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pevam-retail-investment-blog · 7 years ago

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The Internal Rate of Return (IRR) is possibly the most widely used and most often abused measure used to calculate the potential profitability of an

investment. This is not a maths theory lesson, as a crowdfunding partner we want to share with you what the big buttons on our dashboard do without the confusing jargon.

PEVAM’s investment analysis always includes a forecast return using the IRR metric, it is, therefore, worthwhile exploring the basis of our approach and clearly setting out why this approach best presents returns and how we avoid the potential pitfalls together.

WHAT IS AN IRR?

In plain terms, an IRR calculation represents an investments ‘Total Returns’. Which in our case is the rate at which our real estate investments grows or falls in value, taking into account all factors that add to the investments

profitability (rent income + rental growth + capital gains) and deducting all costs (fees + capital expenditure + capital value losses).

So far so simple, the net position of all your pluses and minuses gives our profit. However, the same level of profit earned over a 3 year investment period is much more attractive compared to the equal profit earned over 10 years investment period. In this sense, you can think of an IRR as a time sensitive compounded annual rate of return.

The IRR is useful because it can provide an “apples-to-apples” comparison of two cash flows with different distribution timing. This is a truer measure than a “Return on Investment” or ROI calculation that is a simple how much did I put in and what did I get back sum.

YOU DON’T HAVE TO BE AN ENGINEER TO DRIVE A CAR

A racing car driver does not have to build Formula One racing car and the spectators will never race in a Grand Prix, however, they all have a common appreciation of the principals involved. In the same way we aim to set out the key principals used for calculating IRR investment returns, putting the spectator in the driver’s cockpit without complicated technical jargon and frightening mathematical formula. So to getting to grips with what all the buttons and pedals do we have summarised 4 key elements below;

1. TIME

We have to remember that our IRR calculation is forward looking, which unless you have special powers requires us to make assumptions about events in the future.

•The further into the future we look with our IRR assumptions the less accurate our assumptions are likely to be.

•Because we are calculating the time value of our invested capital the length of our implied investment time period will impact on IRR.

The shorter the time period for earning returns the higher the IRR, all other things being equal. While almost any time period can be used, it is important to check that realistic time periods have been used as returns can be manipulated to look better by shortening the investment period form say 5 to 3 years. Typically professional investors will calculate using a 5 year cash flow to compare apples with apples in the knowledge that if they exit in the 4th year they are ahead of forecast IRRs for the investment.

2. DEBT

Our IRR calculates the return on equity invested, which means the cash we have to pay to cover the purchase price of say £1million + purchase costs – Bank (senior) Debt. Therefore the amount of capital that we have to invest is directly related to the amount of bank debt or “level of gearing” we use for the purchase.

•The higher the level of bank debt as a percentage of the purchase price, “ higher the gearing” the greater the risk of potential bank default.

•By increasing bank debt and reducing the amount of capital invested, investment returns can be made to look more attractive as the same level of return is earned for less capital invested.

Debt is not bad but it does need to be treated with care. The use of debt forms part of prudent investment business plan as it increases returns to investors, shares some of the risks with the bank and allows capital to be diversified over more investment opportunities. When comparing investment opportunities investors need to be wary of IRR returns being inflated by excessive debt levels without taking into account the associated risk.

While banks themselves have become much more risk adverse, investors should expect gearing of 50 -60% of the purchase price (excluding purchase cost) for a reasonably sound property investment.

3. CASH FLOW

Our investment into property provides us with an asset, which gives us a right to collect income. Our forward-looking IRR calculation has to make assumptions based on our potential to exercise the right to collect income from our property. Put plainly, if our property enjoyed a 10-year lease to the Government with fixed yearly rental increased, our rent

forecast assumptions would be extremely accurate and predictable. On the other hand, vacancy, rent reviews, tenant break options or lease expiries all require the manager to make assumptions on our ability to collect income beyond the fixed lease term. Forecast assumptions should be based on sound market knowledge and professional experience.

•The reliability of the IRR is greatly decreased with the number of forward- looking assumptions that need to be made.

