Introduction to Real Estate Investing and Investment Analysis

1. Lecture 11 Introduction to Real Estate Investing

2. Types of Investment Opportunities • Ownership of Income-Earning Assets • Savings Accounts • Corporate Bonds • Gov’t Bonds • Common/Preferred Stock • Non-Financial Assets • Commodities • Business Ventures • Luxury Items

3. Real Estate Investment • Real Estate Mortgage Investment • Interest payments derive rates of return • S & L’s, Lending Institutions, Brokerages • Owner Financing • Real Estate Equity Investment • Income-earning capacity based on factors such as NOI, EGI, PGI, expenses, etc. • Specific to individual investor’s return requirements

4. Specific Investor Objectives • 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

5. Risks in Real Estate Investment • Business or Income Risk • Unanticipated changes in the economy • Financial Risk • Expenses exceed income • Principal Risk • Property value expected to increase when market values for the property in fact decline • Interest/Money Market Risk • Changes in Capitalization Rates • Purchasing Power Risk • Inflationary changes in the economy

6. Obstacles in Real Estate Investment • Objective information sources about the Subject are difficult to obtain • Comparable property data is limited • Reliable price quotations are not available on a frequent basis • Typically only a select amount of buyers/sellers in a market • Transactions are cumbersome, time-consuming, inefficient, etc. • Time-consuming negotiating and bargaining • Legal factors and tax considerations • Relatively illiquid market

7. Lecture 11 Investment Analysis

8. Purpose of Investment Analysis • Analyze property- and investor-specific items that derive property value • Income and Expense Factors (historical and forecasted) • Specific investor/investment (return) objectives

9. Income Items in Investment Analysis • Contract rents (NOT market rents) for leased periods • Vacancy and collections based on lease contracts

10. Expense Items in Investment Analysis • Considers debt obligations • Before-Tax Cash Flow and After-Tax Cash Flow • Considers ad Valorem property taxes, operating expenses, depreciation allowances, capital improvement expenditures (replacement reserves)

11. Before-Tax Operating Income Potential Gross Income (PGI) Less: Vacancy/Collection Loss Allowance Effective Gross Income (EGI) Less: Operating Expenses/Management Fees Before Debt Net Operating Income (NOI) Less: Debt Service Before-Tax Cash Flow (BTCF)

12. Lecture 11 Value Determination from Cash Flow

13. Discount Rate v. Capitalization Rate • Capitalization Rate • Converts one cash flow into a value determinant • Discount Rate • “Discounts” streams of cash flows into present values based on the theory of “Time Value of Money” • Used for highly-volatile streams of cash flows

14. Lecture 11 Example: Apartment Building