Loan Officer Training 07/10/2024 - How to Analyze Internal Rate of Return - Loan Officer Training with The Mortgage Calculator

Episode Transcript
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Restream recording Jul (00:00):
Welcome everyone.
My name is Kyle Hiersche.
I'm the CEO of the MortgageCalculator joined here by our
president Nick Hiersche and oursales manager Jose Gonzalez.
This is our loan officer sale,loan officer training series
that we do every Tuesday,Wednesday and Thursday evening
at 7 PM Eastern tonight.
We're going to be talking abouthow to analyze the internal
rate.
Of return.
So Jose has a presentation readyfor us.

(00:21):
I'll go ahead and let him takethis.
Good evening, everybody.
Thank you for joining us fortonight's training.
Now, at the mortgage calculator,as you all know, we're very,
investor intensive, right?
We, we lend on all types ofproducts, right?
Agency.

(00:42):
Non Q.
M.
Primary second homes investmentproperties, but we really love
our investment propertyinvestors and as you all know,
at the mortgage calculator,we're also all about adding
value to the transaction asmortgage loan officers were not
just application takers here.

(01:04):
That's why we love dealing withthe investors and the investors
love dealing with us, right?
Because we know how to break itdown for them.
We're in, in their investmentproperty analysis, right?
That's very important.
To add value in that mannerbecause investors are very picky
who they work with.
So they definitely want to feelthat they're working with an MLO

(01:27):
who they can feel as a member oftheir investment team and
definitely knowing, or assistingin, investment property
analysis.
is a great way to add value tothe transaction.
That's why tonight's, trainingis on.
And I added a little twist tothe title here, how to analyze
real estate, internal rate ofreturn and return on invest.

(01:54):
They're very similar, butthey're not the same thing.
And let's break it down.
So what are we talking aboutwhen we say, you know, internal
rate of return.
It's very specific.
The internal rate of returnidentifies the annual growth

(02:17):
rate of an investment.
And this is the important partwhere it differentiates from
return on investment, right?
Taking into consideration thenet present value of the funds
invested, right?
Because what could you have donewith that money if it's going to

(02:39):
take you three years or fouryears, for example, it could be
the term on your investment.
You definitely definitely needto know what's the net present
value of the funds and then whatwould that money be worth.
on its own, in three or fouryears, whatever would be the
term of your investment, right?
Because then you're going to seethe future value of the money

(03:00):
and then the value of the moneyafter you invest it.
And hopefully the value of themoney after you invest it is
greater than the future value ofthat money would you have, have
not done anything, right?
So that's the key because theinternal rate of return
increases over time as the cashflow generated by the business

(03:23):
increases and is divided by theset expenses and initial
investment, right?
And that's the other differencethere because as the business
generates cashflow, that's, youknow, the money left over after
all your expenses and stuffother than mortgage, as it

(03:45):
increases, then that amount isalso Put into the mix to
determine your internal rate ofreturn.
And I'll explain that a littlebit more slides to come.
Now the return on investmentindicates the total growth of
the investment.
And for real estate, it's mostcommonly analyzed on an annual

(04:10):
basis.
Most of you will probably.
Not use internal rate of return.
Most for real estate.
Most of you will probably usethe return on investment and
why?
Well, it's more commonly usedbecause it is a simpler way of
determining the profit of theinvestment without adding the

(04:31):
net present value of moneyconsideration that the internal
rate of return utilizes.
And I'm going to shed a littlebit more light here on that in
the next three slides.
So here I have, And segmenthere, and on the next slide, I

(04:53):
have the next part of it.
I had to break this up into twoslides because this is a rental
property cash flow analysistemplate.
Now, these are available.
There's many online calculatorsfor this.
This is just one that I happenedto choose because it was pretty
easy to use.
Now, first thing you need to dois you need to determine the net

(05:16):
operating income and the cashflow, right?
So, first you start with,determining what is the gross
monthly operating income.
And to determine that, as youcan see in the first section, Up
on the top, we have three unitsfor this property, average

(05:37):
monthly rent per unit, totalrental income, for the three
units per month.
Then we have a vacancy factorand we have a gross monthly
operating income.
So it's average rent per unit inthis case, 250 a night times 30
nights times the number ofunits.

