Financial Analysis and underwriting is a absolutely critical skill for syndicators and fund managers to know like the back of their hand, I used to coach people on how to syndicate real estate in a program that I used to have.
Today, we're going to take a look back, and we're gonna go back to one of what I would call a rapid implementation call, it was taking that information that I have that background and experience I have, and putting it to use and making it available to the people who I was coaching through the
process. So this is an excerpt out of one of those calls, it's a deep dive into the machinery itself, how the gears fit together as primarily also a between the facts and assumptions and how they all work as part of this big machine in order to generate money to pay for investors, I hope you find it useful. Financial Analysis is the process of evaluating business businesses, projects, budgets and other finance related
transactions to determine their performance and suitability. And obviously, that's what we're mostly concerned about right now. So this is the you know, making see it's that evaluating piece that really is what we're trying to do, trying to identify if this is something we want to do it this something that makes sense. So it's the that evaluation that we're doing. But at the same time as syndicators, I would say, We also do this underwriting piece as well, because underwriting is to, to
finance or otherwise support or guarantee something. So I would argue that as syndicators, we are basically supporting that the overall thing, when we come up with our projections that we're putting in our PPF, we are actually saying, you know, this is what we are putting our name behind and putting our
reputation on. So to me, that is underwriting. I think it's just important just to set a framework that we that we talked about them in the same thing, and I probably will keep saying them synonymously as well anyway, because it's habit, they aren't actually the same thing. So you may want to call it out to when you're when you're talking to investors, it's probably better to say financial analysis, because that does kind of cover your underwriting as well. Because if somebody is a
stickler for those definitions, they may call you on it. And I fortunately haven't been yet, but I could be. So what are we doing when we are doing financial analysis? There's two phases to this. So the first oops, the first phase is we are taking a snapshot in time. As of now, what does that property
look like? So what are its characteristics? So if we looked at all the things as let's put it this way, if we look at all of the things that go into the bucket of the financial analysis, we've got the most important thing for the the now analysis is fact. We're trying to say these are the facts about the property right now. Now we're gonna go into those in a little bit more detail. But that's the the main thing that we're trying to do today. And then much smaller than that,
that impacts how we look at that. And that changes this picture that we're taking with this camera is our assumptions. Right, it's small because it's just, they're not as big or important at this now stage. But what are we trying to do when we're trying to do an analysis and build projections or a performer which I really considered to be the same thing? We're trying to set up something for the future. That's supposed
to be a clock in case you can't tell. And that other one's supposed to be a cam And so we're trying to say what is it going to be in the future? Now, oops. Cloud Backup, when we're looking to the future of what this looks like, the facts that we have, aren't very become much less important. Because time erodes all those things, leases start expiring, and maybe they'll renew and maybe they weren't, taxes may go up, or they may come down, they don't really go down, but they taxes
may go up, or they may go up a lot. And it's our assumptions that start ruling the debt. And I'm gonna run out of room assumption start ruling the day. So we go from big fact to little fact and little assumption to big assumptions. And these are what's changes. Now, the further you go out, the bigger this effect is, because, you know, you're going to have to make
more and more assumptions. And the more and more things change, the more and more those assumptions that you made, in the very beginning, will do it. And so this process is building
your pro forma. The reason we are even talking about this right now is because it's important to have in your head that the either the proof, certainly the performance that you get from other people, but even the performance that you get from yourself, that you're doing yourself for your own investments, there's there's two ways of looking at, at that pro forma, and how and how you're going to use those assumptions.
