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Equity Investment & The Investment Decision

Equity Investment & The Investment Decision. Real Estate Investment Advantages. Pride in Ownership Personal control Self-use & Occupancy Estate Building Security of Capital Operating Cash Flows Leverage Tax Shelter factors Capital Appreciation & Inflation Protection.

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Equity Investment & The Investment Decision

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  1. Equity Investment&The Investment Decision

  2. Real Estate Investment Advantages • Pride in Ownership • Personal control • Self-use & Occupancy • Estate Building • Security of Capital • Operating Cash Flows • Leverage • Tax Shelter factors • Capital Appreciation & Inflation Protection

  3. Real Estate Disadvantages • Illiquidity • Required equity capital • Management burden • Depreciation of value • Government controls • Real estate cycles • Legal complexity • Lack of information & education

  4. Trade-Offs:Risk/Return

  5. Risks • Legal: Zoning, public opinion, public services, etc. • Market risks: Marketability study • Will it rent? Will it sell? • Market study: S&D, Competition • Absorption rates: How fast is space being utilized

  6. Risks Cost risks: • Interest rates • Estimates poor • Labor • Weather Possible Solutions: • Guaranteed price contracts • Watch out for cushion • General contractors: Reputable & bonded • Completion bond (Lenders may require) • Guarantees price • Cost plus contracts: Developer pays costs + fee

  7. Return Measures • Cash Flow (Net Spendable) Pro Forma: • Cash on Cash= Net Spendable/Down payment • =1100/10000=11%

  8. Return Measures • Rate of return on total capital: = NOI/Total Capital • = 14/120 = 11.7% • Return on Equity (ROE) = CF Before Tax/Equity • = 1.1/20 = 5.5% • Favorable leverage: If ROE > ROR • If unfavorable leverage: • Don't buy • Reduce Price • Try to lower APR or increase term • Raise NOI or lower expenses • Restructure (ie., more equity)

  9. Return Measures • Equity cap rate: = CF before Tax/Equity • (ie., required ROE) • For example: • Your desired cap rate is 14% • CF before tax is $1,100 • Equity value = 1.1/.14 = $7,857 • Plus loan of $100K • Therefore property value = $107,857 • Risk measures: BEP & Debt Coverage Ratio

  10. Discounted CF Analysis • Income Cap Rate: • NOI/Market Value • Compare to other opportunities • Do Cash Flow Spread sheet: • Ratio Analysis • Sensitivity Analysis: • What if we change the value of a variable? • Scenario Analysis: Worst versus Best? • Monte Carlo Analysis: • Randomly assign values & check bottom line

  11. Investment Analysis Process • Strategy: Determine First!! • Return/Risk Objectives • Ownership Form • Market Analysis • Screening Criteria • Location/Property Analysis • Generate Alternatives: Those that pass screen • Use Basic Financial Feasibility Model • Develop Finance Screens (APRs, CapRates, NOI) • Examine Finance Alternatives (Loans, Equity, etc)

  12. Investment Analysis Process • Negotiate Basic Terms with Seller • Price • Financing • Covenants • Escape Clause • Do Detailed Feasibility Research • Market: • Supply & Demand, Competition, Absorption, Vacancy • Marketability: Property Condition • Legal, Political, Environmental • Management & Operations

  13. Investment Analysis Process • Structure Tax Benefits • Cost Recovery • Useful Life • Passive Loss Limitations • Discounted CF Analysis • After-Tax CF, DCF, Adjust for Risk • Final Negotiations & Closing • Management of Property • Termination • Sell, merger, IPO

  14. Control • Purchase Price & Terms • Form of Ownership • Financing amounts, rates, terms • Tax structure & Planning • Property management • Property location • Tenants & Lease rates & terms

  15. Negotiation • Maximize knowledge position First! • Set your initial demands far from final objective • Probe for bottom line • Raiseyour aspiration level/deflate your opponent's • Buyer: • Start with lower price than seller wants • Lukewarm attitude • Point out defects • Mention competitive offers • Seller: • Mention other offers you have rejected • Price is probably going up • Negotiate most critical items first and

