Understanding Highest and Best Use Can Yield a Hidden Profit

highest and best useHighest and best use is an important concept in real estate that should be understood in the process of making a real estate investment.

Simply put, highest and best use for real estate can be defined as “the best economic use of a property with respect to what is legally and physically possible at any given time”.

We undoubtedly have all driven through a commercial area where office buildings and retail stores surround a lowly single-family home. Although the current use of the property might be residential, and at face value the property worth as much as other similar single-family homes throughout the city, obviously this is might not the highest and best use for the property.

A change in zoning or other regulations that would allow the owner to convert the property to commercial use (for instance) can indeed increase the property value dramatically.

Understanding that developed property can have more than one use can yield a hidden profit. So there are some situations that would warrant a real estate investor to consider that the best and most profitable use with respect to a rental income property might not be its current use.

For example,

  1. A house or small units on a commercial or industrial lot
  2. A house or small units on a large lot zoned for a larger multiple unit complex
  3. A property where the parcel map shows the building sitting on two or more separate tax lots
  4. A four-plex that actually consist of two duplexes on separate tax lots
  5. An apartment with large enough unit’s to configure and add a second or third bedroom
  6. A rental property where zoning permits additional extra units

Naturally, the mathematics will vary greatly due to local restrictions, building setbacks, green belt requirements, parking codes and such, to the extent that each property has a different end result. Nonetheless, real estate investors should always consider the highest and best use for a property and understand that its real value (and profitability) might lie just beneath the surface; if not immediately, perhaps in the nearby future.

 

Online Real Estate Calculations Plus Formulas–Save 64%.

iCalculator is a unique web-based calculator that will enable you to make dozens of online real estate calculations easier and faster than those you would commonly make with a held-held financial calculator.

Plus, you can learn the formulas in real time as you calculate!

Here’s the deal.

iCalculator was developed by ProAPOD Real Estate Investment Software because financial hand-held calculators are typically cumbersome. Even non-complex computations require a series of keystrokes along with an open eye on the instruction manual. All of which is time-consuming.

So I decided to mimic those real estate calculations with an online solution I call iCalculator in order to make it quicker and easier. While I was at it, I also decided to make iCalculator a robust learning tool for users; so I included the definitions and formulas for those calculations.

As a result, iCalculator enables users to make online real estate calculations in seconds as well as to learn the essential elements associated with real estate investing.

How it Works

iCalculator contains numerous calculators arranged by category. These categories are readily visible in the toolbar and quickly accessible.

  • Mortgages
  • Time Value
  • Cash Flows
  • Tax Shelter
  • Investment

1. Select Category A category selection opens the appropriate list of calculators assigned to that category. These are displayed in open view in the left menu.

3. Select Calculator A calculator selection then displays the appropriate form along with a clear explanation of the calculator, a definition of the calculation and an example.

4. Complete Form Once the form is completed the user simply clicks the Calculate button to display the solution and formula.

Illustration (click image to enlarge)

online-real-estate-calculations

Benefits

  • Quick and easy!
  • 24/7 mobile online access!
  • Dozens of calculations!
  • Definitions and formulas!

Pricing

  • One-time low payment of $24.95
  • No subscription fees
  • No update fees
  • 5-day money back guarantee

So You Know

iCalculator consists of dozens of online real estate calculations. And you can purchase this unique online real estate calculator risk-free for just $29.95. A 64% discount off the retail price of $79.95 by virtue of this article. Learn more about iCalculator and take advantage of the 64% discount…

 

How Cap Rate Benefits Rental Property Buying Decisions

Cap rate (or capitalization rate) is a rate of return commonly used for the valuation of investment and commercial real estate by real estate investors, brokers, appraisers, and other income property analysts.

In fact, it might even be said that cap rate is one of the most popular rates of return associated with real estate investing, and perhaps the most widely used to initially gauge investment real estate performance and value.

There are essentially two reasons for this.

  1. The return directly links a rental property’s value to its net operating income for the current or coming year.
  2. The return provides an easy way for real estate investors and analysts to compare similar investment property values in a given area.

In the first case, the benefit of the capitalization rate is that it expresses the relationship between the property’s value (i.e., asking or selling price) to its income after annual operating expenses (i.e., the net operating income).

In the second case, the benefit is that it’s an easy calculation widely used by appraisers and analysts and therefore provides a good way to compare the financial performance and value of one rental property to other similar properties.

In this article we’ll discuss capitalization rate by looking at its formulation and application so you see how to use the return to make your own prudent rental property buying decisions.

Formulation

Foremost, let’s consider the two components required for making the calculation. Namely, property value and net operating income (NOI).

