Real Estate Investments Topic 12 I The Nature

Real Estate Investments Topic 12 I. The Nature & Scope of Real Estate Investments

A. Definition of Real Estate n Real Estate is artificially delineated space references to a fixed point on the surface of the earth with a fourth dimension of time. It is built to house an economic activity that is subject to cultural preferences and restricted by the public infrastructure.

Concepts n B. Space--Time Product • Real estate is a space-time product, that is it generates income over time in exchange for the use of space. Examples: apartments, football tickets, wedding receptions

D. Characteristics n The Real Estate Market Characteristics: • • • 1. 2. 3. 4. 5. Highly Stratified, Local Markets Heterogeneous Product Private, not Public, Transactions Unsophisticated Investors Unorganized Market

E. Investor Motivations n n n n n 1. Pride in Ownership 2. Personal Control 3. Self-use and Occupancy 4. Estate Building 5. Security of Capital 6. High Operating Yield 7. Leverage 8. Tax Shelter 9. Capital Appreciation 10. Portfolio Diversification

F. Investment Disadvantages and Risks 1. n 2. n 3. n 4. n 5. n 6. n Illiquid Management Depreciation of Value Government Controls Real Estate Cycles Legal Complexity

G. Participants 1. Builder/developer n 2. Syndicator n 3. Property Manager n 4. Construction Lender n 5. Permanent Lender n 6. Managing Equity Investor n 7. Passive Equity Investor n

Real Estate Investments Topic 12 II. Overview of Investment Decision Process

A. Framework for Real Estate Investment Studies n 1. Strategy • Develop an overall investment philosophy n 2. Analysis • Measuring return n 3. Decisions • Risk and return evaluations 4. Investment Transaction n 5. Feedback n

B. Investment Analysis vs. Feasibility Analysis n 1. Investment and Investment Analysis • • a. Capital Assets b. Equity c. Debt d. NOI e. Lender/Equity Relation f. Maximizing Wealth g. Return and Risk

B. Investment Analysis vs. Feasibility Analysis (continued) n 2. Feasibility and Feasibility Analysis • • • n a. b. c. Site in Search of a Use in Search of a Site Investor Looking for the Best Investment Alternative 3. Investment Life Cycles • • • a. b. c. Property Life Cycle Ownership Life Cycle Investor Life Cycle

B. Investment Analysis vs. Feasibility Analysis (continued) n 4. Ownership Life Cycle • • • n a. b. c. Acquisition Operation Disposal/Termination 5. Investor Life Cycle • • a. b. c. d. Young Investor Middle Aged Investor Older Investor Institutional Investor

Real Estate Investments Topic 12 III. Decision Making Approaches to Real Estate Investment

B. Traditional Financial Decision Making Approaches n 1. Investment Value Approach • a. Invest if: V C • b. Reject if: V C n 2. IRV I • Assumes: – a. Productivity = NOI o – b. NOI is stabilized – c. Holding period is infinite – d. Capital is recaptured from income, except land R V

Stabilized NOI Ye = 10. 5% Year NOI * PV factor PV 1 $53, 918 *. 904977 $48, 795 2 56, 645 *. 818984 46. 391 3 59, 352 *. 741162 43, 989 4 62, 037 *. 670735 41, 610 5 64, 698 *. 607000 39, 272 6 67, 185 *. 549321 36, 906 Sum = $256, 963 n

Stabilized NOI (continued) Stabilized NOI = PV of NOI/PV of Annuity n Stabilized NOI = $256, 963 / 4. 292179 n Stabilized NOI = $59, 868 n

Estimating Re n Consider: • a. • b. • c. Real Rate of Return Inflation Risk Premium

C. Modern Capital Budgeting Approaches 1. n 2. n 3. n 4. n The Present Value Model Internal Rate of Return Modified Internal Rate of Return Risk Analysis • a. Ratio and Sensitivity • b. Simulation • c. Elasticity

Investment Principles 1. The investor should buy the assumptions that create the yield rather than the yield itself. n 2. The investor should be as concerned about what to offer the next buyer as with what he is buying n 3. The investor should price the property apart from the tax advantages. n

Investment Principles 4. The investor must compare alternatives. n 5. The investor should understand the potential profit and risk in terms of DOLLARS. n

Sources of Return from a Real Estate Investment Cash flow from operations n Tax Savings n Equity buildup from loan amortization n Loan refinancing proceeds n Appreciation of property value (sales proceeds) n

The Market Revenue Model : (Back Door) Market Rents Equity Acct. Cash x BEP = Margin = (1 - BEP) x - Reserves - Vacancy - RE Taxes - Operating Exp. CTO CASH FOR DEBT Re Rm JEA JMA + Justified Investment Value

The Capital Revenue Model: (Front Door) Cost of Project Equity = (1 - m) x Amount x m= Debt Amount x Re x Rm CTO ADS + NOI + Operating Expenses + Real Estate Taxes + Vacancy Allowance PGI/Net Leasable Area = Required Rent to be Charged

Example Data n n n 1. 2. 3. Project Cost: $7, 000 M =. 80 Loan Terms: . 064, 20 yrs, annual pmts. • Hence, Rm =. 09 n n 4. RE Taxes = 10% Operating Expenses = 30% Vacancy Allowance = 5% Market Rents = $4. 00/S. F. Reserve Account = $44, 000 Re = 14%

Example Data (continued) 1. n 2. n 3. n 4. n 5. n 6. n 7. n Cost of Project: $7, 000 Loan to Value: 0. 800 Mortgage Constant: 0. 140 Mortgage Constant: 0. 129 Operating Expenses: $343, 000 Vacancy Losses: $55, 500 Net Leasable Area: 260, 000

Capital Revenue Model (CRM) n n n n n Cost of Project: Equity Amount: Cash Throwoff: Debt Amount: Annual Debt Service: Net Operating Income: Plus Operating Expenses: Plus Vacancy Losses: Equals Potential Gross Income: PGI/Net Leasable Area Equals REQUIRED RENT: $7, 000 $1, 400, 000 $ 196, 000 $5, 600, 000 $ 504, 000 $ 700, 000 $ 343000 $ 55, 500 $1, 098, 500 $4. 225

Example Data (continued) 1. n 2. n 3. n 4. n 5. n 6. n 7. n Cost of Project: $7, 000 Loan to Value: 0. 800 Equity Dividend Rate: 0. 140 Mortgage Constant: 0. 129 Operating Expenses: 37. 21% Vacancy Losses: 5. 00% Net Leasable Area: 80, 000

Market Revenue Model (MRM) n n n Market Rents: $1, 100, 000 Cash Retained for Equity Account: $ 166, 500 Less Reserves: $ 44, 000 Less Vacancy: $ 55, 500 Equals Cash Throw-Off: $ 67, 000 Divided by Re Equals Just. Eq. Amt. : $ 478, 571 Account Allowing for Monies-Out: $ 943, 500 Less Operating Expenses: $ 333, 000 Less Real Estate Taxes: $ 10, 000 Equals Cash for Debt: $ 600, 500 Divided by Rm Equals Just. Debt Amt. : $6, 672, 222

Market Revenue Model (MRM) (continued) n Justified Investment Value: $7, 150, 793