REAL 4000 exam 3

true

t/f: NOI is considered the fundamental determinant of market value for income-producing properties?

graduated or ““step-up” lease

lease that establishes a schedule of rental rate increases over the term of the lease

NOI= $137,700

determine NOI using above line treatment of capX:

Subject Property:
Number of apartments 15
Market rent (per month) 1000
Vacancy and collection losses 10% of PGI
Operating expenses 5% of EGI
Capital expenditures 10% of EGI

$282835.42

n=360

i/y=4.5/12

pv=325000

fv=0

pmt=CPT

then

2nd+AMORT

p1=1

p2=84

BAL= 282835.42

Assume you have taken out a partially amortizing mortgage loan for $325,000 that has a term of 7 years, but amortized over 30 years. Calculate the balloon payment at maturity (end of year 7) if the annual interest rate on this loan is 4.5%.

10.04%

EDR=BTCF/equity

Given the following information, calculate the equity dividend rate for this investment: first-year NOI: $18,750; before-tax cash flow: $11,440; acquisition price: $570,000; total equity portion of investment: 20% of acquisition price.

$1506262

CF0= 0

CF1-4= 150000

CF5= 150000+1250000

NPV:

I= 7

NPV= CPT

Suppose that an income-producing property is expected to be purchased at a 15% overall cap rate, and expected to yield cash flows for the owner of $150,000 in each of the next five years, with cash flows being received at the end of each period. If the opportunity cost of investment (discount rate) is 7.00% annually and the property can be sold for $1,250,000 at the end of the fifth year, determine the value of the property today using the DCF approach

$2452685

GSP= 173644/.0725=2395089.66

-selling expenses: 2395089.66*.045

=2287310.621 (this is NSP)

TCF3= NOI + NSP

165375+2287310

Consider the table of projected NOI cash flows for a commercial real estate asset below.  

Year 1	Year 2	Year 3	Year 4	Year 5
$ 150,000	$ 157,500	$165,375</span></p></td><td colspan="1" rowspan="1" style="width: 77.5pt; border-width: medium 1pt 1pt medium; border-style: none solid solid none; border-color: currentcolor windowtext windowtext currentcolor; padding: 0in 5.4pt; height: 10.9pt;"><p><span style="line-height: 19.9733px;">$  173,644	$ 182,326

If the building is sold at the end of Year 3 at a 7.25% going-out cap rate, and 4.50% in selling expenses are incurred, what is the total cash flow (TCF) in year 3?

$10572251

have to project for NEXT year (6)

(913058+ (913058*.1) ) / .095

.1 is the growth rate, could also just multiple NOI5 × 1.1 to get NOI6

Suppose that examination of a pro forma reveals that the fifth-year net operating income (NOI) for an income-producing property that you are analyzing is forecasted to be $913,058 (you can assume that this cash flow occurs at the end of the year). If you estimate the projected NOI growth rate for the property to be 10% per year, determine the projected gross sales price (sales price) of the property at the end of year 5 if the going-out capitalization rate is 9.5%.

$1935714

NOIyr1/overall cap rate

135500/.07

Suppose that you are attempting to value an income-producing property using the direct capitalization approach. Using data from comparable properties, you have determined the overall capitalization rate to be 7.0%, a reasonable discount rate of 9%, and an exit cap rate of 12%. If the projected first-year net operating income (NOI) for the subject property is $135,500, If the projected second-year net operating income (NOI) for the subject property is $145,500, and the projected final-year total cash flow for the subject property is $1,155,500 what is the indicated value of the subject using direct capitalization?

at least 75% of the value of REITS assets must consist of RE assets is the only true statement

→ at least 100 shareholders

→ 90% taxable income must be distributed

→ no 5 investors can own more than 50%

There are a set of restrictive conditions that REITs must satisfy on an ongoing basis in order to maintain their special tax status. All of the following statements regarding the main restrictions are false except

at least 75 percent of the value of a REIT's assets must consist of real estate assets.

at least 50 investors must own a REIT's shares.

a REIT must distribute at least 75% of its taxable income to shareholders in the form of dividends.

no five investors can own more than 10 percent of a REIT's shares.

false: commercial banks are LENDERS to CRE, not equity owners

t/f: Commercial banks collectively own hundreds of billions of dollars worth of commercial real estate equity, and the vast majority of these holding are the result of indirect investment through real estate securities.

false: Limited partnership allows flexible allocation of cash flow

t/f: The limited partnership ownership form requires cash flows to be allocated to each shareholder in proportion to his or her ownership of the entity, thereby preventing special allocations to multiple classes of investors.

high transaction costs and low liquidity

high costs because of search costs, due diligence, legal, and information costs

low liquidity because there’s few participants, takes longer to close a sale, and you can’t sell a slice of a building like you can sell shares of stock.

