Real estate- Chapter 2

fair estimate of today’s value

what should i pay for this asset

time value of money

value of a dollar in my pocket today is worth more than a dollar in my pocket in the future

present value

the current worth of all positive outcomes or gains that are expected to occur in the future, calculated by discounting those future benefits back using a specific discount rate, essentially telling you how much those future benefits are worth today based on the concept of tvm

income approach

assumes that the value of a property equals the present value of anticipated future benefits

opportunity cost

alternative investment opportunities of comparable risk are available.

financial principle

based on the assumption that a positive interest can be earned on an investment

compound interest theory

assumes periodic interest is earned on funds that have been deposited. interest is also earned on interest

discounting

mathematical process where expected future cash flows can be reduced to present value estimate by calculating what would be needed today to grow at compounded interest to the future expected value

time period, interest rate, future cash flows, present value

what is needed to compute the discounting process

reversionary cash flow

selling the property at teh end of the hold period

risk

credit worthiness, the certainty of any future cash flow is reliant on the underlying asset

interest rate

represents the rate of return or yield rate, the internal rate of return that the investor would expect to earn

internal rate of return

the discount rate that makes the Net Present Value of a project zero, discounts all expected future cash flows to a present value equal to the original investment

discount rate

can be any rate used to calculate the present value of future cash flows, minimum required rate of return,  higher the risk higher the minimum rate of return (lower the price)

risk free rate + risk premium

discount rate equation

risk free rate

generally considred to be the US treasury yield

risk premium

rate above the risk free rate that accounts for the illiquid nature of real estate

cash flow/(1+r)^t

present value equation

present value- initial investment

NPV equation

discounted cash flow

in commercial real estate, analysis is a valuation method that helps investor determine the value of a property over it s expected hold period

cap rate

ratio of some measure of cash flow from an investment to the value of that investment

Annual NOI/Property market value

cap rate formula

NOI/Cap rate

market value formula

Cap rate x market value

NOI formula

exit cap rate

anticipated rate of return on an investment property at the end of the hold period, projected noi for the year of the anticipated sale

Issues with cap rates

ignore critical factors that drive returns, anticipated NOI growth, required capital investment, market risk perception

location and asset type

cap rates are influenced by

lower cap rates

indicate investors are willing to accept lower initial yields- due to typically to the potential growth of the NOI or lower perceived risk

higher cap rates

indicate investors demand higher yields to compensate for higher risk or limited growth

forecasting

assimilating information from the past, identifying relationships between influencing factors, drawing conclusions on what will happen in the future

proforma

standardized framework for summarizing property performance

potential gross income

anticipated total potential income that can be expected from property at full occupancy before operating expenses are deducted

effective gross income

anticipated income from operations after vacancy and collection losses. often a percentage of PGI

net operating income

income remaining after all operating expenses are deducted from EGI but before mortgage debt service, tax depreciation, or any state or federal taxes are paid

before tax cashflow

noi that remains after debt service has been deducted but before tax depreciation or income taxes have been deducted

after tax cashflow

noi that remains after income taxes have been paid

reversion

the cash that investor receives after the asset has been sold

operating expenses

fixed expenses, do not vary based on occupancy level

variable expenses

vary with occupancy, utilities, janitorial fees, management fees, professional fees

operating performance measures

occupancy, lease expirations per year, average in place rents, average market rents

depreciation

the IRS allows commercial real estate investors to reduce the value of their investment property in equal installments over a period of 39 years. this useful life doesn’t involve land value, only the building and improvements. 

merchant developers

developers that build or sell properties, after leasing the property to the tenant the developer sells the property to investors

stabilized occupancy

a projected range of occupancy for rental property. The expected occupancy that the project will have after being on the open market for a certain time period

holding period

how long the owners hold the property before the sale,

marketing period

required to actually sell the property

absorption period

time required to rent up the property

resale value

reversion, forecast of the price to be recieved

gross lease

landlord pays all operating expenses

net lease

tenant pays a portion of the operating expenses

triple net lease

tenant pays all operating expenses in addition to rent: real estate taxes, building insurance, maintenance and utilities

net useable area

space occupied by tenants

net leasable area

may include a pro rata share of the common area

gross building

total floor area of the building

rental units of comparison

rent per square foot of gross building area, rent per square foot of net leasable area, rent per unit, specialized unit basis

vacancy and credit loss estimate

encourages developers to build, most cash flow forecasts contain an adjustment

3 methods to estimate reversionary value

resale price as a dollar amount, estimating a percentage change over the holding period, applying a terminal cap rate to estimated NOI one year after teh end of the holding period 

NOIn/Rt

reversionary value formula

partitioned IRR from reversion

the share of the IRR of PV that stems from the anticipated CF- provides an indicator of the degree of dependence on exit cap rates

cash on cash yield

a year one measure of levered operational cash flow divided by equity interest. Essentially a levered cap rate. assesses immediate income performance

levered IRR

a holding period return that incorporates the effect of debt. the IRR of unleveled CF less debt CFs. 

equity multiple

sometimes referred to as MOIC-multiple on invested capital. offers a simple measure of cumulative return by dividing the total cash received by the total equity invested

Loan to value

loan amount to the property’s value - quick assessment of leverage, higher ratio means higher debt service payments- higher default risk

Debt service coverage ratio

measures a property’s ability to cover debt payments by NOI/annual debt service, 

Debt yield

NOI/loan amount provides a measure of CF relative to debt, lender’s cap rate

loan sizing

dictating how much capital lenders are willing to provide against the property’s value and income potential

underwriting

sizing and evaluation of a loan opportunity