Week 10 CRE

How do you calculate unleveraged IRR?

Input CF0, CF1, CF2 and solve for IRR.

What is the first step to calculate IRR on a financial calculator?

Enter CF0 as a negative value.

What is the second step in IRR calculation?

Enter CF1 and CF2 as positive cash flows.

What does the calculator output when solving IRR?

The annual return on the investment.

What does CF2 include in IRR problems?

Final year cash flow + sale proceeds.

How do you estimate growth rate in the example?

Compare Year 2 operating cash flow to the terminal value.

How do you convert unleveraged to leveraged cash flows?

Subtract debt service and adjust initial investment for loan proceeds.

What happens to CF0 when leverage is added?

It becomes smaller because debt reduces equity required.

What happens to CF1 and CF2 when leverage is added?

They are reduced by debt service payments.

What is the first step in leveraged return calculation?

Determine loan amount using LTV.

How do you calculate loan amount?

Property value × LTV.

What is the second step in leveraged return calculation?

Calculate debt service using loan terms.

What is the third step in leveraged return calculation?

Subtract debt service from cash flows.

What is the final step in leveraged return calculation?

Compute IRR using new leveraged cash flows.

How do you calculate monthly debt service?

Use PMT with loan amount, interest rate, and amortization.

What inputs are used in PMT?

PV = loan amount, i = rate/12, n = months.

How do you calculate annual debt service?

Monthly PMT × 12.

How do you calculate DSCR?

NOI ÷ Debt Service.

What does DSCR tell you?

Whether income covers loan payments.

What does a DSCR of 1.0 mean?

Income exactly covers debt payments.

What does DSCR below 1.0 indicate?

Income is not sufficient to cover debt service.

What does DSCR above 1.0 indicate?

Income exceeds debt service.

How do you calculate Debt Yield?

NOI ÷ Loan Amount.

What is (GI)DY?

NOI / initial loan amount.

What does a higher Debt Yield indicate?

Lower lender risk.

What is the first step in break-even analysis?

Calculate total debt service.

What is the second step in break-even analysis?

Determine required income to cover expenses and debt.

What is break-even rent?

Required income ÷ (units × occupancy rate).

What is break-even occupancy?

Required income ÷ (rent × units).

How do you calculate total potential rent?

Rent per unit × number of units.

How does occupancy affect effective income?

Multiply total rent by occupancy rate.

What happens to break-even occupancy if debt service increases?

It increases.

What happens to break-even rent if expenses increase?

It increases.

Financial leverage

The use of borrowed funds to potentially increase the return on an equity investment.

What does financial leverage use?

Mortgage (debt) capital.

Can financial leverage increase or decrease returns?

Yes, it can be positive or negative.

What is positive financial leverage?

When borrowing increases the return on equity.

What is negative financial leverage?

When borrowing decreases the return on equity.

What key metrics are impacted by financial leverage?

LTV, DSCR, and Debt Yield.

What does LTV measure?

The proportion of debt used relative to property value.

What is unleveraged return on investment?

The return generated by the property without using debt.

What cash flows are used to calculate unleveraged return?

CF0, CF1, CF2.

How do you calculate unleveraged return on investment?

By finding the IRR of the unleveraged cash flows.

What does IRR represent?

The annualized return that sets NPV to zero.

What does growth in property value reflect?

Increase in future cash flows and sale price.

What is leveraged return on investment?

The return on equity after accounting for debt financing.

What changes when calculating leveraged return?

Cash flows are adjusted for debt service and loan proceeds.

What does a 75% LTV mean?

75% of the property is financed with debt.

How does leverage affect initial equity investment?

It reduces the amount of equity required.

How does leverage affect cash flow?

Debt service payments reduce cash flow to equity.

How does leverage affect returns?

It can amplify gains or losses on equity.

Why can leveraged returns be higher than unleveraged returns?

Less equity is invested while returns are earned on full property value.

Why can leveraged returns be lower than unleveraged returns?

Debt payments reduce cash flow and increase risk.

What is break-even analysis in real estate?

Determining rent or occupancy needed to cover expenses and debt service.

What is break-even rent?

Rent required to cover expenses and debt at a given occupancy.

What is break-even occupancy?

Occupancy required to cover expenses and debt at given rent.

What must be calculated first in break-even problems?

Debt service using loan terms.

What is needed to calculate break-even rent?

Total required income and occupancy level.

What is needed to calculate break-even occupancy?

Total required income and rent.

How does occupancy affect revenue?

Higher occupancy increases total rental income.

How does rent affect revenue?

Higher rent increases income per unit.

What is the goal of break-even analysis in underwriting?

To assess risk of not covering debt obligations.

What does a lower break-even occupancy indicate?

Lower risk.

What does a higher break-even occupancy indicate?

Higher risk.

As Amortization goes UP

Break-Even goes DOWN

As LTV goes UP

your "Cushion" (distance to break-even) goes DOWN

If Interest Rate is grader then Unleveraged IRR

your return goes DOWN as you borrow more.