•The most common pitfall is underestimating void costs, all the expenses and fees incurred replacing a tenant will lower returns.

Over and above bank interest costs and agents fees, a vacant commercial property will be subject to rates and in order to secure a top quality tenant landlords may also be required to pay a strong tenant an incentive in the form of “rent free”. These all have a negative impact on the investments returns.

Based on the assumption that our right to collect income from our asset is exercisable, ie; someone will want to pay us to occupy our property, the manager has to make a reasonable assessment based on the information available to him today. Investors should watch for forward-looking assumptions on rental growth or tenant lease renewals that are not backed up by robust justification with market data and a contingency plan.

Getting all of these elements right requires hard work and experience on the part of the manager because being overly negative is not good either as it will kill the investment before you even start.

4. EXIT VALUES

Our investment generates a return from rent, however, it is not until we sell or “exit” that we have our original investment or “principal capital” returned with a capital appreciation derived from the increase in our assets value. Exit values are a major component of IRR calculations, we buy on the assumption that we are going to sell for more someday – right?

•The profit of our investment is hypothetical until we are able to turn our forecast on timing and forecast value of our exit into reality.

•Just because we can’t be proven wrong does not mean any exit value can be adopted.

Prudence and research can improve our accuracy and ensure that our IRR is a valuable tool helping us evaluate investment opportunities.

Simply forecasting value growth through capital gains or “yield compression” is a very lazy approach to supporting an investment proposal and can massively inflate our IRR calculation.

Don’t be afraid to ask how management have forecast exit values, they will need to demonstrate solid impartial research and reassure investors that a prudent approach has been taken on this key assumption. In more mature markets, like the United Kingdom, there is a considerable amount of historic data and sector specific research available to help investors make reasonable forecasts benchmarked against solid facts.

IRR

These four main points provide the principals driving the Internal Rate of Return, there are many other considerations but these are all likely to fall under one of these key principals.

In addition to the legal and technical due diligence, the team at PEVAM’s underwriting of value will be focused on understanding and substantiating our assumptions relating to these key principals. With over 20 years of experience across many international markets and sectors, we will personally drill down into the detail on each property and market to make simple and strait forward investments for ourselves and for our investment partners.

LAST WORD FOR THE CAREFUL INVESTOR

Be a savvy investor and don’t be afraid to ask the management team how or why they have arrived at their assumptions for each of these IRR drivers.

Your nose will tell you the rest…..

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pevam-retail-investment-blog · 7 years ago

Photo

The Internal Rate of Return (IRR) is possibly the most widely used and most often abused measure used to calculate the potential profitability of an

investment. This is not a maths theory lesson, as a crowdfunding partner we want to share with you what the big buttons on our dashboard do without the confusing jargon.

WHAT IS AN IRR?

profitability (rent income + rental growth + capital gains) and deducting all costs (fees + capital expenditure + capital value losses).

YOU DON’T HAVE TO BE AN ENGINEER TO DRIVE A CAR

A racing car driver does not have to build Formula One racing car and the spectators will never race in a Grand Prix, however, they all have a common appreciation of the principals involved. In the same way we aim to set out the key principals used for calculating IRR investment returns, putting the spectator in the driver's cockpit without complicated technical jargon and frightening mathematical formula. So to getting to grips with what all the buttons and pedals do we have summarised 4 key elements below;

1. TIME

We have to remember that our IRR calculation is forward looking, which unless you have special powers requires us to make assumptions about events in the future.

•The further into the future we look with our IRR assumptions the less accurate our assumptions are likely to be.

•Because we are calculating the time value of our invested capital the length of our implied investment time period will impact on IRR.

2. DEBT

•The higher the level of bank debt as a percentage of the purchase price, “ higher the gearing” the greater the risk of potential bank default.

•By increasing bank debt and reducing the amount of capital invested, investment returns can be made to look more attractive as the same level of return is earned for less capital invested.

While banks themselves have become much more risk adverse, investors should expect gearing of 50 -60% of the purchase price (excluding purchase cost) for a reasonably sound property investment.

