CHAPTER ELEVEN

1. CHAPTER ELEVEN INVESTMENT ANALYSIS AND TAXATION OF INCOME PROPERTIES

2. Motivation For Investing • Rate of return • Price appreciation • Diversification • Tax benefits

3. Hierarchy of Investment Strategies • Sector or Industry • Type of property in the industry

4. Investment Strategies • Property sector investing • Contrarian investing • Major economic, technological and other factors would make a property of poor type. • Market timing • Growth investing • Value investing • Overlooked by investors

5. Investment Strategies • Size of property • Strategy as to tenants • Arbitrage investing • Turn around/ special situation • Blue chip properties

6. Real Estate Investment Analysis • Investment Strategy • Investment philosophy • Investment objectives • Investment policies

7. Investment Decisions • Forecast cash flows from operations • Forecast cash flow from sale • Determine present value of expected cash flows • Apply an investment decision criterion

8. Forecasting Cash Flows From Operations • Potential Gross Income • Effective Gross Income • Operating Expenses • Net Operating Income • Non-Recurring Expenses

9. Net Operating Income Calculation

10. Net Operating Income Example

11. Forecasted Cash Flows From Net Operating Income

12. B- Forecasted Cash Proceeds From Sale

13. C- Present Value Calculation

14. Net Present Value (NPV) • The net present value is the present value of a project’s cash inflows, minus the present value of the cash outflows. • The cash flows are discounted at the investor’s required rate of return– in the example 12 percent.

15. Net Present Value Calculation

16. Net Present Value Calculation

17. NPV Decision Criteria • If NPV>0, the project exceeds the investor’s required rate of return. • If NPV<0, the project does not meet the investor’s required rate of return. • If NPV=0, the project’s expected return equals the investor’s required rate of return.

18. Internal Rate of Return (IRR) • The internal rate of return is the discount rate at which NPV=0, • the rate of return at which the present value of the cash inflowsequals the present value of the cash outflows.

19. IRR Decision Criteria • If IRR> the required rate of return, then accept. • If IRR< the required rate of return, then reject. • If IRR= the project’s expected return equals the investor’s required rate of return.

20. NPV and the IRR • NPV: cash flows assumed reinvested at discount rate • Generally preferred to IRR for making decisions • IRR: cash flows assumed reinvested at the IRR rate • May provide inferior wealth maximizing ranking of alternative opportunities to the NPV • Multiple solutions possible • Easily compared to other investments and widely used

21. Debt Financing • Capitalization Rate • Equity Dividend Rate • Mortgage Constant • Operating Expense Ratio • Loan-to-Value Ratio • Debt Coverage Ratio • Debt Service • Max debt service

22. Debt Financing: Investment Criteria: Profitability Ratios • Capitalization Rate: • Ro= NOI/ Acquisition Price • Equity Dividend Rate: • Re= EDR= BTCF/ Initial Equity • Mortgage Constant: • Rm= MC= Debt Service (DS)/ Initial Loan Amount • Debt service is the cash required over a given period for the repayment of interest and principal on a debt.

23. Investment Criteria: Financial Ratios • Operating Expense Ratio: • OER= Operating Expenses/ EGI • Loan-to-Value Ratio: • LTV= Mortgage Balance/ Property Value • Debt Coverage Ratio: • DCR= Net Operating Income/ Debt Service • Max debt service: • NOI/Desired DCR

24. End of chapter!