DEBT SERVICE COVERAGE RATIO (DSC) - What it is and Why it Matters For You!

The Debt Service Coverage Ratio (DSC) is a term often used by bankers and others when discussing investment real estate. In my experience, DSC is one of those items often examined by bankers when evaluating the potential of an income property. Thus, it is something that real estate investors should understand.

What is a Debt Service Coverage Ratio?

DSC is a ratio of income to principal and interest payments. It measures cash flow. A DSC of 1 means that there is roughly equal amounts or money coming in and going out. A number greater than 1, like 1.5, would mean that you have positive cash flow. While a number below 1 would mean the property has negative cash flow.

How is Debt Service Coverage Ratio Calculated?

When calculating DSC each property is often looked at individually. But, one can lump everything together to get an overall picture of the investor and their business.

DSC is calculated as follows:

DSC = Net Operating Income (NOI) / Principal and Interest Payments

Lets do a quick example.

A propertys gross monthly rental income is $1500. To calculate NOI, subtract out expenses and vacancy credits along with taxes and insurance. For simplicity, lets say each of these equal 10% of gross income or $150 for a total of $600. Thus, NOI is $1,500 - $600 or $900.

The monthly principal and interest payments are $600.

The DSC is therefore $900 / $600 or 1.5.

Here is Why it Matters

The above example shows that the property has excellent cash flow. A ratio of 1.25 or higher demonstrates that the property will be generating enough cash to handle expenses, some potential emergencies and still have enough left over to pay the debt service (mortgage). Essentially, it demonstrates that the property is a good risk from a cash flow standpoint. It tells the banker that there will be money available to repay the loan, even after all other expenses.

Here is Where You Should Use It:

Calculate the DSC ratio for your existing properties and include it in your info packet when shopping around for commercial loans. This will demonstrate that you have properly structured your business and have cash coming in to handle your expenses.

Also, calculate the ratio for your bank when approaching them on financing a potential purchase. It is another way to help them say YES to your loan request by showing that the purchase is a good risk.

To Sum Up

Using the DSC ratio demonstrates to bankers and others that you just might know what you are talking about when it comes to real estate investing. It puts you on their level because you are speaking their language. It may just be what you need for the banker to tell you yes.

Article Posted by Kevin Perk on 9/9/13 from The Bigger Pockets Blog

NEW VIDEO HIGHLIGHTS HOW URBAN RENEWAL WORKS HERE IN CDA

Thought this was interesting.

We've seen the successes. The Kroc Center. Riverstone development. Higher Education Campus. New downtown library.

The citys urban renewal agency, the Lake City Development Corporation (LCDC), played an integral role in all of these projects. But where did the money come from to help support these progressive community endeavors?

Take a few minutes and we'll help you understand.



As part of its ongoing commitment to public transparency and open communications, the Lake City Development Corporation has produced a brief educational video that is now available. The video includes comments from community citizens, including local business owners, and LCDC Chairman Denny Davis. It also details how urban renewal works through a process called tax increment financing.

This video is not a sales tool. Instead, it is the LCDC's effort to clear up misunderstandings about the agency's work, shed some light on our mission and respond to frequently asked questions about urban renewal funding with easy-to-understand factual data, graphics and comments.

A link to the video will be available on the agency's website, lcdc.org. It will also be included on our Facebook page. The LCDC has developed two versions. A brief 3-minute video and a more comprehensive 7-minute video.

Producer Eden Irgens said the video provides an important community service.

"I came up with the idea because there are a lot of misconceptions about the Lake City Development Corporation and urban renewal," said Irgens, co-founder of the Coeur d'Alene-based marketing firm Range. "We tried to take the science of urban renewal and show through a visual concept how it works."

Dave Patzer, chairman of the LCDC's Communication Committee, said the video is a means to educate the public on urban renewal.

"We decided this was an important project to continue our commitment to transparency and convey to people in the most understandable way the message of tax increment financing and specifically the goals of the Lake City Development Corporation," Patzer said.