In contrast to public markets, private markets are characterized by individually negotiated transactions that take place without the aid of a centralized market. Therefore, private markets will generally have

false: FFO = Net income + real estate depreciation and amortization − gains on property sales + losses on property sales

t/f: FFO is the financial metric that measures the value of a REIT by taking the reported value of all the underlying properties it owns and deducting all liabilities such as mortgage payments. 

false: intention of parties is the dominant rule

t/f: A fixture is an object that formerly was personal property but has become real property. Of the four rules for determining whether an object has become a fixture, character of the article and manner of adaptation is the most dominant rule (i.e., if there is a conflict, the rule that prevails).

false: the most common are Limited Liability Corporation, LLC and Limited Partnerships

t/f: The most common forms of indirect ownership in commercial real estate that allow for "pass-through" returns are C-Corporations and Tenants in Common.

11.86%

For the following levered total cash flow returns, what is the levered IRR?

Year	0	1	2	3	4	5
Total Cash Flow (Pre-Tax)	$(400,000)</p></td><td colspan="1" rowspan="1" style="border-width: medium 0.5pt 0.5pt medium; border-style: none solid solid none; border-color: currentcolor windowtext windowtext currentcolor; border-image: initial; padding-top: 1px; padding-right: 1px; padding-left: 1px; font-weight: 400; font-style: normal; vertical-align: bottom; white-space: nowrap; text-align: left;"><p>$        30,000	$30,900</p></td><td colspan="1" rowspan="1" style="border-width: medium 0.5pt 0.5pt medium; border-style: none solid solid none; border-color: currentcolor windowtext windowtext currentcolor; border-image: initial; padding-top: 1px; padding-right: 1px; padding-left: 1px; font-weight: 400; font-style: normal; vertical-align: bottom; white-space: nowrap; text-align: left;"><p>$        31,827	$32,782</p></td><td colspan="1" rowspan="1" style="border-width: medium 0.5pt 0.5pt medium; border-style: none solid solid none; border-color: currentcolor windowtext windowtext currentcolor; border-image: initial; padding-top: 1px; padding-right: 1px; padding-left: 1px; font-weight: 400; font-style: normal; vertical-align: bottom; white-space: nowrap; text-align: left;"><p>$        533,765

-31794.95, no because NPV is negative

enter cash flows

NPV:

i=14

NPV→ cpt

For the following levered total cash flow returns, what is the levered NPV, and should you pursue the investment if your levered discount rate is 14%?

Year	0	1	2	3	4	5
Total Cash Flow (Pre-Tax)	$(400,000)</p></td><td colspan="1" rowspan="1" style="border-width: medium 0.5pt 0.5pt medium; border-style: none solid solid none; border-color: currentcolor windowtext windowtext currentcolor; border-image: initial; padding-top: 1px; padding-right: 1px; padding-left: 1px; font-weight: 400; font-style: normal; vertical-align: bottom; white-space: nowrap; text-align: left;"><p>$        30,000	$30,900</p></td><td colspan="1" rowspan="1" style="border-width: medium 0.5pt 0.5pt medium; border-style: none solid solid none; border-color: currentcolor windowtext windowtext currentcolor; border-image: initial; padding-top: 1px; padding-right: 1px; padding-left: 1px; font-weight: 400; font-style: normal; vertical-align: bottom; white-space: nowrap; text-align: left;"><p>$        31,827	$32,782</p></td><td colspan="1" rowspan="1" style="border-width: medium 0.5pt 0.5pt medium; border-style: none solid solid none; border-color: currentcolor windowtext windowtext currentcolor; border-image: initial; padding-top: 1px; padding-right: 1px; padding-left: 1px; font-weight: 400; font-style: normal; vertical-align: bottom; white-space: nowrap; text-align: left;"><p>$        533,765

False, enhancing quality typically raises NOI, which increases value, which decreases cap rate.

t/f: Enhancing the quality of an asset will typically lower NOI, and raise the cap rate

false: everyone’s investment motive and valuation is different

t/f: Investment value is based on the expectations of a typical, or average (market) investor.

<0, if NPV is negative

Net present value (NPV) is interpreted using the following decision rule: The investor will NOT purchase the property as long as the NPV is

false: more leverage would INCREASE IRR

t/f: Assuming the going-in IRR is greater than the effective borrowing cost, if an investor increased her leverage, say from 75% to 80% LTV, we would expect NPV to increase, while going-in IRR would decrease (all else being constant).

