Real Estate Investments

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Real Estate Investments

• Topic 12
• I. The Nature Scope ofReal Estate Investments

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A. Definition of Real Estate

• Real Estate is artificially delineated space
  referenced 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.

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Concepts

• 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

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D. Characteristics

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

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E. Investor Motivations

• 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

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F. Investment Disadvantages and Risks

• 1. Illiquid
• 2. Management
• 3. Depreciation of Value
• 4. Government Controls
• 5. Real Estate Cycles
• 6. Legal Complexity

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G. Participants

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

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Real Estate Investments

• Topic 12
• II. Overview ofInvestment Decision Process

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A. Framework for Real Estate Investment Studies

• 1. Strategy
• Develop an overall investment philosophy
• 2. Analysis
• Measuring return
• 3. Decisions
• Risk and return evaluations
• 4. Investment Transaction
• 5. Feedback

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B. Investment Analysis vs. Feasibility Analysis

• 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

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B. Investment Analysis vs. Feasibility Analysis
(continued)

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

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B. Investment Analysis vs. Feasibility Analysis
(continued)

• 4. Ownership Life Cycle
• a. Acquisition
• b. Operation
• c. Disposal/Termination
• 5. Investor Life Cycle
• a. Young Investor
• b. Middle Aged Investor
• c. Older Investor
• d. Institutional Investor

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Real Estate Investments

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

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B. Traditional Financial Decision Making
Approaches

• 1. Investment Value Approach
• a. Invest if V ? C
• b. Reject if V ? C
• 2. IRV
• Assumes
• a. Productivity NOI
• b. NOI is stabilized
• c. Holding period is infinite
• d. Capital is recaptured from income, except
  land

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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

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Stabilized NOI (continued)

• Stabilized NOI PV of ?NOI/PV of Annuity
• Stabilized NOI 256,963 / 4.292179
• Stabilized NOI 59,868

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Estimating Re

• Consider
• a. Real Rate of Return
• b. Inflation
• c. Risk Premium

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C. Modern Capital Budgeting Approaches

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

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Investment Principles

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

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Investment Principles

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

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Sources of Return from aReal Estate Investment

• Cash flow from operations
• Tax Savings
• Equity buildup from loan amortization
• Loan refinancing proceeds
• Appreciation of property value (sales proceeds)

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The Market Revenue Model (Back Door)
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The Capital Revenue Model (Front Door)
PGI/Net Leasable Area Required Rent to be
Charged
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Example Data

• 1. Project Cost 7,000,000
• 2. M .80
• 3. Loan Terms .064, 20 yrs, annual pmts.
• Hence, Rm .09
• 4. RE Taxes 10Operating Expenses
  30Vacancy Allowance 5
• Market Rents 4.00/S.F.
• Reserve Account 44,000
• Re 14

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Example Data (continued)

• 1. Cost of Project 7,000,000
• 2. Loan to Value 0.800
• 3. Mortgage Constant 0.140
• 4. Mortgage Constant 0.129
• 5. Operating Expenses 343,000
• 6. Vacancy Losses 55,500
• 7. Net Leasable Area 260,000

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Capital Revenue Model (CRM)

• Cost of Project 7,000,000
• Equity Amount 1,400,000
• Cash Throwoff 196,000
• Debt Amount 5,600,000
• Annual Debt Service 504,000
• Net Operating Income 700,000
• Plus Operating Expenses 343,000
• Plus Vacancy Losses 55,500
• Equals Potential Gross Income 1,098,500
• PGI/Net Leasable Area EqualsREQUIRED RENT
  4.225

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Example Data (continued)

• 1. Cost of Project 7,000,000
• 2. Loan to Value 0.800
• 3. Equity Dividend Rate 0.140
• 4. Mortgage Constant 0.129
• 5. Operating Expenses 37.21
• 6. Vacancy Losses 5.00
• 7. Net Leasable Area 80,000

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Market Revenue Model (MRM)

• 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

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Market Revenue Model (MRM) (continued)

• Justified Investment Value 7,150,793