Via, Lake City Development Corp.

THREE REASONS WHY COMMERCIAL REAL ESTATE INVESTING MIGHT BE YOUR NEXT STEP

Almost 10 years ago now, I was at a crossroads with my investing career. At that point, after investing in residential real estate units for approximately 15 years, I started to ponder the idea of going into the commercial real estate investing arena. It just seemed like the next logical step, I had always done single-family units for the most part but I did buy a six unit building once and had three duplexes and some commercial garages that I had built. I had been a realtor, rehabber and painting contractor throughout these first 15 years and now I was thinking bigger. After all, in my opinion its just more zeros, right?

How I Got Started with Commercial Real Estate Investing

When I was thinking about getting into commercial real estate investing, I started to try to find some places that were available in the Philadelphia area and I was struggling. There just wasnt much available at the time where the numbers seemed to work. Everything just seemed too expensive. Personally, I preferred something over 100 units because in my mind it could justify an on-site manager and an on-site maintenance man. Then by chance, something happened.

At the time of my conundrum, I ran a Real Estate Investor networking group and a company from New Jersey came to speak about commercial real estate. I was floored by their presentation, it just made sense. With experience raising private money, I was able to join their team assisting this company with the fundraising of private capital. What I learned next was that by using private placements these owners were purchasing $30 million worth of commercial property and a storage center with none of their own money.

We went on to raise $8 million for down payments and improvements and they proceeded to get some form of owner financing. Private placements also insulated the owners from most of the liability if anything went wrong. Their goals at the time was to turn the parks around within five years, raise lot rents, refinance and pay back their private investors. Now the $30 million worth of commercial property would be all theirs. Heres the best part, they had no previous experience other than taking a Scott Scheel course! What they learned and taught me was really why it makes sense to invest in commercial property.

Three Reasons Why Commercial Real Estate Just Makes Sense

1.) Economy of Scale - To put it simply, you can manage a lot more apartments, mobile home parks, and offices than you can manage residential homes. Did I say a lot? Because I mean A LOT more, like 100s of units more. If you have enough units to justify an onsite manager and maintenance person, you can give them a free apartment and/or a small salary and you're out of the property management game. Plus if they live there, this person will most likely be on call 24 hours a day – this gives your place a better reputation, makes people happy, and it keeps the property up to date and in good shape.

Plus you dont really have to hire too many outside contractors; some maintenance departments even paint and cut grass. And the contractors that do come in will usually give a discount since with large apartment complexes theyre getting quantity work, thats usually steady as well. I know because I used to be a contractor for places like these and they were my most consistent jobs every month. Also owning a large commercial property usually simplifies the maintenance and upkeep of the units by having all the same carpet, paint, furnishings, etc.,

2.) Valuation - Market comps and replacement value do play a part in valuing commercial property, but the TRUE value is found by determining the NOI (Net Operating Income). Net Operating Income is Gross Income minus operating expenses (and it doesnt include debt services). There’s a great example in one of Scheels articles called How Commercial Property is Valued that simplifies the process greatly, “Lets say a commercial property generates $100,000 in NOI. Investors in most parts of the country would gladly pay $1 Million to buy a property with a $100,000 annual income stream (a 10% return). This desired return on investment is also known as a cap rate.

Thus, as a (very general) rule of thumb, you can take the NOI of a property and divide by 10% (or an appropriate CAP rate for the market you are evaluating) to determine the value of the property. If you were able to find a way to increase the NOI on that same property from $100,000 to $150,000 [(by say raising the rent, lowering vacancies, etc.)], the property would rise in value from $1 Million to $1.5 Million (based on a 10% cap rate). And this of course is a major concept with commercial real estate investing. Much like residential, you dont make the most money with a property that’s in great shape, you make the most money with a property that needs work or that could have it’s value raised.