$343674

GSP-selling expenses= NSP

NSP- remaining loan balance= BTER

Given the following information, calculate the before-tax equity reversion (BTER) in year 5: Year 5 NOI: $60,294; annual debt service: $58,444; Year 5 exit cap rate: 6%; Year 5 Gross Sale Proceeds (GSP): $1,015,312.50; Year 5 selling expenses: 4% of GSP; Year 5 remaining mortgage balance: $631,026.

-59656.61

Given the following information, calculate the Levered NPV for this property (assume all are levered cash flows): initial cash outflow: $200,000; levered discount rate: 15%; TCF for year 1: $25,876; TCF for year 2: $23,998; TCF for year 3: $23,013; TCF for year 4: $22,105; TCF for year 5: $144,670

13%

cf0= -1538462

cf1=100000

cf2=103000

cf3=109273

cf4=119406

cf5=134393+2110000

IRR→ cpt

Using the pro-forma table below, what is your unlevered IRR?

 

	0	1	2	3	4	5	6
Purchase Price	(1,538,462)
Loan Proceeds	833,333
Loan Fees	(16,667)
NOI		100,000	103,000	109,273	119,406	134,393	155,798
-DS		(50,000)	(50,000)	(50,000)	(50,000)	(50,000)	(50,000)
BTCF		50,000	53,000	59,273	69,406	84,393	105,798
NSP						2,110,000
-Loan Payoff						(830,000)
BTER						1,280,000
Unlevered Discount Rate:	10%
Levered Discount Rate:	12%

 

19%

cf0= -1538462+833333-16667

cf1=50000

cf2=53000

cf3=59273

cf4=69406

cf5=84393+1280000

IRR→ cpt

Using the pro-forma table below, what is your levered IRR?

	0	1	2	3	4	5	6
Purchase Price	(1,538,462)
Loan Proceeds	833,333
Loan Fees	(16,667)
NOI		100,000	103,000	109,273	119,406	134,393	155,798
-DS		(50,000)	(50,000)	(50,000)	(50,000)	(50,000)	(50,000)
BTCF		50,000	53,000	59,273	69,406	84,393	105,798
NSP						2,110,000
-Loan Payoff						(830,000)
BTER						1,280,000
Unlevered Discount Rate:	10%
Levered Discount Rate:	12%

194817

cf0= -1538462

cf1=100000

cf2=103000

cf3=109273

cf4=119406

cf5=134393+2110000

IRR= 10

NRV→ cpt

Using the pro-forma table below, what is your unlevered NPV?

	0	1	2	3	4	5	6
Purchase Price	(1,538,462)
Loan Proceeds	833,333
Loan Fees	(16,667)
NOI		100,000	103,000	109,273	119,406	134,393	155,798
-DS		(50,000)	(50,000)	(50,000)	(50,000)	(50,000)	(50,000)
BTCF		50,000	53,000	59,273	69,406	84,393	105,798
NSP						2,110,000
-Loan Payoff						(830,000)
BTER						1,280,000
Unlevered Discount Rate:	10%
Levered Discount Rate:	12%

 

225590

cf0= -1538462+833333-16667

cf1=50000

cf2=53000

cf3=59273

cf4=69406

cf5=84393+1280000

IRR=12

NRV→ cpt

Using the pro-forma table below, what is your levered NPV?

	0	1	2	3	4	5	6
Purchase Price	(1,538,462)
Loan Proceeds	833,333
Loan Fees	(16,667)
NOI		100,000	103,000	109,273	119,406	134,393	155,798
-DS		(50,000)	(50,000)	(50,000)	(50,000)	(50,000)	(50,000)
BTCF		50,000	53,000	59,273	69,406	84,393	105,798
NSP						2,110,000
-Loan Payoff						(830,000)
BTER						1,280,000
Unlevered Discount Rate:	10%
Levered Discount Rate:	12%

 

2.21

positive BTCF (1596072) / negative from time 0 (721796)

Using the pro-forma table below, what is your levered equity multiple?

	0	1	2	3	4	5	6
Purchase Price	(1,538,462)
Loan Proceeds	833,333
Loan Fees	(16,667)
NOI		100,000	103,000	109,273	119,406	134,393	155,798
-DS		(50,000)	(50,000)	(50,000)	(50,000)	(50,000)	(50,000)
BTCF		50,000	53,000	59,273	69,406	84,393	105,798
NSP						2,110,000
-Loan Payoff						(830,000)
BTER						1,280,000
Unlevered Discount Rate:	10%
Levered Discount Rate:	12%

false: higher discount rate lowers NPV

Considering the pro-forma table below, if you change your levered discount rate to 25%, you will make an even higher levered NPV, and should go forward with the investment. 