You have a a way that is I would call it let's call it optimistic and then we'll call it I don't really want to use pessimistic I'll say conservative. So they're either optimistic or conservative. So because that's generally the terms that we use in the industry, we don't generally say pessimist, so we can use assumptions that are very optimistic, and they're still true and based in have a foundation for choosing them. But they're not, they're not the most necessarily the most likely
to happen. Because when you're predicting the future, I mean, there's obviously a huge range between, you know, from something like, you know, very unlikely to happy happen to unlikely to happen. And they probably go on some sort of bell curve and to how they actually play out. And so if this is our bell curve, our optimistic is probably at this end of the spectrum. And our, our conservative is probably at the
center of the spectrum. So they're just they are like, they're within that bounds of like, but not, they're not, they're on opposite ends of each other. You wouldn't want to go all the way to this end and be so optimistic that you're predicting that you know, you're going to 10x or 10x the the rents every year for the next 50 years, because that's never
gonna happen. But you also don't want to predict that the moon is going to fly into the building and destroy it and melt it all down and it won't be an insured loss both of them I suppose could happen in some in some world just not very likely hours. So let's go through kind of how this range happens between fact and assumption and amateurs this he is and we start
with the facts on this side. We start with the assumptions on this because that's really what they come out they come out of each other facts for the for any property, somebody want to name a fact go for it. What's what's a fact Size. Size Great. Yeah, it's gonna be a certain size. Absolutely. Maybe you have plans on growing it, but that's an assumption whether that's gonna get what else? Fry price I think a lot size. I think well, yeah,
certainly lot sizes. I don't think price is a is a is a I don't think price is a is a is a fact, which it's not done yet. You know what they're asking, but you don't know what they're actually going to get or what it's going to be at the end of the day. So I think it's still a little bit gray. Sar sure stands for floor area ratio. So there's sighs I'm gonna put location here because it's kind of a big topic, right? So we have existing tenants, right? They they exist, they're in your
building. And that it's not going to change that they are in the building at the moment that you're taking that snapshot. What you don't know is whether Well, let's start with what the rental amount. So we don't know what their their rent, let's say you don't necessarily know what their rent is going to be rent next year, if they are on CPI. And oops, if so, and we'll talk
about that more, probably not in this call, but another comp. But if their rental increases are, are pegged as something like the consumer price index, you don't know what Consumer Price Index is going to be, you probably are using a figure like 2% or something different figure it out. But it's an assumption that you're making. You don't know what the default rate is going to be. You don't know if those tenants are going to default on
the on their lease or not? Or if they're what kind of credit risk they are. They you know that they are in existence, but you don't know the likelihood of that actually happening. So there is a chance that's going to happen. And that percentage that you apply is a question mark, you don't know the likelihood of renewal to guess that you're gonna make. So other facts that you know demographics demographics at the given time, is, is absolutely there. But you don't know in the next 10 years?
If you know, is it growing? Is it shrinking? Something can happen? Is it gentrifying or not? So I'm going to put it over here too. Because the demographics in the future, you're gonna, you're gonna make, you're gonna make some guesses. And those all have an impact on ultimately, your your market. And maybe it's gonna be your it might be how your your market sees it in the community. So maybe it would change your cap
rate, or maybe it's going to change your rents. But certainly demographics and the how they change is going to have a pretty profound impact on what your property's going to do. You've got operating expenses, now, you've got operating expenses that are historical, but you don't know what they're going to
necessarily be in the future. Let's take property tax. So we in California, we have a more set set system, but we're very much in the minority in the way we do things most of the country has, has what the assessed value is going to be and then it can that assessed value can change it can go up or it can go down. And similar in California, you know there's there is still
ambiguity here prop 13 could go away. Whereas was on the last election was to move prop 13 To eliminate prop 13 Four for commercial buildings, it didn't pass but it could have made it so that was also assessed value for commercial buildings. So it's not a It's, it's an assumption that you're going to make whether it's going to stay or not. Now, you probably are going to assume it. But it's still in that realm. You have a management company. But you don't know if they're going to
continue or raise rates. You don't know whether I mean, if you're doing it yourself, you don't know whether your costs of doing the management are going to go up. So that make it so that you're going to need to change your your management fee or not. Utilities is a huge one. So, so I'm going to put these
together actually, utilities, contract labor. And by this, I mean things like your garden, Port Portage, pest control, etc, etc, etc, anyone that you're hiring, that isn't part of your regular workforce, is contract labor, and then we'll put repairs and maintenance. So all three of these you are gonna guess on what the growth rate is going to be. Most of the time, I'm guessing it's gonna be 2%. But that's probably a little bit on the optimistic side, because I want that expense to be less,
where 3% would probably be more conservative. Certainly on utilities in California, guessing on a low growth rate of 2% is probably very optimistic. Then we've got a whole nother category of your market leasing. And your market leasing is something is a fact that what does exist is your, your market and historical terms your market and historical rents the how long it takes to to turn it. And
commission mounts, things like that. So I mean, all of these things can change, because you have no idea what the future terms are going to be. You have no idea what future rents are gonna be. You have no idea how long it's going to sit on the market. You don't know if Commission's if those greedy brokers are going to start demanding more Commission's or not. And, and if you're doing your own commission, I mean, if you're doing the leasing on the property yourself, you still
