Is it time to buy Real Estate in the USA? - Wert-Berater, Inc.

June 4, 2010 - PRLog -- Is it time to buy Real Estate in the USA?

Considering that financing is limited and that many deals are all cash (equity), the rate of return for investment grade real estate must match expected relative returns plus a margin for risk, lack of liquidity and entrepreneurial profit.  Hence,  the "Discount Rate".  The buildup of this rate could be as follows:

Expected Relative Returns: 0.3 to 1.5%% (CD's, passbook savings, bonds, and so on)
Lack of Liquidity: 0.5 to 1.5% (what is would cost to break your CD contract for instance)
Risk:  5 to 15% (Depends on the type of real estate and is normally correlated with the "Capitalization Rate)
Entrepreneurial Profit: 5 to 15% (The cost of your time to be involved in a project)

Thus, the Discount Rate could range from as low as 10.80% to as much as 33%.  Now the Discount Rate is the same as what is called the "Internal Rate of Return".  In real estate, often there is downtime in the cash flow stream after an acquisition.  For instance, the property may be under construction or no tenants to pay rents.  Thus, the cash flow could be negative for this period.

Once cash flow becomes positive, that stream of cash flow is often referred to "Cash on Cash" meaning that dividing cash flow by the total monies invested.  This mathematics is simple, yet sometimes oversimplified.  This is because it should include amortization if there is financing involved that is amortized.

Upon a sale or "reversion" there is typically a bulk of money that is paid at the end of the investment.  This is why the IRR or Internal Rate of Return is used to calculate an investment into real estate and is preferred over the cash on cash returns as a method of determining if a real estate investment is good.

The basics of IRR are that it should be equal to or greater than the Discount Rate. Thus, IRR = Discount Rate, then the deal is profitable.  This calculation is complicated to forecast because there are so many external and internal aspects to a real estate project from how the market is doing to how well the property is managed or even how well tenants manage themselves in order to pay on time.

Extraordinary expenses may arise such as the loss of a tenant, major capital item breakdowns, competitors lowering their rents and so on.  Thus, the best way to forecast is to engage a third party firm who can create models that "stress" the potential outcomes.

The answer to the question, “Is it time to buy Real Estate in the USA?” is based on your discount rate and finding a project that matches your investment return needs.

Wert-Berater, Inc. uses the Monte Carlo Simulations, Decision Tree Analysis and other parametric and non-parametric approaches to examine risk.  To learn more, please visit the Wert-Berater, Inc. website at http://www.wert-berater.com
or call 888.661.4449.

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Teamed with VTN Consulting, Wert-Berater provides all civil engineering, construction consulting, appraisal, feasibility study, and risk management services to lenders, investors, commercial and investment banks. http://www.wert-berater.com