Return on Investment for Properties in South Florida
Gaston Reboredo • December 20, 2019
Calculating the Return of Investment for properties - Capitalization Rate and Value

Several investors are not calculating their return on their real estate investment the right away. We see many overpriced properties being purchased by investors due to lack of analysis. In this blog we are going to explain a simple way of analyzing the return of a real estate investment in its first year of acquisition. Future blogs will explain more sophisticated analysis, such as Internal Rate of Return and Net Present Value.
We are going to use in this example a multifamily building, an apartment building held for rental investment. The same concepts can be applied to any residential or commercial property investment. We are going to be talking about yearly figures.
The first number in our analysis is the Potential Gross Income (PGI) which is the maximum income the property can produce being 100% occupied at market rent. If the building has 10 units and market rent is $1,000 per unit per month, then the PGI for the year is $120,000.00
As we know not all units can be rented all the time. Tenants move out, sometimes we do not collect full rent due to collection situations, etc. Then a vacancy factor must be applied to the PGI to arrive at the Effective Gross Income. This is called the Vacancy Rate and is market derived unless there are specific factors affecting the desirability of the subject property such as physical obsolescence but in normal circumstances the vacancy rate is inherent to specific market conditions and can be market derived.
Once we arrive at the Effective Gross Income we need to deduct all Operating Expenses, such as Property Taxes, Maintenance and Repairs, Management Fees, Property Insurance, Licenses, Utilities (is paid by Landlord), Grounds and Landscaping, Leasing Commissions (amortized) and any other cost or expense related to the operation of the property and necessary for the property operation.
When we deduct the Operating Expenses from the Effective gross Income we arrive at the Net Operating Income. But not quite, because we have not deducted Capital Expenses, the amount of money we have to spend over time for roof replacement, equipment replacement (Air Conditioning and Appliances) Parking Lot resurfacing, Painting, and any other expenses necessary to keep the property going over time. These Capital Expenses are not spent yearly but when necessary and must be estimated and forecasted and accounted for and amortized over the life of the asset being replaced or improved. These are known as Reserves for Replacements, money we put aside every year from the operating income in order to have sufficient funds when the replacement takes place. For example if I know an Air Conditioning is 10 years old and its useful expected life is 15 years, i need to take into account that in 5 years most likely i will have to replace the unit. If the cost of a new unit is $5,000 then i need to put aside $1,000 as Reserves for Replacement yearly if I am buying the property today in order to have enough funds for the replacement of the unit in 5 years. To be technically correct we need to apply the expected inflation rate over that period because the cost of the unit is $5,000 today but due to inflation most likely the unit will cost probably $5,500 in 5 years when we apply an estimated inflation rate. It is a good practice to actually separate these funds not only accounting for them but actually going into a money market account, savings account or government bonds and rolls over year to year until used, if the unit is expected to be replaced in 5 years but lasts 7, then I will have in year 7 more than enough funds to replace the unit so I can either adjust my yearly reserves for replacements, distribute the excess to Partners or keep the additional funds as a cushion. It is very important to spend sometime in this concept and properly account for all variables and obtain the best possible estimates.
Then from the Effective Gross income we need to deduct the Operating Expenses and Reserves for Replacement or estimated Capital Expenditures to arrive at the right Net Operating Income.
If we divide the Net Operating Income by the Total Acquisition Cost (Purchase price plus Closing costs) we obtain a return for that year of operation which is called Capitalization Rate or Cap Rate. The Cap rate is a good indication of an expected return of the property. Also the Cap Rate can be market derived by calculating actual sale prices and income and expense figures on recently closed similar properties. The Market Derived Cap Rate can be used to determine the market value of a given property and compare it with the asking price. If we have a target Cap Rate we can then determine the offer we want to make to purchase a property, knowing all other variables.
You can see that up to this point we have done the analysis before tax and before financing. Usually we perform analysis before and after tax but we will discuss in another blog. Financing has nothing to do with property value at this point and we will analyze the effects and pros and cons of financing a real estate investment.
For now the concept of Cap Rate reflecting the return of the investment and being a way to arrive at a property value, calculating Net Operating Income and then Cap Rate can help investors pay no more than market value for properties and compare available properties and their offering prices with their return on investment goals.
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In the world of property management, insurance is one of the critical elements that ensure both the landlord’s and the property management company's protection from potential risks and liabilities. One of the common practices in property management is for the management company to be named as an "additional insured" on the landlord’s liability insurance policy. But what exactly does this mean, and what requirements must be met for a property management company to be added as an additional insured? This blog will delve into what it means to be an additional insured, the benefits and coverages it provides, and the steps involved for a property management company to be included in a landlord’s liability insurance. What is an Additional Insured? An "additional insured" is a person or entity that is covered under someone else's insurance policy. In the context of property management, this means that the property management company is protected under the landlord's insurance policy in case of claims or lawsuits related to the management of the property. By being named as an additional insured, the property management company receives many of the same protections as the landlord, particularly when it comes to liability claims. For instance, if a tenant or visitor is injured on the property and decides to file a lawsuit, both the landlord and the property management company could be named in the lawsuit. If the property management company is listed as an additional insured, the insurance policy will provide coverage for both parties in defending against the claim, thus reducing the property manager’s potential exposure to financial loss. Why Should a Property Management Company Be Added as Additional Insured? Adding a property management company as an additional insured is a common industry practice and offers several advantages for both landlords and property managers. Protection Against Liability Claims: One of the primary reasons to add a property management company as an additional insured is to protect them from potential liability claims. Since property managers are responsible for handling various aspects of the property, from repairs and maintenance to tenant relations, they are at risk of being named in lawsuits. As an additional insured, the property management company is shielded from these risks and can rely on the landlord’s insurance policy to handle claims related to their activities. Risk Mitigation: Having a property management company named as an additional insured helps mitigate risks for both the landlord and the property manager. It ensures that there is adequate coverage for potential claims that could arise from the property’s day-to-day management. This reduces the likelihood of disputes between landlords and property managers over who is liable for a particular claim, streamlining the process for addressing legal matters. Cost Savings: If a property management company is added as an additional insured, they do not need to carry separate liability insurance for that specific property. This can result in cost savings for the management company, which can be passed on to landlords in the form of reduced management fees. Of course, property management companies must carry their own general liability and professional liability insurance policies but being named as additional insured on a landlord's liability policy avoids the need of carrying a liability policy for that specific property which results in savings of operating costs and therefore provides the abiity for the management company to pass on those savings to the landlord in the form of lower management fees. 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Property Damage Claims : If damage occurs to a tenant’s property or personal belongings due to the negligence of the property manager (for instance, a leak that was not promptly repaired), the additional insured coverage can protect the management company from liability. Legal Defense Costs: In the event that a property management company is sued, the insurance policy will cover legal defense costs, including attorney fees, court costs, and any other related expenses. This is particularly important as legal fees can quickly add up, even if the property manager is ultimately not found liable. 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Adding a property management company as an additional insured on a landlord’s liability insurance policy is a crucial step in mitigating risks and ensuring comprehensive protection for both parties. By understanding what additional insured status means, what coverages it provides, and the steps involved in obtaining this coverage, property management companies can better protect themselves from potential liabilities and provide landlords with greater peace of mind. For landlords, including their property management company as an additional insured is a relatively simple process that can prevent costly legal battles and ensure seamless management of their rental properties. As with all aspects of property management, clear communication and well-defined agreements are key to protecting both parties and ensuring the long-term success of the property management relationship.