldn't have you'd have to go back to the owner the seller on the first Tab and say hey I can't pay you 9 million too I could pay you 9 million one or go back to the bank and say I gotta get a lower rate I got to get more IO I got to get something different to keep playing with these numbers you get a question sometimes from your mortgage broker you get a question sometimes to the bank and they the bank asks you it tells you you know I promise you 75 at six percent interest rate mistake I can't give that to you or may I could give you I have another alternative for you would you rather take 80 at six percent at six and a half percent I don't know is that a good deal on that deal so I need more money less money but you plug in the number you go back to the first page and plug the number we'll go back to page one and on on and you start doing for the deal economics and you just change it from 75 to 80 percent and then we change the rate from six to six point five and we go back now to investment returns and let's see how that changes wow of course I want to take that deal it does not so good for the supplemental but I get to the 25 right now irr just by that difference of course I'm gonna go take that deal now you see you're seeing the whole dynamic of a real estate deal at your fingertips and what did you start with easy numbers now let's go Equity waterfall in the area that almost no spreadsheet has this is the most complicated you really need someone with a really real strong knowledge in analytics and underwriting to really be able to calculate this and especially if you want to have little complexities this is really going to tell you the equity waterfall the terminology of equity waterfall is when the equity comes out think about a waterfall a waterfall goes like this as the water keeps going down what happens to equities the money starts coming out of the deal who gets it how is this split between the partners there's a GP that's a general partner hence gparency servicing the whole real estate industry but providing transparency for the GP and everyone involved in the transaction around the GP and there's the lp The Limited partner The Limited partner is the investor who invests with the GP so at the highest level they could be several GPS several people together buying the deal but main people buying it and then they could be 40 20 10 5 LPS when investing with them but a lot of times they become complicated negotiations the starting point is okay I'm going to invest in the deal and the GP says yeah this is such a home run after I give you back your money I want uh 30 of the deal no way no one gets 30 of the deal if I off my money I'll give you 20 but it's a home run so they go back negotiate say you know what let's make the final deal and listen how complicated this deal could go they agree that the GP is going to put in 10 of the money the lp is going to put in 90 of the money and they're like oh let's talk about the hurdle the first negotiation when it comes to a real estate deal like how does everyone make money understanding all the sides like I said before there's two parts in a business there's the equity that stays forever we agree what percent of the deal do I own it's forever then is an employment contract people work there the salary could go up the seller could go down they could earn a commission they could earn profit sharing but the equity doesn't change so the concept is two people going to business they agree to a split I own this percent you own that percent that's fixed then for working I have to get paid so the GP would get paid they could take a management fee that belongs to them they get the management fee because they're working it the people who put up money say hey I want my money to also get paid I want my money to get a salary that's called a preferred return because I can buy money in the bank when we take it out of the bank give me some interest rate and then I'm taking the risk with you we split the profits at a certain split that they go so there's a terminology called a hurdle one has to be hit first and then this happens and then what hits second third fourth sometimes it's easy deals sometimes it's complicated I'm going to show you a deal that has a total of three hurdles the first hurdle would be from zero percent return until eight percent there's no promote promote means that the GP doesn't get anything special so we'll start the first hurdle zero percent type in eight and now you keep the promote to zero automatically it's going to create the second hurdle it's going to open up starting at eight right from what happens on eight until eternity but no you worked at a deal that doesn't go till eternity to infinite it goes from 8 to 12. let's change infinite to twelve now the promote the promotion that's going to go to the to the GP to The Syndicate there's gonna be twenty percent of that point and then from 12 till infinite you're willing to give 35 percent what this does right now if you look at the right side of the screen the totals it now tallies up for you to say okay in total that's how much money was put into the deal we see how much the GP and LP put in what is the distribution to the GP the GP distribution is how much money do they take out the lp distribution is how much of the distribution went to the lp what is the GPS irr what is the total distribution they got what is the the equity multiplier and the same thing for the lp so when we had a 25 of the first page because of this Arrangement the GP is going to work with 45 and you're walking away with 21 percent does that net work out for you so there's three numbers really at play here he has the deal irr and then there's based on the split of how you're splitting all those profits who gets what of it and if you want to negotiate at least you know where to negotiate sometimes I tell people you it just doesn't sound like 35 you can only have 30. go back into the deal and change the number from 35 to 30. see how big a difference it is or the lower number and just play with the number and see is it really changing the world if it's changing the world to you then negotiate it but sometimes you might ask for something else it's not important to the other party that's why I spend a lot of time asking people to invest with or I want to invest with me I won't understand the background what are they thinking out what do they want what they want to come to what they want to get to and then this week understand how to negotiate this let's go now to the last tab oh the last tab is a simple one it's just a write-up so simply put the first part just writes up the deal and as you know I'm big into Tech I like the chat gbt so it's more acute for now but I'm sure over time will get developed a lot better is that the rights at the summer the neighborhood straight some chat CPT the beauty now is unlike these complicated spreadsheets is that now you can actually just click the share button on the top creates a link and then you can send it out to people so when you're finished doing this you could call up your Guru and say could you please do me a favor I just underwrote this deal can you look it over if I missed something or you could call them on the phone it's so easy say in in a matter of two minutes you probably repeat all the numbers you put into the spreadsheet one of the things I built out on the toolkit on this Marketplace is that when you're here you could see all the different possible things out calling someone what are the rates so you have an idea without having to call someone you want to just do your own little due diligence but more importantly also we have properties that are for sale we have properties of vendors on it I always felt that the due diligence isn't is about people not about just oh buying a report somewhere because you never know what questions were asked some companies that do due diligence you know they do their diligence they have people work in a different country making calls like hey I'm calling from blind company what happened to this or what happened to that and they can make human error instead would you rather call the players in the marketplace so my advice to you is in due diligence is before you even go to your underwriter you want to go ahead and call look in that area are there anybody linked and active in that area and Copa Brokers say hey I see another area to get another opinion the main assumption number is what cap rates are building's trading in over here what can I expect rents per unit so you can know hey if this building has 30 units and this is the rent I could expect potential gross income to go this way are things on its way up are they flat are they down if things on the way up you might go and not use a three percent growth rate maybe use a four or five percent growth rate in the height of inflation I saw people underwrite a deal assuming they're going to get six percent for the next 10 years inflation's here forever right it's not at the same six percent markets keep changing but when you start talking to people you know what you could plug in the numbers once you think you have the right deal the time you want to really go ahead is to go to the underwriting is the pre-noi underwriting and that's where I want to leave you at this point so to recap the education when you hear about deals that went sour most of the deals did not go sour because the noi was off because at a high level you notice certain things most deals that went off went off in the assumptions from this point from the noi what cap rate to apply what's the projections going forward did you were you able actually to borrow the money you thought you could borrow did your Equity come in at the right price what was the deal between the partners we ought to play it out did you really calculate what would be that when you did an assumption you can do a refi to use what cap rate when you told me I have a 25 irr for example what cap rate did you use when you're selling the building that's a question to ask I see people say rates are coming back down so in seven years I could use a five cap again a lot of people see you crazy nothing less than seven whatever the number is but that's what these deals go sour and that's really what I think is most of the due diligence should be focused in this area I want to thank you very much I hope this is beneficial to you and if there's anything I could ever help you as I make an offer always to people I'm gonna give it my cell number here it's 917-597-2197 my email address is irazy iraz@gparency feel free to reach out to me if I can be of help with anything thank you very much