Real Estate performance is determined through:
- The aggregation of multiple streams of income
- The preferential tax treatments of those income streams
- The value of the mortgage pay downs
- The impact of inflation
- Value created through repositioning
The components of value:
Annual Income Stream (Cash on Cash Return)
Upon completion or acquisition of a property, cash flow generated by the property is distributed to our investors on a quarterly basis. In Heritage Hill Capital Partners' investment opportunities, the initial investor return is typically in the range of 8% to 10% (annually) depending on type of real estate and risk level for that type of real estate. This return does not include the value add equity created repositioning.
Annual Increase on the Income Stream
In each real estate project, there are typically annual increases in revenues as the result of negotiated rent increases in the tenant leases. Modest annual increases in the range of 1% to 3% typically flow through to the cash flow at higher percentages because operating expenses are only a fraction of gross income. As a result, as the property matures, cash flows typically increase to levels above the initial preferred return.
Most real estate contains some level of mortgage debt and each mortgage requires all or partial reduction of principal during the life of the loan. This pay down reduces the mortgage balance and represents an additional (deferred) value to be received by the investor, either at the time of sale or re-finance of the property.
Increased Value of Real Estate
As the cash flow of the project increases, the overall value of the property also increases, typically at about the same percentage rate as the increase in the cash flow before debt service.
From a tax perspective, real estate is considered a depreciating asset. As a result, the tax laws allow the annual deduction of a portion of the value of the real estate based on the projected life of the property. Additionally, some expenses related to acquisition and/or development of the property is typically amortized over a shorter timeframe. The combination of these two events shelters a portion of the investor's cash flow from taxes. As a result, the cash flow has a higher pre-tax value than cash flows from unsheltered investments such as the dividends from stocks or the interest income from bonds.