3.) Creative Financing - Probably my favorite of the three reasons is that you can purchase multi-unit properties with little or no money down through private money partners. Commercial loans are often more lenient and flexible than residential loans. You can also use a combination of financing. For example, if you were buying a $10 million commercial building, the bank may lend you $7.5-8 million and the balance may be raised with a combination of owner financing and private money. The seller may hold a 2nd mortgage of a million dollars, interest only for 5 or 7 years. The remaining million dollars along with closing costs and renovation capital could be raised through a private placement.

In this example, the managing partners would be Class A members with at least 51% ownership (to maintain control) and would oversee day-to-day operations and could not be voted out under normal conditions. The remaining investors would be Class B members and would own shares of whatever the company owned whether theyre units, equipment, rental bank accounts, etc. Keep in mind the buyers will be receiving all security deposits and often times are allotted repair credits from pre-purchase property inspections or seller assists towards closing costs when negotiating the purchase of the property.

I have seen cases where buyers walk away from closing with cash. For example, I had a guy from my local commercial group who walked away with cash in his pocket at a recent closing from doing what is called a lease-back. A lease-back is an arrangement where the seller of an asset leases back a portion of the same asset from the purchaser. This enables the seller to lease back some vacant space in the current building, paying for it in advance at closing, and allowing the buyer to get better financing from the bank by raising the value of the property through the increased NOI.

So Now What?

Today, Im still involved in several commercial deals. I still utilize many of the skills Ive learned, especially those involving fund-raising through private placements, with a variety of new projects today. Im currently working on a 12,000 square ft. office building deal (and it looks like the sellers are willing to hold some paper too!). So when are you going to jump in the commercial pool and take action? Go out and join a commercial real estate group, ask questions, read books, and get started today!

Article Posted by DAVE VAN HORN, www.pprnoteco.com on MAY 15, 2013

MORE DIRT PLEASE - PURCHASING LAND FOR REAL ESTATE DEVELOPMENT

Dirt, mud, rocks, soil, and grit-it all has a ton of value to your real estate development project! Whether you are working with a single parcel or developing a massive master-planned project, land is often the very first thing you will invest in when developing any new property. After all, our buildings have to sit on something. They cant be built on air.

The value of land is tied to your specific sites characteristics, yet it is also subject to external market conditions and local regulations. Unlike with buildings, land doesnt depreciate (something you cant use for tax purposes). And its value fluctuates like any other market.

As land is often the very first thing developers analyze when taking on new projects, how does one even begin to dig into the dirt (pun intended) to evaluate the viability of a specific parcel, site, city block, or region?

If youre beginning at step one and want to start researching land, be sure to consider these site characteristics as you way your options:

Site Size
We live in a world thats constrained by physical limitations. Site size plays a big role in what can be built. Does your project call for 150 parking spaces? If so, you likely wont be searching for a half-acre site. Do you anticipate two or more phases for your project? If so, extra vacant land will be needed. When starting, if you have a general idea for the project you want to develop, site size is best analyzed in buckets because of the variability from site to site (think something like: 0-2 acres, 2-6 acres, 6-15 acres, etc.).

Zoning
I considered writing, zoning, in all caps because its such a crucial element of any project. Many projects are derailed because of zoning and entitlement issues. A sites value is often aligned with the zoning regulations that govern its planned use. Since value is tied closely to a sites highest and best use, one can add value instantly to a site if they are able to change/improve zoning restrictions. However, this typically doesnt happen without public input and approval from ones local zoning board–which are two unknowns and can often be part of a lengthy process. Zoning is an element of land valuation that requires close collaboration with local zoning officials and the public. On top of zoning specific to the site, adjacent land uses can play an important role in your land acquisition.

Development Trends
I sat through a workshop recently that outlined the investment strategy of land banking. The strategy hinges on identifying markets and specific parcels that will likely appreciate in value as development occurs in and around the area. While hard to predict, development trends can play a large role in the value of a site. A vacant parcel of agricultural land with nothing around for miles probably has less value than that same parcel with retail centers and subdivisions popping up everywhere (unless theres something in that soil!). If you have the ability to take the pulse of your market before the growth or decline occurs, which is easier said than done, development trends will put you in a strong position to gauge the market strength for your specific site.