(05:59):
And then, after considering our25 percent vacancy factor, we're
at 16, 875 as gross monthlyoperating income.
Right.
So then after that, We need todetermine the monthly operating,
fixed and variable expenses,right?

(06:23):
Those can be obtained from the,property information.
You're looking at stuff likeproperty management fees,
repairs and maintenance, realestate taxes.
And remember, these are allbroken down onto a monthly
basis, so you may have theannual figure for some of these,
like taxes and insurance, andyou're just gonna divide by 12.

(06:46):
So, homeowners or propertyassociation fees, if applicable,
what is being put intoreplacement reserve for future
expenditures, what are theutilities, and any other monthly
operating expenses for the unit.
So then you get your total thereof your opera of your monthly

(07:09):
operating fixed and variableexpenses.
And then you have to determinethe annual net operating income.
So for that, you would get yourgross monthly operating income,
which we've already determined.
It's right here, this sectionright here, the gross monthly

(07:30):
operating income minus themonthly operating.
operating expenses and that willgive you your annual net
operating income.
So we have that figure righthere, the 149, 596.
04.

(07:52):
Then next we would, We wouldcalculate the cap rate and the
cap rate is calculated bydividing the net operating
income figure is 149, 596.
04 by the property value to giveyou a cap rate.
In this case, we have a cap rateof 11.

(08:15):
51.
And then we have here to finishour calculations.
Now, Now we have, we're, we'restill working on our ROI because
ROI return on investment isbasically your cash on cash

(08:35):
return.
That's where we're trying to getto the cash flow, right?
So we've determined here the,net operating income, but that's
not our cash flow because, Imean, it's our cash flow if the
property, is, free and clear,doesn't have a loan on it.
So in this case, now wedetermine our, we have to come

(08:57):
up with our annual debt serviceamount.
So we have our down paymenthere.
We have our loan amount.
We have our acquisition costsand loan fees, when the property
was purchased, the length of themortgage.
And the annual interest rate.
So in this case, the initialinvestment total, was 202, 485.

(09:23):
And then, you know, that is ourdown payment plus our
acquisition costs and loan feesthat you see right there.
So 202, 485, our monthlymortgage payment, 7725.
73.
Out of that, we have 82, 523.

(09:44):
22 is interest and 10, 185.
49 is principal.
So, our total annual debtservice is Is 92, 708 and 71
cents.

(10:05):
So then what you do there is,and let me back up to the other
slide, you get the annual netoperating income, one 49, five
96 cents.
04 and you subtract the totalannual debt service of 92 708.

(10:25):
71 to arrive at our annual cashflow before taxes of 56, 887.
33.
And then on a monthly basis it's4, 740.
61.

(10:50):
So basically, once we have yourour cash flow, then the cash on
cash return is basicallydividing the annual cash flow,
56,887 point 33 by the initialinvestment of 2 0 2 4 85 to

(11:14):
arrive at your return oninvestment.
Of 28.
09%.
So now regarding the internalrate of return, right?
Cause that was ROI and theinternal rate of return is a
very complicated formula becauseyou're looking at net present

(11:36):
value of the money.
You also have to take intoconsideration other factors,
like the term of the investment,right?
Because the initial investment.
Will be spread out over timethat allows more cash flow to be
considered into the equation.
So it could be a moving targetif, if, the term of the

(11:58):
investment is fluid, right?
So that's why it's really,Better really just to grab the
online calculator, put theinformation in there and just
click calculate.
Oh, now, as I was saying, the,if, if the investment will be
sold, that's another thing thatyou have to take into

(12:21):
consideration.
Because then the profit from thesale will also need to be
included.
That, that profit figure may notbe clear when you're initially
investing, right?
You're investing now.
You expect the investment tohave a term of three years or
four years, but you don't reallyknow what the investment will

(12:43):
sell for after three or fouryears.
I mean, you can estimate it.
So you'll have an estimatedinternal rate of return, but.
You know, is that a realisticfigure really depends,
especially with real estate,right?
I mean, property values go up,property values go down again.
That's why, investors tend tolike more the return on