3. CASH FLOW

•The reliability of the IRR is greatly decreased with the number of forward- looking assumptions that need to be made.

•The most common pitfall is underestimating void costs, all the expenses and fees incurred replacing a tenant will lower returns.

Getting all of these elements right requires hard work and experience on the part of the manager because being overly negative is not good either as it will kill the investment before you even start.

4. EXIT VALUES

•The profit of our investment is hypothetical until we are able to turn our forecast on timing and forecast value of our exit into reality.

•Just because we can’t be proven wrong does not mean any exit value can be adopted.

Prudence and research can improve our accuracy and ensure that our IRR is a valuable tool helping us evaluate investment opportunities.

Simply forecasting value growth through capital gains or “yield compression” is a very lazy approach to supporting an investment proposal and can massively inflate our IRR calculation.

IRR

These four main points provide the principals driving the Internal Rate of Return, there are many other considerations but these are all likely to fall under one of these key principals.

LAST WORD FOR THE CAREFUL INVESTOR

Be a savvy investor and don’t be afraid to ask the management team how or why they have arrived at their assumptions for each of these IRR drivers.

Your nose will tell you the rest.....

#IRR Property Investment High Street Retail Investment Management Real Estate

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pevam-retail-investment-blog · 7 years ago

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We are very pleased to have Natasha Collins guest blog for us on this important topic. Natasha Collins MRICS is a chartered surveyor who owns and runs NC Real Estate, a firm which specialises in lease advisory and property management consulting as well as invests in its own properties.

THE 1954 ACT – IT’S IMPORTANCE IN COMMERCIAL PROPERTY.

Business tenancies are governed by the Landlord and Tenant Act 1954 Part II. Essentially tenancies which fall within this act have security of tenure. This means they have an automatic right to renew at the end of the lease. This is incredibly important when looking at commercial investments.

Whether a business lease falls within security of tenure (Inside the Act) or not (Outside the Act) will govern the strategy for the investment. A business tenancy which falls within the Act, means that the tenant has the right to renew at the end of their lease. A business tenancy will always be inside the act unless it is expressly stated and agreed that it shall be taken outside the act.

Furthermore, a business lease which is Inside the Act does not terminate with the effluxion of time (end of the fixed lease period). The tenant is entitled to continue holding over (I.e. in possession of the premises and paying an interim rent) until either the Landlord or Tenant serves notice to terminate, or enter into a new lease, in accordance with the provisions of the Act. If the Landlord wants to terminate the lease, there are only 7 grounds on which a Landlord can do this:

• Breach of repairing covenant

• Persistent delay in paying rent

• Other substantial breach of lease covenants

• If the Landlords provides suitable alternative accommodation

• Uneconomic subdivision – i.e. the Landlord could get more rent from renting out the property as a whole

• Demolition / reconstruction - For development Landlord must prove firm intention, prove funding and planning, substantial work & necessity to gain vacant possession

• Owner occupation - For re-occupation the Landlord must have owned the premises for 5 years & prove intention to occupy for business purposes

If the Landlord is successful in ending the lease and agrees it on grounds e-g, the Landlord must pay the tenant compensation.

This is 1 x Rateable Value if they have been in occupation for less than 14years and 2 x Rateable Value if they have been in occupation for over 14 years.

THIS IS WHY IT IS IMPORTANT FORLANDLORDS TO HAVE AN ACTIVEINTEREST IN BUSINESS RATES. BY KEEPING BUSINESS RATES LOWLANDLORDS WILL HAVE LESS TO PAYIN COMPENSATION IF THEY NEED TOEND AN INSIDE THE ACT LEASE!

OUTSIDE THE ACT

A business tenancy which is outside the Act does not have the right to renew on expiry of the lease. Therefore, the last day of the lease is the last day of the term. If a new lease isn’t agreed then the tenant must vacate.To agree a lease outside the Act you must expressly advertise that a lease is outside of the Act. The tenant must also sign a statutory declaration to agree to taking a lease outside of the Act.You will know if a lease is outside of the Act by reading the lease.It will state that the lease is outside the provisions of section 24-28of the Landlord and Tenant Act 1954 Part II. These are the sections which govern the right to renew.