don't necessarily know what you're going to charge. Because you may want to charge the other side it. And it's we're looking at at all of this through the lens of really the whole investment itself, not just you know, your pocket, obviously, but But building out projections for your investors. So each one of these things put as has an impact. And then capital expenses, obviously. Who knows, right? Who knows what's going to happen on that a track system may explode, and suddenly you
need to replace it. The roof may suddenly cave in and you need to replace it. Something can happen. You're making an assumption on Well, I think this is going to need to be replaced or be repaired at this point in time, but you don't know. And so those all go into your Proform. So again, the reason that we're talking about it here and in this context is because all of these things are part of your that snapshot that you're taking right now. But to build that a pro forma. Those are all
assumptions that become the overriding thing. To that drive, your your number at the end of the day. They're very it's very easy to make a property look stellar, and it's very easy for a property to look horrible. All in how you're painting the picture. revenue. And it's really up to you to decide, you know, it's a terrible drawing, it's up for you to decide where on the bell curve, you are going to put those assumptions. I mean, if you're gonna put them here, or here, or here, or here,
whatever, it's up to you to make that decision. And when you do make that decision, just know that you're making that decision. This is the same reason that a, you know, a sophisticated read doesn't just won't take a broker's pro forma, because they know that it's always going to be over here that the broker is going to be painting their assumptions, and they're being much more conservative on what their projections. So they don't want to see it, it's not even worth
their time. Does they want they've got their own assumptions that they've decided are, are what they're going to base everything off. And it would also be who viewed to act in a similar manner, start figuring out what your assumptions are going to be about what things you do, I mean, likelihood of renewal is how we'll see how do I do this. So CPI always set at 2%. It's in general around there over the
past 20 years. default rate, somewhere between 5% 10% If we are talking in a generally normally affluent area, likelihood of renewal is really up to the tenant, it's more of a feel thing. It's somewhere between 50% to 90%, maybe 95. If you're really, really comparable. Demographics, I mean, you're probably paying attention to demographics as it went in. And whether you thought it was, you know, an area that's gentrifying, you're probably more likely to be interested in
it. Whereas if it's an area that you think is going to go downhill, and you think it's going to, to tank, I don't think you're going to be putting investor money there. Your property taxes you're going to be doing based on either kind of figuring out where you were historical for assessed value, or if you're in California, you're using 2%, because that's what prop 13 says the maximum rate is. For management, you're probably going to keep it consistent. For the growth rate,
I tend to use 2%. For for these, if I'm making a projection for what I'm going to tell investors 2% is a reasonable rate. But it is probably a little bit optimistic. Certainly when it comes to things like utilities, market leasing assumptions. Now, here's where you probably are going to base things mostly on on history. So unless you've got a great deal of familiarity in the market, and kind of have a feel for where everything should go, you'll probably pull a bunch of lease comps or ask other
agents for lease comps, and base everything around that. And then your capital expenses, you're gonna be relying on your, your inspectors, your property managers, you know, people who have that industry knowledge who can say, well, you've probably got another seven years left in this roof. And then you'll you'll you'll figure that out. So I'm going to pause here. Are there any questions on this part? So far? Is that okay, good. Was this was this this was this too fast? Was it a good
pace? It was too slow. I think I've pretty much got that part. Okay, good. Alejandro Anthony. Good to go. Okay, good. Was it a good pace? Was it a good pace? Anthony tech. Yeah. Okay. Good luck. Yeah. Okay. Perfect. All right. So. All right. Now, the next part I want to talk about and this probably is going to be kind of review but I want it to B. It all kind of builds on itself. So this is the way that I see. This, see, we've even got a little diagram built in and
ready to go. This is the way that I see it. The very basic calculation of, of how cap rate works. So, and I'm going through my vision of it, because I think the way I see it kind of sets up how IRR works better and isn't exactly the same way that they teach in, in the real estate courses, etc. So, at some point in time, you buy this machine, call it machine, which is the property and you paid cash for this machine. And so that is your
cost. So, we've got, we've got a series of gears that are all kind of going to get now this gears turning around this is your this can be thought of as your income to nice big gear. They go in opposite directions because their gears this gear is your expenses. Actually, I would let's just call it expenses, because I don't want to get to compete. And then out of that comes your and we'll have a go all the way out, that comes out your cash flow. Or in this case, let's actually that will be a
little bit like. So let's say that this is your so this will be operating expenses just because we're going to call this their outcomes your noi. So now automatically in our machine, we've got everything we need in order to calculate our, you know, where what our cap rate is. And the cap rate is just all it is it's just a performance metric. It's just a performance metric of how that machine runs. And so it's just simply the the NOI over your cost is your, you
know, going in cap rate for the building. And it's but all it really does, it doesn't mean anything more than just a simple performance metric to give you an idea of of how this thing works. So as things change over time, you know, as it as income goes up. So hopefully expenses come down. Your NOI is going up. And then for that same cost, your cap rates going up. Now if it costs you more obviously then it's going to be be degraded. So I put it in that context just to set the frame
for how how the cap rate works. Hope you found that blast from the past useful. My name is Tilden Moschetti. I am a syndication attorney with the Moschetti syndication Law Group.
Now if we can help you put together a Regulation D rule 506 B or 506 C offering don't hesitate to give us a call, whether you're doing a business that you're raising capital for buying real estate by putting together a real estate fund or a private equity fund, or you're a developer and developing real estate need extra capital were the people to call