Comparable Land Sales
Comparable land sales are weighed heavily when valuing a specific parcel of land because, unlike improved properties, other approaches tied to income generation and cost of construction arent relevant. As with comparable building sales, land sales have discounting and appreciating adjustments to consider. No two sites are ever alike, so the comparable qualities of a land sale should be adjusted accordingly.

Clean Transactions
Similar to building sales, land sales dont always occur at full market value. When evaluating comparable sales, if any hint of distress or non-arms length terms are present, a comparable sale might not fully articulate market value for a specific site. For a quick example: I researched a 12-acre mixed-use parcel that was sold six months ago for $1.2 million. Every aspect of the analysis indicated that this price was appropriate for the site. A year prior to that sale the same site sold for $500,000 at a bank foreclosure auction. This first sale did not provide the clearest indication of value because the transaction occurred under an element of considerable distress. Did the most recent sale occur substantially above market value? No exactly. Did the buyer in the distressed sale get a heck of a deal? More than likely.

Utilities and Infrastructure
Utilities and infrastructure are major expenses for any project at any scale. If a site has utilities, roads, and sidewalks already in place (assuming your project calls for them), the value of your land should increase because these expenses wont be incurred during construction. If these site improvements are obsolete and have to be torn out or reworked, one has to consider the extra expense in their development pro forma. The acquisition price should adjust accordingly.

Environmental Conditions
A super fund site is going to have very different environmental concerns than a vacant greenfield agricultural site. Environmental conditions are not always obvious on the surface, often an environmental study is required. Before any shovel hits the dirt, make sure youre well aware of the expenses required to alleviate or avoid any environmental issues. Many sites look ripe for development, yet remain vacant because of environmental problems that came up during pre-development.

Flood Zones
Have you ever driven through a densely built area and been surprised that one or two parcels are completely vacant? Why hasnt anyone built on that site!? In some cases, the sites location within a flood plain is the single answer to that question. Flood zones can dramatically impact the value of a site if there is high potential for a flood.

Quick tip: Check out FEMAs flood plain maps (FEMA.gov) to view detailed flood information for any site in the United States (search, FEMA flood plain maps, in your favorite search engine). When you type in the address of the parcel youre interested in, a map can be viewed that shows where flood plains are in that area. If you see that your site is right in the middle of a major flood plain, be cautious about the, buildability, of the site.

Topography
99 times out of 100 it is more expensive to build on a sloped site than a flat site. Topography plays a large role in site preparation expenses, design, and site constraints. If your site has large topography changes, consider the added expenses needed to build retaining walls, heftier foundations, leveling, etc.

A Few Extra Things to Consider
Here are a few additional questions to be aware of when evaluating a sites viability for your development project. Are new roads, sidewalks, sewer/water/gas/electric lines needed on your land? Will your city/municipality assist or finance this site prep or will you need to cover these expenses, all before a single building is built? Can you cover carrying costs related to taxes, utilities, insurance, and financing while you hold the land?

While there are many factors that contribute to valuing, acquiring, and building on vacant land, its an exciting part of the development process. Its also a piece of the development puzzle where one can add considerable value and creativity. Yet, given the elements that can quickly derail a project, land acquisition should be analyzed holistically and thoroughly.

Story Via:Kyle Zaylor, MAY 4, 2013, The Bigger Pockets Blog

2013 NORTH IDAHO COMMERCIAL REAL ESTATE MARKET FORUM

Engage in conversation with experts within the commercial real estate industry, as we discuss how regional growth, the state of the economy and world events impact our real estate market. Learn about trends and hear from specialists in office, retail, multi-family, investments and industrial/flex-tech.

Check out Craig Hunters Speech

Check out Rob Kannapien's Speech