DO NOT DEMAND OR ACCEPT RENT, SERVICE CHARGE, INSURANCE, ORANY OTHER FORM OF EXPENDITUREFROM A TENANT FOR ANY PERIODAFTER EXPIRY OF THE LEASE. THISMIGHT GIVE SECURITY OF TENUREAND AUTOMATICALLY ENTER THEMINTO A NEW INSIDE THE ACT LEASE

STRATEGY FOR THE 1954 ACT

It is important to know whether a business lease is inside or outside the Act. This will govern the strategy around the investment you are buying.If an inside the Act lease is ending shortly, you may want to wait to purchase the property. The current Landlord can then negotiate vacant possession, VP, and deal with the expense associated with doing this (compensation and legal fees). If it turns out that the currentLandlord cannot get VP then you may want to re-assess the deal.It may not be worth your time waiting for the next lease to end. This could involve going through the turbulent process of ending the lease.Then if successful paying the tenant compensation based on the new rateable value decided in 2017!However, if you want to retain the current tenant. Consider buying the property quickly and negotiating terms which work for you, rather than letting the current Landlord do it. In this case buy the property prior to the tenant having 12 months left on their lease. Then prepare to servenotice on the tenant for renewal exactly 12 months before the lease ends, the earliest date you can serve notice.Alternatively, if you are buying a property which you are looking to develop then you will want the business leases to be outside the Act and preferably ending around the same time. What you will notice is that rents are sometimes lower for outside the Act leases. This isbecause they aren’t as tenant friendly.

OFTEN LANDLORDS COMPENSATE FOR LOWER RENTS BY OFFERING A RENT FREE, TENANTS ONLY BREAKS OR FRIENDLIER RENT REVIEW CLAUSES. THESE ARE ALL ITEMS TO LOOK OUT FOR AND CAN IMPACT THE YIELD/ VALUE PLACED ON A PROPERTY!

Often the 1954 Act isn’t a factor taken into consideration by commercial investors. However, it is something that must be understood and discussed with a solicitor. Prior to getting to the stage of your offer being accepted on a commercial investment, you must decide on your strategy. Then you must look at this in conjunction with the business leases within the building.If your strategy doesn’t work with the lease structures in place you either need to move on to plan B or go and find another property. is that rents are sometimes lower for outside the Act leases. This is because they aren’t as tenant friendly.

THE 1954 ACT - OTHER HELPFUL INFORMATION

To help you understand that Act further I have put together a summary table. This shows the key sections of the Act and a brief summary of what they cover.

THE 1954 ACT IS LENGTHY AND ALWAYS BEST DISCUSSED WITH YOUR SOLICITOR. NOTICES NEED TO BE SERVED CORRECTLY AND AS A LANDLORD YOU HAVE TO BE MAKING SURE YOU ARE ACTING RIGHT.

Buying commercial property can be extremely rewarding and give you excellent returns. Your investment will succeed where your strategy works well with the properties lease structures.

NC Real Estate has just launched its first online course Manage Your Property Portfolio in 15 Minutes a Day which aims to make Landlords the most efficient, effective and successful property managers.

Head over to www.ncrealestate.co.uk to find out more and to read NC’s awesome blog. Or contact NC [email protected] and follow her on twitter @NCReal_Estate.

#Landlord and Tenant Act 1954 Commercail Real Estate Property Investment High Street Investment

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pevam-retail-investment-blog · 7 years ago

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Interview with Doug Hardman – PEVAM

Hi Doug,

Thank you so much for agreeing to come on the NC Real Estate Blog. You did a great guest blog post for us the 10 Reasons to Crowd Fund Commercial Property a few weeks ago, so thank you for agreeing to come back on!

When I asked if you wanted to do an interview for NC Real Estate your words were ‘Happy to do an interview, if you are looking for a non-standard real estate career!’ so of course that made me even more interested in your property journey as I love the non-standard and my readers do too.

