Real Estate Finance and Investments: Lecture 6

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Real Estate Finance and Investments Lecture 6

• Cost of
• Borrowed Money

2
Interest Costs and Rates

• Nominal rate or contract rate interest rate
  based on face amount of promissory note
• Effective rate rate actually paid
• Common difference lies with origination fees and
  discount points
• Real rate of interest effective rate, adjusted
  for price inflation

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Specific Investor Objectivesin Real Estate

• Periodic Cash Flow
• Liquidity
• Price Appreciation
• Increase in Equity Through Mortgage Reduction
• Tax Shelter
• High Rate of Return Equity
• Leverage
• Estate Building
• Inflation Hedging
• Psychological Factors

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Comparison of Financing Alternatives

• Effective interest rates differ
• Different contract rates
• Differences in effective rates due to differences
  in loan origination fees or discount fees
• Lenders often refuse to quote rate until late in
  loan approval process

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Real Estate Finance and Investments Lecture 6

• Measures of Investment Worth

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Ratio Analysis

• Ratios are employed to gauge the reasonableness
  of relationships between various measures of
  value and performance
• Income Multiplier Analysis
• Financial Ratio Analysis

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Income Multiplier Analysis

• Express the relationship between price and either
  gross or net income
• Multiplier analysis permits obviously
  unacceptable opportunities to be weeded out
• Gross income multipliers
• Market Price / EGI or PGI
• Net income multipliers
• Market Price / NOI

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Financial Ratio Analysis

• Frequently employed to facilitate inter-property
  comparisons.
• Operating ratio
• Operating Expenses / EGI
• Break-even ratio
• (Operating Expenses Debt Svc) / EGI
• Debt coverage ratio
• NOI / ADS

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Traditional Profitability Measures

• Attempt to relate cash investment to expected
  cash returns in some systematic fashionnot
  equally successful
• Overall capitalization rate (free-and-clear rate
  of return)
• NOI / Market Price
• Equity dividend rate (Cash-on-Cash rate of
  return)
• BTCF / Initial Cash Outlay (equity capital)

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Traditional Profitability Measures

• Brokers rate of return
• (ATCF Equity Buildup) / Initial Equity
• Payback period
• Cash Outlay / Annual Cash Flow

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Traditional Profitability Measures

• Shortcomings of traditional measures of
  investment performances
• Ignore cash-flow expectations during the later
  years of the holding period
• Ignore cash-flow expectations from disposal

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Adjustments for More Rational Analysis

• Five major factors governing the relative
  attractiveness of a real estate investment must
  be incorporated into rational real estate
  investment analysis

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Adjustments for More Rational AnalysisMajor
Factors

• Anticipated stream of net cash flow to the
  investor
• Expected timing of cash receipts
• Degree of certainty with which expectations are
  held
• Yields available from alternative investment
  opportunities
• Investors attitude toward risk

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Adjustments for More Rational Analysis

• Time-adjusted investment evaluation measures
• Discount expected future cash flows to make them
  more nearly comparable to those receivable in the
  present