Momentum,Play,vs.,Repositionin business, insurance Momentum Play vs. Repositioning (Cash Flow vs. Appreciation)
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Lets take a look at two different strategies that are used in both commercial and residential real estate. These strategies require different approaches and have different risks. A brief definition of a momentum play or cash flow investing is where the investor purchases a property that is already cash flowing, with little or no changes. This is often done in areas where rents are on the rise. It reminds me of a blue chip stock ~ slow and steady. Repositioning a property or appreciation investing, requires upgrading a property, including upgrading the clientele. Often these properties require significant rehab work. The show, Flip This House is based on repositioning. Momentum plays or cash flow investing are less risky and thus have a lower return on investment. The capital investment is lower. Generally, a momentum play requires a 20% down payment and some money for capital reserves. This property is already cash flow positive and the goal is to look for ways to improve that cash flow. No large sums of money are necessary for rehab, improvements, or negative cash flow. Momentum plays or cash flow investing is a good strategy to consider for a first commercial project. Lets take a look at an apartment example. We always buy value plays, as noted in previous blogs. Assuming an apartment building is $1M purchase price with a $100,000 NOI (cash flow not including debt service). Debt service is $80,000 on an annual basis. That means the $200,000 in down payment earns 10% annually also known as 10% cash on cash return. That is $20,000 annual cash flow to you. In the first year you increase rents, reduce maintenance costs, and start charging utilities back to the tenants. Overall, you increase the NOI to $120,000. Now your cash flow is $40,000 annual cash flow and the value of the property is $1.2M. Not bad. Repositioning a residence for appreciation is fairly simple and well understood. The investment is for the purchase, rehab and carrying costs of the project. Generally, the object is to sell the property for a quick profit. When looking at repositioning a commercial property, there are significant investment requirements. Rehabbing a commercial building means both construction costs and significant negative cash flows during construction. A reposition play (appreciation investing) usually involves decreasing vacancy, increasing rents, and increasing the quality of tenants. The rewards can be extreme. One needs the financial backing to complete the project during the turnaround before running out of cash. Repositioning a commercial property is a good choice for the experienced investor with deep pockets. Lets take a look at another apartment example. Assuming the apartment building has a $1M purchase price with an NOI of $20,000. Debt service on this project is $80,000 as in the example above, however youre only getting $20,000 to pay that. Youll need to invest more money to make the payments on this project. Vacancy is running around 50%. Rents are way below market value, but the condition of the property dictates the lower rents. Rehab cost estimates are $200,000. You will need at least $200,000 for a down payment + $80,000 holding costs + $200,000 for rehab costs. So why would anyone buy this building? Upon completion of rehabilitation and stabilization of rents to market rents, the project will provide an NOI of $300,000. Once complete, this project will cash flow $220,000 and have a value of $3M. Notice there is a bigger appreciation play and less cash on cash in this example. This might be good for experienced individuals looking for high appreciation. While the reward is higher when repositioning a commercial property, the investment and risks are higher. Be cognizant of the type of strategy that is right for you and your investors.
Momentum,Play,vs.,Repositionin