As promised for the next series of newsletters we will be examining each individual investment type of real estate; from what it is, to lenders underwriting requirements to getting your loan approved.

The key to any piece of commercial real estate as you know from my previous articles is cash flow. If there is no positive cash flow without a significant down payment it is not a "good" investment today. You may elect to hold an investment and hope for appreciation upon a future sale, but that is not going to give you cash today.

The investment types that will be covered in this series of articles are all known as "cash cows". They typically return an investor a consistent cash flow and therefore a good cash on cash return. Today's topic will be the exciting area of Land Development

Now I can hear you already saying that there is no cash flow in a land development deal for many years. And you would be right, unless we look deeper into the subject. On the face of it all land that is sitting idle does not generate cash flow, in fact it does the opposite, it costs you money if you have any sort of financing against the property.

So how can an idle piece of property generate cash flow?

A piece of property might just be situated on a main thoroughfare where there are lots of cars going by the property everyday. Visibility is the key, Can you now think of a cash magnet as all these people drive by your property every day to and from wherever they may be going. Imagine that you want to get the word out about a product, service or new development, Wouldn't you want a sight that had a great deal of visibility for your billboard or advertisement?

That's exactly what you should do. You should lease the right to put a billboard on your property for the time that the demand is there while you begin to process your land development maps.

Another idea is to apply to get a cable telephone provider to lease your property for wireless telephone service. Many land owners that have property that is clear of transmission lines and is high up are vying for these cable tower transmission deals. Tree Farms or Pumpkin patches can also be used for seasonal income.

Another use of your idle land is to lease it out for farming. Organic farmers are searching high and low for the right property to farm. The benefit to you is not only that you receive cash each month for the use of your land but also that farmers will keep the property clear and grubbed, therefore you won't have to worry about environmental issues cropping up because the property will remain in a manicured stage.

These are just some of the uses of vacant land. You are only limited to your imagination as to how to generate cash flow.

Hint Think recreational use as another use of your property.

For further ideas please request to be on our mailing list for our upcoming book, which will deal exclusively with land development and the various ancillary uses of land.

Key Commercial Loan Indexes

Fed Prime Rate 8.250%

10-Year CMT 4.640%

30-Year CMT 4.830%

USD 6 MOS LIBOR 5.330%

As of March 31, 2007

If you have been following my articles over the last year you will note that they are easy to read and comprehend. Today though, this article is going to be more of a nuts and bolts article with terms and definitions. To understand Cash Flow you have to do the math. There is no way around this, so this article will have lots of math for those of you that love the numbers.

When discussing cash flow we are talking about what remains after all expenses have been paid on a particular investment, known as NOI.

NOI, Net Operating Income - gross income of the property less direct operating costs, but excluding depreciation, amortization and interest expense.

The investor’s bottom line is NOI, and NOI will dictate what loan if any will be approved, as well as how much money the investor will have for his discretionary income at the end of the fiscal year.

Cash Flow is sometimes also referred to as EBITDA. Don't try to sound this out phonetically it is pronounced Eh Bit Da. EBITDA stands for Earnings before Interest, Taxes,Depreciation, and Amortization.

EBITDA are the addbacks that lenders can add back to the Investors discretionary cash flow.

The next term to understand the application of is Debt Service Coverage Ratio or DCR for short. A lender then applies the applicable Debt Service Coverage Ratio to determine how much spendable income an investor has that can be used for future debt service

DCR, Debt Coverage Ratio - the ratio of NOI (net operating income) to the anticipated debt service.

The investor must be aware of whether the loan has a high probability of getting funded. The higher the DCR, the greater likelihood of the deal closing. A low DCR yields a property that is not cash flowing,

INCOME TO DEBT MEASUREMENTS - DEBT COVERAGE RATIO CALCULATION

The higher ratios means that the investor most likely put more money down to purchase the property and the resulting loan is lower in proportion.

Debt Coverage Ratio is Net Operating Income divided by Annual Debt Service of the loan.
For example a commercial property's net operating income is $72,000 per year and the debt service for the loan is $55,000 per year the debt coverage ratio is 1.31%

(Calculation) $72,000 per year debt net operating income divided by the debt service of $55,000 per year.

Return on Investment is used for all investment types , (ROI) is nothing more than a sophisticated calculation that is applied to a piece of property that you are planning to purchase.

The best way to understand the complicated formula for ROI is to apply a scenario.

To keep this calculation simple we are only going to use one year of rental income and we will then assume the property will be sold with a 7% increase due to inflation.

Assume a property is for sale for $1,000,000.00. The investor is able to put down 30% or $300,000.00. The property will generate a cash flow of $12,500.00 per month
Annual Operating Expenses are currently running at $50,500.00
Property is currently showing a 5% vacancy factor
Annual debt service is approximately $61,000.00.

What is the Return on Investment for our investor?
ROI % is the Cash Flow before taxes divided by total cash invested.

Gross Rental income = $150,000 (monthly of $12,500 * 12)
Less Vacancy Factor = $7,500.00 (Gross rent of $150,000 * 5%)
Gross Operating Income = $142,500 (Rental of $150,000 - vacancy of $7,500)
Less Operating Expenses = $50,500.00 (given above)
Net Operating Income, (NOI) = $92,000 (Operations $142,500 - Operating Expenses of $50,500.00)
Less Annual Debt Service = $41,500.00 (given above)
Cash Flow Before Taxes = $50,500 (NOI of $92,000 - Debt Service of $41,500)

Return On Investment = 16.83% ($50,500.00 divided by total cash down payment of $300,000) Less Vacancy Factor = $7,500.00 (Gross rent of $150,000 * 5%)

As you can tell this is a complicated but practical calculation that you must master. For more complicated transaction financial calculators can be employed and all you need to do is enter the additional years of cash flow to determine your ROI. But as a teacher once told me if you do not understand the calculation model any result will look right.

email: harlan@loanforbiz.com

phone: 858-592-0659

web: http://www.loanforbiz.com