photo credit: vivalars
This is a beginner’s guide to Commercial Real Estate Analysis, so let’s cut the technical fat and get straight to the point.
Recall the following posts:
Time Value of Money – If you were offered ‘$100 in the future’ or ‘$100 today’, you would prefer the money today. Why? Because at that specified moment in the future, the offer would be ‘$100’ or ‘$100 and all the money earned’. Simply, we want money today and all its Potential Earning Power (don’t forget about inflation!).
Why this helps: we know money in the future is worth less than money today.
Present Value -Present Value is the current worth of a future sum given a specified discount rate.
Why this helps: present value can be applied to multiple cash flows!
And just like that we arrive at Net Present Value: the sum of *all* discounted future values (note: cash flows are often projected or assumed).
Commercial Real Estate typically requires an initial investment (or negative input) included at time zero of the calculation (often a down payment, or purchase price). I’m a very visual person, if you find any of this confusing, spend a few moments with the following graph and you’ll find yourself back on track!
As you can see, Cash Flows are projected with an assumed discount rate (10%, 15%, and 20% scenarios above!) which forces each individual cash flow to a present value, and sums in the right hand column to a NPV for the entire investment.
NPV is an indicator of how much value an investment adds. In financial theory, if there is a choice between two mutually exclusive alternatives, the one yielding the higher NPV should be selected and generally speaking the following is true:
- If the NPV of an investment is greater than zero, accept!
- If the NPV of an investment is less than zero, reject!
Simple as that! A positive Net Present Value says that by investing, you’ll have more theoretical money in your wallet TODAY than you would by not investing. Of course, that acceptance assumes no risk and limitless funds, but remember you’re probably tying up your money, and future cash flow isn’t always certain (but that’s what you’re being paid for!). So most of the time, you have to be picky.
We’ve put together a great excel tool to visualize the variables involved in Net Present Value (click!), and of course, it’s free.
As we wrap up our four-part series featuring the unique qualities of Commercial Real Estate Billionaires, we remember the vision it takes to build super communities and super wealth, the courage it takes to remember your vision and believe in your own capability, the action it takes to move your beliefs forward, and finally, we summarize with the basic nature of a Commercial Real Estate Billionaire.
Super wealth isn’t for everyone. It’s possible you’re born into the mentality. It’s possible we’re all capable, but very few of us access the right character qualities to achieve ten-digit dollar status.
If we’re to trust Richard LeFrak, our final Commercial Real Estate Billionaire, a man with a “mini-city” to his name, $4.3B to his wallet, and the 62nd richest American to his wealth status, we must assume it takes more than a late night cash-prayer to achieve unimaginable wealth. (more…)
A personal favorite and a slight diversion from the series, the third installment of How to Spot 4 Commercial Real Estate Billionaires features Sam Zell, the 60th richest person in America, weighing in at $4.4B.
Rather than underwrite Sam myself, I’ll let him tell the story in the following interview transcript on Jan. 27 2011, Sam Zell’s “Advice to Entrepreneurs”:
“I’ll tell you a story that I think is probably the most significant advice that I give young entrepreneurs. It’s the story about a Jewish man who lived in New York who started an appliance store in Brooklyn. [He was] very successful, very observant. He went to the synagogue every week, and life went on.
And then one day he went to the synagogue and after he finished his regular praying, he reached out to God and said ‘God, I’ve never asked you for anything, I’ve always been traditional, I’ve always been observant, but I’ve really got a problem. And the problem is that the neighborhood is changing, the business is tanking, and God, I need to win the lottery.’
The next morning he gets up, checks the newspaper and he didn’t win. So the following Saturday he gets up, goes to the synagogue again and now business is worse. And he’s really getting worried again. He finishes regular prayers, reaches out to God again and says the whole bit: ‘Business is worse, the creditors are calling every hour instead of once a week … I need to win the lottery, please. I’ve never asked you for anything.’ (more…)