Before I was involved with my current business, I was the CFO of a property company. I worked close with probably one of the most creative and ballsy property men in the country…….and he was not a CA!
He taught me the magic of the commercial property financial model specifically the impact on the long term cash flow.
Simply put, it pumps cash!
There is no doubt that the wealthiest people in the world know this and they all unreservedly invest in property in some manner or form.
So what is it that makes it so fascinating?
Well, working in the industry and applying my accountancy skills it didn’t take long to see some unique aspects of the real estate business that makes it so exciting.
You can get property valuations to work on a simple back-of-the-cigarette-box calculation. Using the YIELD method, it is easy to get to a ball-park value quite quickly without doing the detailed NPV/IRR calculations (obviously these need to be done at a later stage to double check the numbers).
This simple yield method is the annual EBITDA divided by the yield percentage. This percentage is market driven and is usually related to risk.
So if the EBITDA of building A is R1,000,000 and the yield is 10% pa, then the value f the building is R10,000,000 (EBITDA/Yield%).
I like starting at this 10% yield factor as it is the middle road and I can adjust my risk factor from there.
What comes out of this, though, is the magical part of the whole equation;
For every Rand that I can get in extra rental (or by saving expenses), I get 10 times more on the capital value.
So if I could buy a building on a 10% yield where the rental were say R15 per square meter and I could re-let it out at R30 per square meter, the numbers will look like this:
Gross rental (@R15 per sq meter) R1.250.000 (assumed)
Expenses (R 250,000) (assumed)
Valuation at a yield of 10% R10,000,000
Increase rental to R30 per sq meter
Gross rental (@R30 per sq meter) R2,500,000
Expenses (remain unchanged) (R 250,000)
Valuation at a yield of 10% R22,500,000
Capital gain R12,500,000
(This is a simplistic representation as it assumes that rentals could be doubled without incurring any further costs but many clever property mongols have made their fortunes doing exactly this!).
Look at this carefully – there is definitely something magical happening here.
The arithmetic is accurate and easy.
Take this one step further and you could find yourself buying the property by rising finance from the banks without you contributing any money at all!
If you were able to approach the bank with a signed 10 year lease at R30 per sq meter, they could consider the increased value of R12,5m your equity contribution and happily advance the R10m required to purchase the property.
Yes, this is very simplistic but the theory holds good.
Property is a fascinating business and the theory applies internationally. CA’s, with their training, are ideally suited to this industry. This is besides the fact that it is a wonderful opportunity to create real wealth……..for yourself!