UGANDA, Kampala | Real Muloodi News | Are you searching for a strategy to develop a solid financial foundation and passive income streams?
There are various investment options available to help you grow wealth or bring stability to your finances, however some carry more risk than others.
Investing all your extra cash in the volatile stock market or cryptocurrencies might be a dangerous decision. After all, it is common knowledge for these markets to crash from time to time, and when they do, they take your money with them.
Alternatively some businesses, such as commercial real estate, may give you better long-term security and tremendous promising prospects as long as you execute the investment plan correctly.
Commercial real estate investment returns frequently exceed other forms of investments in the long run. Several commercial real estate options are available, making it simple to diversify your portfolio.
Commercial real estate investment choices include office buildings, multifamily rental properties, retail spaces, mixed-use buildings, and industrial properties.
Furthermore, there are various methods to start commercial real estate investment. Not all of them need an investor to spend money and time purchasing and managing a commercial facility.
Real estate investors may indeed purchase and maintain their properties, but they also have the option of directly sponsoring the initiatives of other investors or taking part in crowdfunding possibilities. Ugandans can take advantage of this. This type of investment can reduce the risk of owning and maintaining commercial real estate investments while also providing a quick return on investment if the property functions as predicted.
Before you delve fully into the business of commercial real estate investment, you must grasp the standard terms.
Here is a list of 20 key terms that any commercial real estate investor, whether beginner or experienced, should be familiar with.
Accrued interest in real estate is the interest amount accumulated on a loan over a period but has not yet been paid to the lender, whether on a mortgage loan or another sort of financing. Depending on the financing deal an investor is on, accrued interest can be a cost or revenue. The accumulating interest, for instance, is an expenditure for the borrower, who will ultimately have to pay the interest to the lender, whether monthly or at a later time, throughout the loan’s term. In other words, the accumulated interest is a source of income for the lender, who will be compensated for the interest earned on the borrower’s loan.
When there are many investors, the capital stack is capital accumulation or the layers of cash used to acquire and run a commercial real estate venture. The capital stack specifies which lenders or investors will receive revenue or wealth created by the property and the sequence in which the funds will be distributed.
The capital stack also specifies which lender has the first right of refusal to collect on the property if the equity owner cannot make mortgage payments. This is significant for investors since there is always the possibility that a property may not generate enough revenue to repay all investors or borrowers. When this occurs, the capital stack specifies who is favoured for payments.
More seasoned investors will probably be keen to know about the capital stack and the advantages of debt sharing—whether equity, preferred equity (share of upside and payment priority), mezzanine debt (chosen to represent a claim on a firm’s profits), or senior debt (borrowed money with precedence over any other obligation).
The capitalization rate, sometimes known as the cap rate, is a calculation used to assess a commercial real estate investor’s expected return on an investment property over a year. The cap rate presupposes that the property is acquired in cash rather than with a loan and assists investors in determining the possible profitability and return on an investment property. You can calculate the capitalization rate using several methods, but the most typical cap rate calculation divides the property’s net operating income, or NOI, by its current market value.
Cash-On-Cash Return (CoC)
Cash-on-cash return is a computation used by real estate investors to calculate the amount of cash received on a cash investment each year. Investors use this statistic to calculate the prospective yearly returns on money invested in real estate developments, both now and in the future. The CoC return is commonly used to assist investors in determining the prospective yearly yield of a particular real estate investment. It can, however, be useful for investors who wish to compare the return profile of one asset to another. Most investors estimate an outstanding CoC return to be between 8% and 12%, although a decent return might be substantially higher or much lower in particular markets.
The term “distressed assets” refers to properties priced below market value. Because the seller has an immediate need for cash, distressed assets are often priced lower than market value. After all, the property is performing poorly. One of the following issues cause a property’s underperformance:
- Physical state deterioration
- A faulty pricing structure
- A short-term problem outside the owner’s control
- Shocks to the economy (like a pandemic)
- Too much debt because of a capital stack issue
Investors want distressed assets because they provide the option to acquire properties at a reduced price, resulting in a more significant return on investment. However, there is a danger that the distressed asset would require costly repairs or other modifications, so not every distressed asset will wind up being an excellent investment.
Debt Service Coverage Ratio (DSCR)
The debt service coverage ratio is a statistic used by real estate lenders to estimate whether a property would generate adequate cash flow to service a loan. The DSCR is calculated by dividing a property’s annual net operating revenue by its annual debt payment, and the result is the DSCR. This not only aids lenders in establishing whether or not a loan may be granted, but it also aids lenders in calculating the maximum loan amount that should be granted on a property. To offer a loan on a property, most lenders will want a DSCR of 1.25x to 1.5x.
In commercial real estate, the equity multiple is the statistic used to assess how much money an investor would make for every cent paid during the initial investment. The equity multiple is calculated by dividing an investment’s projected cash payouts (including principal repayment) by the amount of equity invested. That indicates that for every cent or shilling invested, investors may expect a 50 per cent payback as a return on their initial investment, including the initial amount spent.
Return on Investment (IRR)
The internal rate of return, or IRR, is a metric for determining the profitability of an investment. The IRR is a percentage return that an investor may expect throughout a particular investment’s lifespan. The measure is widely used to assess real estate financing equity transactions—the greater the investment’s internal rate of return, the better.
Loan to Cost (LTC)
A real estate investment’s loan to cost is a ratio that compares the financing amount of a commercial real estate project to the overall cost. This comprises the purchase price and other property-related expenses such as liens, labour, materials, and permits. The LTC ratio is significant since it is one of the criteria used by underwriters to decide whether a project can be funded. The greater the LTC, the riskier the project is to lenders—and if the LTC is too high, the real estate investment business may have difficulty obtaining financing.
