The best single tool that you can use over and over again in a variety of situations to help you make smarter real estate decisions is a mathematical formula called Present Value. You can use it whenever a deposit is made on property to determine the lost income, or when a buyer agrees to pay money sometime in the future to a seller, or in terminating a lease prematurely, or in determining how rent payments might apply toward a purchase price, or in deciding whether to lease or purchase, or in figuring how much to pay for property that produces income. It works not only in real estate but also in valuing investments, and anytime you need to put into current dollars a flow of money that lies in the future.
Present Value is used anytime you have money paid in the future in order to make the right decision. It helps you put different scenarios of cash flows on the same playing field so that you can compare the options. Even though there are templates and apps that can do the work for you, but it helps to understand the basics. The Apple Store has dozens of Present Value apps, and The Louisiana Chapter of the Certified Commercial Investment Member offers a free template that does the math for you, just click NPV Calculator. Even the US government will give you a template to use for GSA contracts. But the best way to understand how the math tool helps is to use a simple spreadsheet.
Let's set up an example and work it through. One real life example is how to get out of a lease. A lease commits the tenant to a long term payment, in return for the predictability of having space in which to operate. Just ask the Roly Poly sandwich shop owners on Tchoupitoulas and Jefferson why a lease commitment is important. You'll have trouble finding them though because they did not have a long term lease and when the property owner wanted to build a Regions Bank branch, Roly Poly had to move. They shut down Roly Poly entirely, lost their income and the building was demolished by the landlord. So leases are good things to have. The commitment when obtaining a lease is that you will lease the property for several years. More often than not, you will personally guarantee the lease and the property owner will come after any personal assets if you terminate the lease prematurely.
Let's examine a situation where you lease property but want to cancel the lease. Maybe you are moving to bigger space in Elmwood. Maybe you are moving to do more government contracts in Baton Rouge. Maybe you are closing down your business and retiring but don't want to subject yourself to a lawsuit from the property owner who now will not have income from the lease payments to pay the bank the mortgage on the property and faces the bank coming after his personal property because you no longer can pay the rent.
Present Value is the following formula:
Don't let the denominator throw you. The Present Value (PV) is the Future Value Payment (C) divided by the Assumed Growth (1+i) where i is the interest rate expressed as a decimal, times the number of periods money is paid (n).
Assume you have a 5 year lease with monthly payments of $10,000 and you want to get out of the lease starting January 1, 2015. You are obligated to make 12 monthly payments totaling $120,000 per year for 5 years or a grand total of $600,000. But you don't offer to pay the landlord the entire $600,000 now to terminate the lease because he would normally have received that in future monthly payments, and a lump sum now can be invested over the next 5 years to grow to more than $600,000. So how much is $600,000 over the next 5 years worth in current dollars as a lump sum? So our spreadsheet starts like this:
In the Present Value cell, enter the formula: =120,000 ÷ (1+.05) where .05 is 5% which is an assumption of the interest rate or growth rate of that money. Our (n) value equals 1. If you were earning your MBA, the professor would instruct you to use the Treasury Bill rate for n, but we are not in MBA class so in this case it is 5% which is an assumption factoring in risk to come up with an interest rate that the landlord would need to earn on your lump sum to replace the lost income you are no longer paying. So now our formula looks like this:
The result shows the Present Value which is the amount of money it would take today if invested at 5% to grow to $120,000 in 12 months. Double check by multiplying the growth ($114,286 times 5%, or $5,714) and adding it back to the principal ($114,286).
To get more accurate you can compound the cash flows monthly, and assume you get all the income at the midpoint of the year, but in that case you would want to use the app or CCIM NOV Calculator. Now we have to carry this out for 5 years to determine the total amount, so our spreadsheet looks like this:
The only change is that in each subsequent year the present value formula adds another (1+.05) to the denominator.
All you do is add up each year's Present Value for a total of $519,537. This is the amount in current dollars invested at 5% that grows to $600,000; therefore, this is the maximum amount a tenant would offer a landlord today to cancel a 5 year lease with payments of $10,000 per month.
Since New Orleans is almost 300 years old, you'd expect some interesting stories behind its more prominent buildings, and the vacant Market Street power plant near the New Orleans Convention Center does not disappoint.
Built in 1927, the 5 story coal-fired power plant probably contains asbestos and who knows what else detrimental to life, but it sits on 7 acres just a Mardi Gras bead's throw from the driving force of the New Orleans' economy: the nation's 6th largest Convention Center which drew 23% of the 8.75 million visitors in 2011. The power plant measures over 500,000 square feet, making it the largest non-office structure in New Orleans commercial real estate.
The building was purchased by Baltimore developer Edward Giannasca for an outrageous price of $10 million, just after Hurricane Katrina, at a time when apartment developers valued the site at most $4-$5 million. It was an offer the owner, Entergy, just could not refuse.
The money to purchase the building came from insurance proceeds on another building, Plaza Tower, owned by a partnership of Giannasca and retired Baltimore Ravens defensive end Michael McCrary (3rd on the Ravens all-time sack list) who claimed fraud since he was not informed of the diverted use of the insurance proceeds. McCrary sued Giannnasca and was awarded $33 million by a Baltimore court which was overturned on appeal. Subsequently, McCrary became dependent on drugs, his wife filed for divorce and a protective order.
Plaza Tower was eventually purchased by a hedge fund managing money for wealthy clients including Michael Jackson, who sold their $10 million investment at auction for $650,000 in 2011. The Market Street power plant sits vacant today, as it has been since 1984, but there are expectations that it will become a retail center with Bass Pro as the major tenant. Even though the property sits in a small industrial area, there are signs of commercial development: a new Wal-Mart down the street and, across Tchoupitoulas Street, the 700 unit Saulet Apartments is in full operation, having sold in September 2008 for $97,000,000. The first step in bringing the power plant back into commerce is to resolve its financial problems, since the owners filed bankruptcy in December 2009 but are expected to emerge in 2012. The property has a claim by MCC Group, a large contractor, and Market Street Ventures which holds the first mortgage, as well as Market Street Trust which has a claim for $6.5 of the $19 million in debt being restructured.
