Here's How an Investor Analyzes Real Estate | Morgan Stanley Investor, Andy Chase

So now you're in real estate. It's net rents over price. Anyone know what property taxes are in San Mateo? 1%. Well, the state mandate is 1%. You start with 1% of the purchase price and then towns, counties will add on top of that depending on where you live to finance schools or extra projects they have. They can assess their, you know, homeowners extra money on top of that. So depending on how good the schools are, it can be 1.25%, 1.5%. I'm not sure right in San Mateo if it's 1.25% or 1.5%, but it's something like that. So when somebody says this building's worth $10 million, how do they come to that number like that? Anyone have an idea? The cost of the land, the cost of the whole building, the infrastructure, the exterior. Sometimes people will look at a building and say it's the replacement cost of It really comes down to what you could rent it for. And if somebody says this building's worth $10 million, I'd say, okay, if Tim has gross rents of $900,000, because if I have gross rents of $900K, I will tell you, well, if you buy this building for $10 million, guarantee you've got $125,000 worth of taxes. That's just 1.25. So now you're minus 1, and it's per year. That's tax. What does it cost for insurance here? Insurance on a building like this with students running around, pools? And gym. I don't know, but I'll bet you it's $50 grand or something. Minus $50K, that's insurance. What do you think it costs for maintenance? How many people, security, is there some plumbers, electricians, stuff's going— when you have a building with 40 rooms, 100 rooms, whatever, what do you think it costs to maintain something like this? You got even one guy full-time overseeing the entire building. I think you got K, just like a representative perhaps. Yeah, now it could be one carpenter, it could be one plumber, one electrician, one handyman, one guy. Making sure the garbage goes out. I don't care what it is, but I can guarantee a building this size has probably got 2 people. Hell, I know houses where they've got full-time caretakers. People aren't cheap. People— I'll say this person costs $100 grand. So they got 2 people at $100 grand, there's $200K right there. That's without any maintenance, depreciation, any special projects like the air conditioning unit broke. This is just basic per-year stuff, which means $175,000, $375,000. So this, this $900 grand— $900 grand. What is, what is his net rents, right? Now you're down to a yield because you paid $10 million up here, right? And that's your denominator. Your numerator is what you've made. You know, you start with the gross rents here and you're left with making, what is it, $425,000, $525,000? $525,000. $525,000, maybe if nothing went wrong and I don't need to repaint it or something, a one-off. Capital expenditure. Capital expenditure. So I'm getting 5.25% on $10 million. Okay, but I have— I mean, there's a pain in the ass owning real estate. I mean, I just said I could buy a bond in General Motors and get 5.5% and not do a damn thing. So unless I think I can raise the rents on you guys and you guys are going to pay more and more and more tuition every year or whatever, you know, is the building worth $10 million? Maybe. It's paying 5.25%. And that's starting with, you know, $900 grand in rents. And I'll bet you right now he doesn't get $900 grand in rents per year from you guys. And I'll bet you I'm light on all these numbers personally, just knowing what costs are around here. But that's how investors look at real estate. You look at it and say, okay, and that's called a cap rate. In that example, that's called a 5.25. I'm paying— I'm getting a 5.25 cap. And what's it growing at plus? 3%. Some percentage because we know the bonds can't grow. That's static. Hopefully over time you buy a— I don't care if you buy a multifamily apartment, you buy a commercial building, you buy a hotel. Hopefully you can raise the rents over time and going back, is this building worth more next year? It's only worth more if the landlord or frankly the other buyer thinks he can raise rents. It's also worth more if door number 1 Rates have gone down. Think about that one. Yeah. How have you come to— okay, let's say you said the valuation is based on rent, but you've worked out rental yield based on valuation. Where is that coming from? I just made up a price. Somebody says this building's worth $10 million. I mean, why is it worth $10 million? No, I said where does the valuation come from? The value— well, I know— you know this number. You know it, and you can then say, okay, 5.25, maybe it's worth 10 because if I'm getting $500 grand of cash flow, it's worth something. I mean, if the building was only worth $5 million and now I'm getting over 10% yield, that's useful. And this is why everything's relative and this is what's key is that if your choice on door number 1 is Treasuries at 2 or Apple bonds at 3 or General Motors, something like that at 5, whatever. 5. And I can get— and this building's yielding me 5%, it's okay. Over time, properties in San Mateo, they're probably raising rents over time. Expectation. Right? And if you— they're raising rents, they were raising rents in San Francisco like maniacs, and a lot of major cities. I think it's about to slow down. It has to stop because you can't have Facebook, Google, name your company, cannot pay starting engineers. I got one of my kids an engineer up in the city. He started at $120 grand, you know, EE computer science, smart kid. So I was like, okay, it is what it is. But they're not gonna pay starting guys, you just can't pay those kind of salaries. Those are net salaries, not with benefits. I'll come back to that one too. And so you, it's hard. And so these buildings are worth, this is worth more if the landlord can raise rents, but I'll tell you— 2000, 2010, if you owned a commercial building, even in Santa Clara, you didn't raise rents. It's just recently that housing has started to go up, but commercial buildings, you can't drive around in the East Bay without seeing a for lease sign somewhere. That's not the case in San Francisco right now, 'cause I'm not sure where y'all are from, but I mean, most major downtown cities are getting pretty tight on real estate, but you go out into the East Bay, You go to even Santa Clara, there's space available for rent all the time. Landlord cannot raise rents. He's just happy to have his building rented. So, and if you go to Iowa or something like that, I guarantee the landlord's just happy to have it rented and he just wants to get a reasonable return, but that return will be relative to this. Why? Why do these things have to be somewhat consistent? Because the landlord has cost of capital. Why? Well, yeah, because people aren't stupid. That's why is the answer. Because if people are saying, wait a minute, I'm going to get— if this building was only worth $5 million and I could get 10%, I'll buy this all day long if my choice is only earning 5% on a bond. But if the building's paying me 5% and I've got to hire property managers and people, and I mean, it's a pain in the ass owning buildings. It really is.