A mezzanine loan is a second loan taken out by an investor to help fund a real estate investment project. This sort of financing is required because it bridges the gap between a senior loan—a bank or lender’s principal mortgage loan—and the equity created. For example, suppose an investor pays USh80 million for property and gets a senior loan for USh50 million, plus an additional USh20 million in equity from investors. In this example, a USh10 million mezzanine loan would fill the senior loan and equity financing gap, completing the capital stack required to buy the property.
Modern Portfolio Theory
Modern portfolio theory is an approach to diversifying assets to create a portfolio that optimises returns while minimising risks. This strategy enables investors to diversify their portfolios across all purchases, including real estate. Modern portfolio theory, for example, would diversify their assets across a variety of property kinds and demands rather than investing in properties in the same neighbourhood or market if one of their investments performs poorly owing to competitive pressures in one location. In such an instance, the investor’s other various assets will shield him against massive losses all through.
Net Operating Income (NOI)
Investors utilise the net operating income to assess how lucrative an investment property may be considering rent payments, operational expenditures, debt servicing, and other sources of income and expenses. This information aids investors in determining if a rental property is worth the maintenance and upkeep costs. The NOI also aids lenders in deciding whether or not to offer a loan on a property. The NOI is calculated by subtracting the property’s operational expenditures from the entire income generated before taxes are deducted.
The phrase “pari passu” means “equal footing” in Latin. It’s utilised in various legal and business situations. When the pari passu clause is used in real estate, it indicates that if the borrower fails to pay, the project’s investors would get equal payments and have equivalent claims to the borrower’s assets. However, this does not necessarily imply that all investors will be compensated the same amount. The investors will be compensated proportionally based on their original contributions, but the money owed will be paid out to all shareholders simultaneously since all investors are equal.
Preferred equity is a capital payback mechanism that permits a private investor to prioritise some investments above others when it comes to repayment. When private investors have a preferential equity position, they are placed below senior lenders and other debtors in the repayment queue but ahead of other equity investors in the property.
Let’s assume an investor paid USh90 million for a multifamily building with a USh60 million loan from a senior lender, a USh20 million bridge loan from a preferred equity investor, and a USh10 million loan from additional investors. The property eventually performs poorly and is sold for just USh80 million. The senior lender would be reimbursed first, followed by the private lender with preferred equity, leaving no money to repay the property’s standard equity lenders.
If the borrower fails, preferred equity investors usually have some options, such as the power to force a property sale to recover the money.
A preferred return is a minimum rate of return that some categories of investors—usually capital investors—must earn before paying others. The ideal return rate varies based on the risk, but it is generally between 6% and 9% for real estate investments. Limited partners, who often put a lot of money in a real estate transaction and bear the most financial risk, benefit from preferred returns. Suppose one capital investment is eligible for a preferred return of 9% on a real estate deal, for instance. In that case, the 9% return must be attained and given to the investor before any other investors may be paid on the deal.
The pro forma is a financial document that aids in estimating a property’s future profit. This document is crucial for investors since it contains real-world property data, such as net operating income, historical and current rental rates, and estimates, such as continuing maintenance and upkeep expenditures, as well as future rent possibilities. This provides investors with a comprehensive picture of the property’s finances, essential when making investment decisions. It enables them to observe how any changes in performance, such as poor occupancy, can influence the bottom line.
Real Estate Crowdfunding
Real estate crowdfunding is a way to pool money from self-directed individual investors to support a real estate project. Real estate crowdfunding allows ordinary investors to engage passively in investments that they would not otherwise be able to access at a low or minimal income. Individual investor capital is then pooled and utilised to acquire or fund the real estate project. So real estate investment businesses seeking finance for their projects may use real estate crowdfunding platforms to obtain money more effectively and flexibly.
Real Estate Due Diligence
Real estate due diligence is “doing research” on a potential investment property and sponsor or lead investor when deciding whether to invest. Real estate due diligence varies in scope and duration, but the purpose is to evaluate if the property and investment are sound. The due diligence process may look at the following aspects of the real estate investment: rental or sales comparables in the neighbourhood and metro; the condition of the property; occupancy rates, rent rolls, and other characteristics of the property’s pro forma; demographic trends and demand drivers in the metro; and capitalisation (cap rate) dynamics in the metro, among other things; and, while considering whether or not to invest alongside a specific sponsor, an LP investor can look at the sponsor’s track record and operational experience.
Triple Net Lease
A triple net lease is a business contract where the tenant commits to cover all of the property’s associated expenditures. Under this form of lease, the tenant is usually responsible for the property taxes, property upkeep, insurance fees, and other routine connected expenses, such as utilities and rent. A triple net lease can be an intelligent approach for tenants to lease at a reduced rate. These leases are often provided at a cheaper rate because the tenant is also covering the additional expenditures. Commercial investors like these leases because they are a relatively low-risk approach to leasing commercial assets to tenants.
Value Add Real Estate
Value add real estate involves purchasing and selling properties that require repairs to achieve their full potential worth.
Buildings that have been neglected, deferred maintenance, inadequate facilities and services, lower-than-average occupancy, or low lease or rental prices are examples of these investments. These homes are riskier for investors since they use more money and sweat work to fix, but they can yield higher returns than other properties.
Bringing to the table appropriate industry experts will provide the investor with an advantage when starting a real estate investment. Knowing how the market operates and how to manage real estate assets with the least amount of volatility can result in an extensive—and hopefully profitable—portfolio.
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