Crash Course: Real Estate Finance

Crash Course: Real Estate Finance

Owning and operating a coworking space take two very different skill sets, but that doesn’t mean coworking space operators can’t learn to be savvy real estate owners, too. During the Global Workspace Association’s latest members-only webinar, a panel of coworking space owners from around the country shared their experiences and offered insight into shopping for, financing, and effectively managing owning your own space.

Coworking experts Josh Fine, Hasan Mirjan, and David Orr all weighed in on the process of managing your business’s finances and approaching banks for financing for buying your own space. You can hear all of their presentations and question and answer sessions by watching the webinar recording if you’re a GWA member. In the meantime, here’s a brief overview.

Alphabet Soup

With a background in real estate and law, Josh Fine of Enterprise Coworking is all too familiar with what he called the “alphabet soup” of the real estate business. However, he broke down the must-know acronyms for members during the webinar.

PGI – potential gross income consists of all the revenue your real estate is capable of producing if every space is rented out at market rate. This forms the basis for many financing calculations.

VCL – vacancy and collection loss takes into account the spaces you won’t rent out (the unrealistic part of the PGI).

OI – other income covers ancillary sources of income (often expressed as a percentage of PGI), such as income from parking fees, mail service, etc. Some of these alternative forms of income can be great additions to your proposal to the bank, since they can be less subject to market variables than actual office space at times.

CAM/NNN/ER – although it can show up in multiple forms, these all come down to expense reimbursement.

EGI – effective gross income is your actual revenue. Think of it as PGI (potential income) minus VCL (what you don’t rent out), plus OI and CAM.

OE – operating expenses are the costs of running your real estate. This comes out of EGI as well, and includes all the expenses of operating your building.

Reserves – these important funds are for building expenses that don’t come up regularly (think roof replacement instead of electric bill). These funds often go into a separate account, and there may be bank requirements surrounding what you must include on this line item.

NOI – net operating income consists of EGI minus OE (cost of operation) and your reserves. It’s what you make after you subtract the cost of keeping your building operational.

ADS – annual debt service is how much you pay each year toward your loans.

BTCF – before tax cash flow is how much money you’re able to keep at the end of paying all operational expenses (but before taxes). Think of it as NOI minus ADS.

Calculating Real Estate Revenue

So what do you do with the alphabet soup? Fine explained that part of real estate as well by walking members through a test scenario.

Imagine you calculate out how much you think you can make per square foot in a space you’re looking to acquire, and that lets you start with a PGI of $250,000. From there, you’ll subtract VCL, since obviously you won’t rent out every space. That might take off $25,000. However, you will also bring in income from other sources like parking (OI), and expense reimbursement (CAM), adding $6,750 and $72,000, respectively. That gives you an EGI (actual revenue) of $303,750.

From that EGI, you have to subtract the cost of operation, which includes regular expenses (OE) as well as more periodic but large expenses (Reserves), so plan on $80,000 for OE and $25,000 annually for Reserves. This calculation brings you to your NOI (net operating income), which comes to $198,750. From there, you’ll subtract your ADS (the debt you owe back on the loan you used to purchase/open your space), which for this scenario subtracts $156,921. This leaves you with your before-tax earnings (BTCF) of $41,829.

What Banks Want

When you approach a bank for funding for a real estate endeavor, they will be looking for several factors to ensure safety for the investment they make into your space. For example, a bank may have requirements regarding DCR (debt-service coverage ratio), which is essential to ensure that you have enough cash flow to make your debt payments. This ratio is usually calculated as NOI divided by ADS. For most loan situations, this will mean you need 125 percent of your net income of your mortgage service payment.

Your cap rate will also affect your loan. These rates are decided by the market and change based on market conditions. In an unstable market, cap rates often spike, leading to less favorable loans for you.

Obviously, just as the bank is taking a risk on you, so you are also taking a risk when choosing to invest. Equity is a less risky form of financing a space, but is much less common, more expensive, and highly dependant on solid partners with cash available.

Another option is an SBA loan, which is a type of loan in which two lenders are ultimately involved to get you a loan that covers usually around 90 percent of your costs. Eventually, this will be split into the bank covering 50 percent and the SBA loan covering the rest, a fairly low-risk loan amount for your bank. Mirjan encouraged those looking for this type of loan to approach small banks, as they tend to be more willing to work on these types of loans.

If you are denied an SBA, remember that often, the issue isn’t the bank or loan itself; it’s the community development corporation in between. Be sure to find a CDC that understands coworking spaces and the ways in which they line up with SBA requirements (they do).

Pitfalls to Avoid

As you consider approaching a bank, be sure that you don’t fall prey to the idea that owning your space’s building makes it so you don’t have to pay rent. You should still be able to afford to pay yourself market rent each month. In fact, our panelists said you can actually sign a lease between your business and your building before approaching banks, allowing them to see that your business is committed to occupying and paying (yourself and thus the bank) for the space.

If you can’t afford to pay yourself market-rate level rent, then you should probably consider what things in your business might be too expensive or else too low a rate.

Also, as David Orr of Tahoe Mountain Lab noted, be careful that you don’t confuse the difference in role between a community manager (or management team) and a property manager (or management team). Be sure to have clear job descriptions and realistic expectations for each of these roles. As much as possible, try to have different teams managing the property and the coworking community, that way members of each team can each utilize the unique but important skill sets that create success in those areas.

You can access the full version of this webinar, including even more Q&A with our panelists, by joining the GWA. Members receive invitations to all of our webinars, where they can interact with coworking experts live or watch recordings of previous webinars, as well as many other great benefits.

This webinar is part of an on-going series available to members of the Global Workspace Association. In addition to invitations to all webinars, which allows for participation in the Q&A sessions, members also have access to recordings of all previous webinars. To view the full version of this webinar, with all the examples, explanation, and Q&A, sign up to become a member. You can join the Global Workspace Association by going here.

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