(13:05):
investment rather than theinternal rate of return.
Now, the main thing, theinternal rate of return is good
for that.
It's a good method to calculatehow long it will take to recover
the initial investment.
When you take into considerationthe net present value of the

(13:27):
money, because as I was statingearlier, if you have that money
available to you now, I mean, isit better just to put it in some
interest bearing, instrument, oris it better to put it into
wherever you're going to investit?
Or is it better just to let itsit?
I mean, a lot of considerations,because of the net present value

(13:48):
and the future value of themoney.
So to recap, Most investors doprefer to calculate ROI instead
of internal rate of returnbecause the ROI gives a clearer
picture of the profitability ofthe project, whereas the
internal rate of return willalso take into consideration net

(14:09):
present value of the moneyinvested and is a better measure
to determine how long it willtake to recover the investment.
As well as the rate of returntaking into consideration the
net present value of the fundsinvested.
And that's what makes it a morecomplicated calculation because
if you mess up on the netpresent value of the funds

(14:30):
invested, you're going to throwoff the whole calculation.
So, the moral of the story hereis I would probably concentrate,
especially when you're dealingwith your investors.
Right.
I would probably, concentrate ondealing more or analyzing more
the return on investment ratherthan the internal rate of

(14:52):
return.
So you can make sure that youadd value to the transaction.
Don't confuse the investor andthen maybe have the investor
thinking that you're makingstuff up.
don't know what you're talkingabout.
Maybe you're a great loanofficer.
But maybe you get a little bitover your head trying to talk
about internal rate of return.
And then next thing, you know,the investor loses confidence in

(15:16):
your credibility and maybe youlose out on that loan, which you
perfectly could have, could haveoriginated because you were
trying to offer assistance onthings of which you had no
knowledge.
So it's, it's good to try to bea consultant, but you know, we
don't want to start making stuffup.

(15:36):
And then lose our credibilityand not be able to, close the
deal, right?
Lose the deal instead of closethe deal.
So at the mortgage calculator,we're all about adding value to
the transaction as loanconsultants.
And we definitely look forwardto having you all, reach out to
us for all of your investmentproperty needs.

(15:57):
Let's see here.
I think there's some questionscoming in that we could pull up
here.
First question is where do youget the monthly rental income
data for the Well, that would bebased on actual property

(16:19):
information, right?
So, if it's a property that youalready own, you should know
what it's renting for.
If it's a prospective propertylooking to buy, well then you
could reach out to the seller tosee if they have a rent roll.
If you're a realtor or if you'reworking with a real estate
agent, you could do rentalmarket analysis and see what the

(16:40):
rental market comps are.
So, you know, a lot of differentways to do it.
We always actually, you know, wealways prefer actual data rather
than market data, if it, if it,if it is actually available.
So if the property is available,is rented, you're going to ask
for a rent growth.

(17:05):
The question is, can I use thesame analysis to figure out
whether the asking price isreflective of true to value on
the property that is beingrented?
Yeah, absolutely.
That's why, you know, the, theanalysis talks about cap rate
really.
Now, that's really the one, thata lot of investors tend to look
at as well when they're tryingto determine the value of a

(17:26):
property, depending on themarket, there's going to be like
a multiplier.
That you're going to consider,you know, is it three times,
four times, five times, whateverit may be for that area, for
that property type, right?
If it's an a type property, a Btype property, a C type
property, but definitely that's,that's, for investment

(17:49):
properties, it's all about theincome, sales approach, you
know, because now we're talkingabout appraisals and valuations.
So when you are doing avaluation, you're going to have
the, the The sales approachyou're going to have the income
approach and you're going tohave the reproduction Approach,
you know, how much is it goingto cost you to reproduce the
structure and the land?

(18:10):
So for investment propertiestrue investment properties I
definitely like to look at theincome approach And see what the
cap rate is at and then see ifthat's something that suits
their fancy.
I don't see any other questionsBut a great analysis.

(18:31):
They're a great topic here fortonight So we appreciate
everybody tuning in and rememberwe do this at 7 p.
m.
Eastern time on TuesdaysWednesdays and Thursdays So we
will see you all tomorrow at 7p.
m.
Eastern for the next episode ofthe loan officer training series

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Loan Officer Training 07/10/2024 - How to Analyze Internal Rate of Return

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