  16. Negotiation (Cont) • Concentrate on items that effect profits • Down payment, price, contract period • Employ conservative concession policy • Don't give in or reciprocate/ • No sportsmanship/ • Never concede first • Never accept a radical counteroffer without analysis • Use intermediaries when to your advantage • With agent, more time to analyze • Advisor: Openly discuss concerns • Try for better deal for both parties: • Place proof burden & satisfaction on them • Prove to you that it is an attractive opportunity

  17. Negotiation (Tactics) • Standard Practice: Terms are "standard practice" • Bogey: “I only can afford $7,500 in cash" • Good guy/Bad guy: • One makes strong demands ... • Opponent is more susceptible to good guy's weaker demands • Deadline: Always use them! • Nibbling: Get additional minor concessions after major agreement • The tie-up: Get the property off the market while you're making decision

  18. Property Types • Land • Most Risky • Low income • Interest, taxes, insurance • Interest deduct income only • No depreciation • 20-30% ROR for risk • Consider • Access/Slope • Zoning • Public services & Utilities • Return=capital appreciation

  19. Property Types • Residential Rental (Houses,Apts,MHs) • Management Intensive • Good financing • Tax shelter • High appreciation • Know location & physical condition • Check neighborhood & proximity to services • Good first step for real estate • Some income -- mostly capital appreciation

  20. Property Types • Office Buildings • More income/less appreciation • Appreciation can be improved w/ maintenance • Needs more knowledge for leasing & • Property management • Types: Downtown vs Suburban Medium vs HiRise vs Garden (Low) • Locations: Highways / Shopping Centers • Better construction • Low tenant turnover ratios • Prestigious clients

  21. Property Types : Shopping Centers • Most sophisticated Investment & Management Expertise • Much more income than appreciation/Few Foreclosed! • Owned by wealthy investors (TIAA/CREF=Mall of Amer) • Types: • Neighborhood center: (Strip): Food, drugs, etc, Built around supermarket/drugstore: 50K Gross leaseable area • Community center: + Clothing, furniture, bank, prof: 150K GLA • Regional center: Full-line Dept store (Anchor): Reit & Insur=Ownership; 400K GLA • Super Regional Centers: Major metro area: 2 anchors, 100-200 stores, Usually % of profits

  22. Property Types : Industrial & Special • Industrial • Warehouses, factories, indust parks • Almost all income • Not easily converted … increases risk • Low risk overall if you have a client • Near highways • Special Use • Need expertise: RE + the application • Risky: Be ready to substitute • Loans are hard to get … banks ?? • Requires time commitment

  23. Development • Overview • Combine land, labor, capital & Entrepreneurial ability • Good developers can “visualize” good uses of space • Creation of space for play, living & working • LT Motive=Income, Mgt, Community/ ST Motive=Cap Gain • Redevelopment: Restoration of older structure

  24. Development • Types: • Land Prep: Lots of all kinds • Sell land to other developers • Erect improvements on land • Who Develops? • Part-time • Proprietorship • Corporation, etc. • Joint ventures (ie., 2 developers)

  25. Development Process:Be ready to bail outStages may be done simultaneously • Idea:Can develop over life of project • Preliminary Feasibility: Rough cut analysis • Are computer programs: Go if profit looks good • GainControl: Ground lease(ties you up), option, seller fin • Feasibility Analysis & Design: • Detailed analysis, Check site, market, legal, financial • Finance: Need cash ASAP, should have already talked • Construction: Problems: cost overruns & contractor fails • Marketing: Lease (don’t lease too early rates change) vsSale: When … remember trade-offs

  26. Redevelopment & trends • Redevelopment: • Costs are high, structures - obsolete • ITCs, grants • Popular trend • Trends: • Mixed use development: One structure • Planned unit development (PUD) • New towns/Village concept: Integrated approach: work, shop, play, live

  27. Professional Help • Real Estate Brokers: • Get a specialist! Has access to information • Appraisers & consultants: Can do DCF • Property managers: • Has rental & vacancy rates, op. expenses, etc • Morgage bankers: • Arrange deals & financing alternatives • Tax advisers and attorneys • Others: • Comm banks, Engineers, Architects, Contractors

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