How did you initially get into the property world? Did you do a real estate degree?

They say that necessity is the mother of all invention, I bought my first investment property at the age of 21 and used my brother’s student loan for the refurbishment costs.

I was studying in a small South African university town in 1990, broke and facing the harsh reality of funding my studies in market oversupplied with cheap students labour all willing to pull pints and serve food for less than the minimum wage.

After a string of failed hare-brained schemes to make cash, I secured a contract from the university that allowed me to install coin operated pool tables and video games in the student café and bar. The scheme was a runaway success from day one and I was literally making money while I slept ….and studied of course.

I quickly expanded to other sites and began generating significant cash flow. Apartheid and trade sanctions meant that the local real estate market was very depressed and there were many vacant buildings with desperate sellers. I bought my first property in a derelict light industrial part of town on receiving a tip-off that a Belgium charity had leased most of the surrounding workshop space for an education programme. The seller owned a small corner house that was rapidly being dismantled by vandals and carried off to be rebuilt in the nearby shantytown.

Let’s just say that if he had not agreed to leave 20% of the purchase price as a deposit for me, to be refunded when the mortgage was paid or settled when I sold, he would have been left with nothing but the foundations of his property.

I paid 20, spend 6 refurbishing and sold in 18 months for 46 after renting it to the Belgian hippies running the charity for twice my mortgage costs. If I had held on to sell after the first free post-apartheid general elections I could have doubled my exit price but I had the small issue of repaying my brother’s student loan.

That was me hooked on property and here I am in a property start up 26 years on!

Has it always been investment that you have been interested in?

The great thing about investment is that everybody’s business is my business. I am interested in everything and I care about rent reviews, property management, thatmakesLandlord and Tenant Act and every legal, technical or personal that makes up a real estate investment deal.

Being a naturally inquisitive person helps and property investment has always kept me interested.

I know you have worked at both DTZ and Cushman and Wakefield, what was it like working your way up the corporate ladder?

I arrived in London, the greatest city in the earth, thinking I was a rock-star entrepreneur on the back of my small town success. In my first job interview with abushy eye-browed partner at Stutt & Parker, I was rather scornfully asked if I hadbeen selling “mud huts” in South Africa. Let’s just say, from that point on I knew thatmy career path was not going to be strait forward.I was told only RICS qualifications allowed you a career in real estate, I was out of time, out of money and very disappointed so I just started working in property anyway doing wwhateverI had to do to feed myself.

After being turned away by successive employers for being too ambitious, I was offered a role as a trainee estate agent in Croydon and a job in Mayfair in the lowly role of arranging short-term-let apartment viewings. I opted for Mayfair, the worst job offer but it put me in the best place to meet people who could positively impact my career and then I worked incredibly hard.

In those days e-mail had just come in but Google and its wealth of information had not been dreamed up and I had to be a sponge for information, learning the hard way mostly; but I was doing it.

In life, it seems like everyone is ready to tell you what you can’t do - only you can show what you are capable of. I have always put myself just beyond my comfort zoneand then worked furiously to close the gap.

Fast forward a few short years and I was working as Investment Director for aa private equity fund in Eastern Europe, when a recruitment agent called me with a job prospect working as CEE Regional Investment Director for DTZ, a top global advisory firm. I told her “I am not your man, you need someone corporate with RICS behind their name..”So I ended up going to the interview as I had never been to Budapest, convincing myself that I did not want the role but having work furiously day and night preparing, second time luckily right?

The letters behind your name are a stepping off point in your career, not a privileged right. I absolutely supported my juniors’ study ambitions but it does not absolve you from getting things done and thinking for yourself. I feel I jumped the cue at DTZ and Cushman & Wakefield in not climbing the corporate ladder but I worked incredibly hard and was not afraid of pushing ahead to show what I could do.

I am not sure I would recommend my career path to anyone. I suppose the takeaway is that you do what you have to do with what you have, hard work and thinking for yourself will help you on your way.

You were a partner at Cushman’s what did it take to get into that position – I know for a lot of my readers that is the dream?