  • Property value is simply the property’s sale or asking price.
  • Net operating income is mathematically the property’s annual gross operating income less the sum of all annual operating expenses. It is typically characterized as the amount of money the real estate investor would receive in a given year (before income taxes and depreciation) if the rental property were purchased for all cash.
Formula

Net Operating Income / Property Value = Capitalization Rate

Application

Let’s assume that you want to determine whether the asking price offered on a rental property under consideration (Property A) is inline with similar rental income properties recently sold and currently on the market. Here are the essential steps.

1. Research the market.
  • First, do a comparable market analysis of all similar rental income properties recently sold (within last year or so). Compute the cap rate for each and average. This establishes an approximate going rate for your local market area.
  • Secondly, compute the rate for each similar property currently listed for sale in your local market area.
2. Calculate Property A.
  • Compute the capitalization rate for Property A by dividing it’s net operating income by its asking price.
3. Compare the rates.
  • First, compare the rate you computed for Property A against the average rate you computed for similar property’s recently sold.
  • Secondly, compare the rate for Property A against the rates you computed for each similar property currently listed for sale.
4. Make your buying decision.

Bear in mind that higher cap rates result in a higher value, and lower rates result in a lower value. Therefore, Property A might be considered a prudent real estate investment if it’s cap rate is higher (or at least equal to) all other cap rates.

  • Foremost, make sure that Property A is inline with the market. This is what the banks will do when considering your financing request. A lower rate for Property A than the average market rate could mean that the asking price is too high.
  • Secondly, see how Property A stacks up against the other rental properties currently for sale. A lower rate might be an indication that there could be better opportunities available.

Consideration

To get an apples-to-apples comparison, you must be sure to obtain the correct income and expenses for each property. This is often difficult to ascertain because it relies solely on what an owner is willing to disclose and, or, how accurately a broker presents that information. So until the income and expenses can be verified, keep in mind that the capitalization rate calculations might be flawed.

What’s the solution?

Use capitalization rates only as a rule of thumb for an easy first-glance assessment and comparison of properties. But never rely on cap rate alone to provide a true picture of a property’s profitability. Prudent real estate analysis always requires you to run and examine all the numbers prior to making any real estate investing decision.

So You Know

ProAPOD Real Estate Investment Software automatically computes cap rate for each rental property you evaluate. You simply fill in the forms.

 

Inflation Rate Calculator, Update 5-25-13

real estate calculationsiCalculator, the online real estate calculator provided by ProAPOD Real Estate Investment Software, has updated its inflation rate calculator in accordance with the latest US government CPI data released May, 2013.

That means you can use this inflation rate calculator to determine any annual inflation rate starting as far back as the year 1913 through the current month in 2013.

For example, I wanted to see how much it would take to purchase the same goods and services now in 2013 for what it cost $100 to purchase in 1913. Incredibly, we would have to spend $$2,348.80 in today’s dollars because the annual inflation rate has risen 2248.8% according to the latest US government CPI data.

Illustration (click image to enlarge)

real estate calculator

Update is Free

This inflation rate calculator update is absolutely free to current users of iCalculator (as are all updates to this online real estate calculator).

  • Login to iCalculator from the ProAPOD website
  • Click “Time Value” from iCalculator’s menu of categories
  • Click “Inflation Rate” in the list of calculators displayed
  • Start calculating

So You Know

iCalculator is a unique online real estate calculator that includes an array of calculators that make dozens of calculations. PLUS it displays real estate investing formulas. So you can learn as you calculate. SAVE 50% by virtue of this article. Learn more about iCalculator and save 50%…

 

What is Net Present Value of Future Cash Flows?

net present valueAny real estate analysis software solution typically used by real estate investors or brokers that considers time value of money undoubtedly includes a calculation for net present value (NPV).

So if you’ve been around real estate investing for a while, it’s likely that you’ve already seen this return in some of the reports you created for your property evaluation.

If you regularly rely upon one of the better real estate analysis software solutions, than perhaps you saw it in a Pro Forma Income Statement or other revenue report. Fair enough.

However, it’s also true that net present value is one of those illusive returns that some might not understand; nor have any idea how to interpret.

So in this article I will attempt to explain NPV well enough to give you the idea of what it is, and how your understanding may help you make a prudent real estate investment decision.

Overview

NPV is the dollar amount difference between the present value (PV) of all future cash flows produced by a rental property and the amount of initial cash investment required to purchase the property (i.e., down payment and closing costs).

  • Present Value of all Future Cash Flows
  • – Initial Cash Investment
  • = Net Present Value

Process

Okay, so let’s step through the process so you understand how the method of arriving at the NPV works.

  1. The investor applies the rate of of return that he or she desires (e.g., 10%)
  2. All future cash flows are then “discounted” back at that 10% rate to calculate the sum total of those future cash flows at their “present value”
  3. Then the initial cash investment required from the investor to purchase the property is subtracted from that sum total of discounted cash flows (their present value)
  4. The result is net present value (a dollar amount)

  • Discount Rate: 10%
  • CF#1, CF#2, CF#3, etc. (discounted at 10% to get their present value)
  • Total PV of those future cash flows less Initial Cash Investment
Example

We’ll consider two examples in order to arrive at both, a positive NPV dollar amount and a negative NPV dollar amount. Then we can look at what each of those results mean.

