What does real estate equity and jet fuel have in common? Both can evaporate before your very eyes! Equity is the rocket fuel of real estate investing. In the last five years we have experienced an entire real estate cycle.
Simplified the real estate cycle is equilibrium, growth, over-built (bubble), bust, recovery. Except for the recovery part we have seen each part of the cycle in the last five years.
A rocket scientist never uses rocket fuel just for fun. Even in experimentation fuel usage is purposeful. Like a Sunday drive, without a known destination- you?re just driv?in. Likewise, the energy and resources required to start and finish a commercial real estate transaction is significant. It is a serious endeavor with large financial ramifications.
The primary ?sense of purpose? in any real estate investment should be, first, preservation of capital. Second is providing a return on investment (or targeted return) given the yield profile of the invested dollars.
Like any endeavor that includes the word ?rocket? there are multiple systems required for a successful launch. Long before we see a rocket take to the sky years of work went into getting to the launch date. In the case of real estate investing, launch day is the day of closing. However, getting to launch day takes months of preparation.
Excluding reliance on layered secondary financing (owner financing, mezzanine debt, debentures, cross-collateralization) equity represents the real dollars that are ?at risk? in a real estate investment.
The equity number should include all soft costs from pre-acquisition expenditures. All in equity is the number that requires yield- a return on invested capital. The only sure way to determine yield is by accurately determining costs basis.
Just like rocket launching, commercial real estate investing is no place for guess work or on-the-job learning. From the very first day resources are at risk to acquire real estate assets every effort should be made to deploy these resources as efficiently as possible. This includes prudent utilization of equity. This includes folding in all soft costs into basis.
If equity is the rocket fuel of real estate investing, prudent use with a high level of expertise is paramount. Always.
Reprint from Multifamily Insight.net by John Wilhoit Jr
Source: http://houstonius.com/wordpress/?p=5679
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