I don’t think I am the best gauge of success as I am not a corporate animal, I just managed to jump the cue because I showed I could get things done. Remember, a partnership or directorship is not the only measure of success and I have seen talented property professionals get their careers stuck behind an equity partner or boss who does not have their best interest in mind. Think for yourself and don’t let other people tell you what you can’t do.

Oh, but don’t forget to be honest with yourself if you can or you will be learning the hard way like I did.

Now you have set up your own firm, what made you jump to that?

I am an entrepreneur at heart so I see this as a return to my natural state. Working for two excellent global firms was fascinating and I learned an immense amount through working with such excellent and knowledgeable colleagues. Perhaps if it had not been for the global financial crisis I would still be in a big firm, though I know now that danger lurks everywhere. Perhaps more so than you realise in the large corporates.

What are the pro’s and cons of working in a big corporate to working for your own firm?

The best thing about working for a big firm is getting the opportunity to play with the corporate machine, working with global resources and clients you could only dream of in a start up.

On your own, you have the freedom to follow your instinct and make your own mistakes and be directly rewarded for your successes. To run your own business you need to have a high pain threshold together with the ability to sustain your positive outlook through setbacks, there is a 100% chance you will fail at least once.

If you do not fail at least once, you are not trying hard enough.

NC Real Estate : http://ncrealestate.co.uk/

#Landlord and Tenant Act 1954 #Property Investment #Real Estate #Investment

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pevam-retail-investment-blog · 7 years ago

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Yes, that is a real thing. You will need to have a clear strategy for analysing and fully understanding rents if you are going to be a successful property investor.

Real estate investment returns are made up of many interrelated factors, however, price and rent are the most likely starting point for most investors.

Buying an investment property is fundamentally owning the right to collect income from your asset; all investment considerations will flow from this basic principal.

SO HOW CAN A PROPERTY HAVE TOO MUCH RENT?

Every property has an inherent rental value or “Estimated Rental Value” (ERV) which is the amount of rent a tenant will pay in a free and open market. As we are buying the right to collect income, this ERV figure is an important component of our investment analysis. We are not only interested in the current rent or “Passing Rent” being paid by a tenant, we are comparing the passing rent with our assessment of the properties ERV. Our rental analysis will produce 3 likely scenarios;

Rack Rented;

If we believe the tenant is paying fair market rents

or the property is “Rack Rented”, we can expect to

continue to collect a similar level of rents from our

asset beyond the current lease term.

Reversionary;

If a property is under rented or “Reversionary”, the

passing rent is lower than our assessment of ERV.

This means our rent value is higher in the open

market we can expect our rental income to

increase via rent review or a new lease.

Over Rented;

When a property is Over Rented, meaning the

passing rent is higher than we can expect if we

had to rent the unit on the open market today.

RENT & CAP RATES

Each of these scenarios has implications for our key

investment principal; our right to collect income today and in the future. The Cap Rate or “Capitalisation Rate” we apply to the passing rent to establish asset pricing takes the ERV into consideration, among other influences on the rate of return we are prepared to accept for an investment.

RENTS IMPACT ON VALUE

Focusing on rents then, the impact on Cap Rates works as follows;

RACK RENTED = No impact of cap rates

REVERSIONARY = Lower cap rates:

Investors are prepared to accept a lower return on investment based on the passing rent in the expectation that future rents will be higher. We calculate that our reversionary yield will be higher when we are able to achieve market rents.

OVER RENTED = Higher cap rates:

We underwrite the value at a higher cap rate as our ERV forecasts that future rents will be lower than the current passing rent. Don’t get sucked in by high returns! Overpaying based on current passing rents is one of the most common mistakes investors make, leaving buyers with a nasty shock when they revert to lower market rent and finding out that the value of their property is substantially lower as a result.

Buying over rented property is not a bad thing, it does, however, require careful analysis and pricing to make sure you have correctly forecast the assets future rental prospects. Higher yielding properties can provide attractive cash surplus and will outperform other assets if the rental market improves during your ownership.

#highstreet #real estate investing #UK Invest #property #property sales #Investment commercial property

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