|
Articles And Announcements
Concessions,
should you use them on your Property?
Dear RSI
Client,
Concessions.
You can’t live with them and you can’t live with
out them, but what does it really mean to the property?
Their affect on cash flow and value isn’t always
clear. Over the
last few years, concessions have become one of the biggest
problems facing the real estate market.
Why are
concessions so bad for the real estate market?
In most cases, concessions lower the net operating
income of the real estate, which in turn lowers the value. To
the average Joe, this looks to be a double hit (lower income
and lower value). Actually,
in real estate it is a triple hit. First, income goes down,
second, the real estate's value is lowered and third, the
capitalization rate is raised and this further reduces the
value of the property.
The
following is a text book example that shows the actual risks
involved when an owner or management company uses concessions
that reduce the income by 10%.
EXAMPLE
|
Value
(any real estate) @ 9% Capitalization Rate
|
$100,000
|
|
|
|
|
Without
Concessions (Assumptions)
|
|
|
Property
Income
|
$18,000
|
|
Property
Expenses
|
$9,000
|
|
Net
Operating Income
|
$9,000
|
|
|
|
|
With
A 10% Concession (Assumptions)
|
|
|
Income
Declines 10%
|
$16,200
|
|
Property
Expenses (remain the same)
|
$9,000
|
|
Net
Operating Income
|
$7,200
|
|
|
|
|
Results
From A 10% Concession
|
|
|
Capitalization
Rate Increases (example 10%)
|
|
|
New
Market Value @ 10% Cap Rate
|
$72,000
|
|
Annual
Cash Return On Investment
|
$7,200
|
|
|
|
The
preceding figures illustrate the affect on real estate of a
10% concession. The conclusion to be drawn from this example
is that a 10% concession could increase the capitalization
rate from 9% to 10% resulting in a loss of market value of 28%
and a loss in cash flow of 10%. This means that if the real
estate were purchased with a down payment of 30%, the buyer
would lose the entire investment.
(Allen
Cymrot)
The
moral, make sure you understand the financial impact of
concessions before you give three months of free rent.
If you have any questions about concessions please
contact me at jmalone@rsiscreening.com.
Sincerely,
Jeff
Malone
Regional
Marketing Director
Rental
Services/ RSI Screening
|