1. Let’s say that the present value of all future cash flows expected to be generated by the income property equals $110,000 and the cash investment required to purchase the property is $100,000.

  • $110,000
  • – 100,000
  • = 10,000 (a positive amount)

2. Okay, now let’s say that the initial investment remains at $100,000 but that the present value of all future cash flows is lower at $90,000.

  • $90,000
  • – 100,000
  • = -10,000 (a negative amount)
How to Interpret the Results
  1. Positive Amount Whenever the NPV is greater than zero, it means that the discounted value of the future cash flows is greater than the initial investment. In other words, you are getting a good deal and getting a rate of return that is actually higher than the discount rate you desire.
  2. Negative Amount NPV less than zero means the opposite. You are getting a lower rate of return than you desire and not getting the deal you’ve had in mind.

Summary

Although it should not be used as the only factor to decide whether a real estate investment provides a good buying opportunity, NPV does provide the real estate investor with a quick and easy way to determine whether the price that will be paid for the property will yield the investor’s desired rate of return (discount rate).

So You Know

ProAPOD Real Estate Investment Software automatically makes a calculation for net present value in both its Investor 8 and Executive 10 real estate investing software solutions.

 

How To Calculate Internal Rate of Return Without Knowing the Formula

internal rate of returnTrying to calculate internal rate of return (or IRR) manually is not very practical for real estate investors, or anyone else for that matter, because the internal rate of return calculation involves tedious mathematical solutions that take a lot time.

Even the most skilled investment real estate specialist probably wouldn’t know the formula for the return, and instead would resort to a financial calculator, Excel spreadsheet, or third-party software program to compute it for them.

So rather than to display the actual formula for IRR (which can be found in other places on the web) let’s instead focus on the concept to show you how to make the calculation without knowing the formula.

Concept

In essence, the internal rate of return is the unique rate that discounts the sum of future cash flows until it equals the initial investment.

  • “Initial investment” is the cash investment made by the investor to purchase the income property.
  • “Future cash flows” is the cash derived each year the income property is held plus the reversion (the proceeds received upon sale of the property).

In other words, IRR is the “discount rate” that will discount all future cash flows (which are future value) to equal the present value of initial cash investment (which is present value).

Application

Let’s say that you’re an investor looking at a rental income property and would like to know what your IRR would be if you held the property for six years. You have to initially invest $435,000 cash to make the purchase, are projecting the property to generate annual cash flows of $43,950, $45,504, $47,108, $23,762, $50,468, and anticipate (based upon your projections) to collect $520,000 upon a sale of the property (reversion) in the sixth year.

  • Initial investment: 435,000
  • CF1: 43,950
  • CF2: 45,504
  • CF3: 47,108
  • CF4: 23,762
  • CF5: 50,468
  • CF6: 52,227
  • Reversion: 520,000
Formulation

First, make your initial cash investment a negative amount to reflect it as a cash outlay. Secondly, combine the sixth years’ cash flow with the reversion (sale proceeds) to show the total amount of anticipated cash flow for year six.

  • CF0: -435,000 (initial cash outlay)
  • CF1: 43,950
  • CF2: 45,504
  • CF3: 47,108
  • CF4: 23,762
  • CF5: 50,468
  • CF6: 572,227 (total cash flow in sixth year)

Finally, apply the rate that will “discount” all future cash flows until that total amount exactly equals the total amount of the present value (the initial cash outlay) and that rate will become the internal rate of return.

Fair enough. But, like I said, it’s not that simple. So allow me to share several resources you can use to make the IRR computation for you.

1. Financial Calculator

The hand-held financial calculators like HP10 and HP12 both make the IRR calculation but they are somewhat tedious because they require a series of key-strokes.

2. Excel Spreadsheet

With Excel you would enter the amounts as illustrated in the schema above and then use Excel’s IRR function. The illustration below shows the result.
irr-excel

3. Rental Property Software

To avoid making the IRR calculation manually, you can also opt to invest in a third-party software solution that creates a rental property cash flow analysis. Just be sure that the software includes computations for time value of money. My own ProAPOD Real Estate Investment Software does include time value calculations and requires you to only populate the forms with the property’s financial data.

4. iCalculator

Excuse one more shameless plug, but I would be remiss not to inform you about the online real estate calculator I developed called iCalculator. It’s by far the quickest and most affordable way to make the IRR computation. Plus, it requires you to populate just one form. The illustration below gives you the idea.

internal rate of return calculation

So You Know

iCalculator makes dozens of real estate calculations with the formulas. You can try it risk-free and save 64% (you pay just $24.95). Click here to learn more and get the discount.