Sources: www.emporium.com www.larryschedler.com www.baltimoreravens.com Times-Picayune, December 2, 2011
Over the last 12 months ending December 2018, inflation, that secretive economic thief that steals your purchasing power, increased 2.2%, continuing to drive the wage price spiral like grandma through a slow school zone, keeping pay raises low and interest rates at the lowest levels in decades. The fat cat donor to this economic bipartisan party has been a decline in energy prices, offsetting the rise in food items, housing and medical care.
Low inflation benefits those who buy assets and borrow money but hurts savers, retirees and those who already own their assets. Just because the Consumer Price Index says inflation is low, it doesn’t mean the cost of medicine and food are any less expensive for senior citizens. Let’s first examine the various ways of measuring inflation, its history and how it impacts our daily life.
The most widely quoted inflation number is called the All Urban Consumers Current Series, but there are 4 other methods of determining inflation and two variations of each. For example, one method is the Urban Wage Earners, another is called the All Urban Consumers and there is also the Average Price Data. There are different base years where measuring started and each gives a different number. There is a method called chained that provides a different result, and some data is adjusted for seasons and other data is not. The first data out is not seasonally adjusted so it is the most commonly quoted. There’s more: in addition to measuring consumers, there are also measures of producers who sell to consumers.
Let’s examine the history of inflation to see what the future holds. Inflation from 1914 to 1990 fluctuated widely, causing interest rates to track with high standard deviations and several recessions, depressions, booms and busts. All this changed when OPEC banded together and raised oil prices in the 1970’s causing the peaks in the above inflation chart skyrocketing over 10%, resulting in President Ronald Reagan threatening to fire the striking Air Traffic Controllers to break the wage/price spiral in the 1980’s. It worked. Unions never recovered their power to secure high wage increases and inflation and interest rates plummeted.
After periods of 10% inflation devastating the economy, the 1990’s welcomed inflation under 5% and, except for the mortgage crisis in 2008, the economy enjoyed steady growth and inflation never rose above 5%. The mortgage crisis was a wringing out of the excesses of the 2000’s when President Bill Clinton spurred home ownership and HUD, Fannie Mae and Freddie Mac loaned money freely to purchase homes, increasing home ownership to its highest levels and making Clinton very popular.
With the breaking of union power and the wage/price spiral, inflation has remained low, under 5%, for decades. This is a strong undercurrent that drives our economy, like a large oil tanker making its way down the Mississippi River-it takes a long time to change its path. This means the future will tend to be more of the same: slow GDP, low inflation, low interest rates but difficulty for businesses to grow by raising prices. The only way to get bigger is to vertically integrate or be creative by developing new products that capture market share.
Over the last 12 months, only the large cities with population exceeding 1,000,000 experienced healthy employment gains, according to the latest numbers released by the Department of Bureau and Labor.
The largest over-the-year percentage increases in employment in these large metropolitan areas occurred in:
The map above shows the cities with employment growth at the bottom of the barrel.
In Louisiana that includes:
In Mississippi, the worst cities are:
Notice the map of worst cities is concentrated in the Northeast, mainly Pennsylvania, Ohio, Indiana, Michigan and Wisconsin. It is no coincidence that these states with declining opportunity have angry voters looking for someone just as angry to lead them out of a poor economy with promises of bring back the economy.
Nonfarm payroll employment increased over the year in 16% for the 388 metropolitan areas with 84% of the cities unchanged over the last year in growing their employment. The largest over-the-year percentage gains in employment occurred in:
The US Bureau of Labor Statistics released the employment numbers as of January 2019, showing employment increased by 304,000 in January, compared with an average monthly gain of 223,000 in 2018. Great news but when you drill down into the data, you will find the news is great for some and not so great for others. You need to add at least 145,000 jobs monthly to keep the economy growing.
In January, employment in leisure and hospitality rose by 74,000 and added 410,000 jobs over the last 12 months. This ranked #3 among all sectors.
Construction employment rose by 52,000 in January and has added 338,000 jobs over the past 12 months, ranking #4.
Employment in health care increased by 42,000 in January and added 368,000 jobs over the last 12 months, ranking #2 among all sectors.
In January, Employment in transportation and warehousing rose by 27,000, following little change in December. Over the year, employment in transportation and warehousing has increased by 219,000.
Farmers know the hind teat produces less milk, so when they say you are sucking hind teat, they mean you aren't getting anywhere. There are several sectors that are not enjoying employment growth like the rest of the job market, with 3 of the 5 below dragging things down because they are large drivers to the economy:
Employment in federal government was essentially unchanged in January (+1,000). Federal employees on furlough during the partial government shutdown were counted as employed in the survey because they worked or received pay (or will receive pay) for the pay period that included the 12th of the month. Employment showed little change over the month in other major industries, including wholesale trade, information, and financial activities.
The result of a misfiring economy is slower than optimal growth, with those sectors doing well in selected major cities offset by those sectors doing poorly and full of angry underemployed, 2nd job, workers who do vote. Interest rates stay low, inflation stays low. Savers and retirees suffer from low returns, but borrowers enjoy low loan rates. Businesses can grow by borrowing rather than selling equity, which strengthens the balance sheet and profitability, fueling the stock market which puts virtual money in everybody's pocket, leading to an overall sense of satisfaction that keeps everybody in office.