	0	1	2	3	4	5	6
Purchase Price	(1,538,462)
Loan Proceeds	833,333
Loan Fees	(16,667)
NOI		100,000	103,000	109,273	119,406	134,393	155,798
-DS		(50,000)	(50,000)	(50,000)	(50,000)	(50,000)	(50,000)
BTCF		50,000	53,000	59,273	69,406	84,393	105,798
NSP						2,110,000
-Loan Payoff						(830,000)
BTER						1,280,000
Unlevered Discount Rate:	10%
Levered Discount Rate:	12%

 

25720.79

Given the following information, calculate the unlevered NPV for this property: outflow at time zero: -$200,000; discount rate: 18%; NOI for year 1: $25,876; NOI for year 2: $23,998; NOI for year 3: $23,013; NOI for year 4: $22,105; NOI for year 5: $23,670; NSP in year 5: 345,000.

false: more leverage leads to higher IRR

t/f: If an investor increases their leverage rate, say from 75% to 80%, we would expect NPV increases, while IRR decreases.

3

the sign changes three times

How many solutions to IRR are possible with the following cash flow? CF0:-700,000; CF1: +40,000; CF2: -71,000; CF3:-12,000; CF4: +1,200,000

1.6

(23013+345000) / (200000+25876+3998)

Given the following information, calculate the Levered Equity Multiple for this property: equity outflow at time zero: -$200,000; discount rate: 18%; Entrance Cap Rate: 6.00%; Exit Cap Rate: 6.25%; BTCF for year 1: -$25,876; BTCF for year 2: -$3,998; BTCF for year 3: $23,013; BTER in year 3: 345,000.

71.3%

cf0= -100000

cf1= 20000

cf2= 40000

cf3= 60000

cf4= 180000+360000

IRR→ cpt

Suppose equity investors have an agreement whereby the general partner/sponsor will split everything with the limited partners "pari passu" until an equity multiple of 3.00 is reached, then the GP/Sponsor will be entitled to a promote equal to 90% of any additional returns.

The sponsor/GP has invested 10% of the equity, and the limited partners have invested 90% of the equity.

What is the expected IRR of the sponsor/GP given the levered cash flows below?

CF0: -1,000,000
CF1: 200,000
CF2: 400,000
CF3: 600,000
CF4: 2,200,000

false: land is considered entry ticket

t/f: Feasibility analysis is often considered the "entry ticket to development" as it is the most important step. 

NPV analysis

The main tool that a developer will use in determining the financial feasibility of a project is

false: screws are a hard cost

t/f:If a general contractor buys screws at Home Depot for a house that they are working on, they will ask that the cost of the purchase be reimbursed by the construction lender as a soft cost. 

mezzanine debt use is less expensive than equity financing

When construction costs exceed the amount of the construction loan, a developer may seek to cover the gap using mezzanine financing. All of the following statements regarding mezzanine debt are false except

mezzanine debt use must go through the foreclosure process in the case of default.

mezzanine debt use is less expensive than equity financing.

mezzanine debt use is less expensive than normal construction financing.

mezzanine debt will dilute equity returns.

false: this is an example of RESOURCES in search of an opportunity

t/f: Suppose that a wall-street investment bank invests $100MM with a luxury hotel development firm, and asks them to provide at least 15% return on their investment.  Of the three occasions for development, this is an example of the use looking for a site.

false: this team member is the civil engineer

t/f: The development team member / consultant who manages the the detailed design of roads, sewers, water lines, and other aspects on and under the land is the Land Planner.

false: construction lenders contribute during construction with a negatively amortizing construction loan

t/f: Construction lenders and the equity investors both contribute to the total cost of a development at time zero (before moving forward with the project), just like in any other property investment. 

false: a miniperm is used when you plan to KEEP the property for a few years after construction

t/f: Miniperm financing is typically sought if interest rates are forecasted to rise, and the developer plans to sell the building immediately upon stabilization. 

150 basis points

(100000/1250000) = .08 development yield

.08-.065 = .015 (development spread)

.015 is 150 bp

What is the development "spread" on a building with a potential stabilized NOI of $100,000; total costs of $1,250,000; and an estimated going out cap rate of 6.5%.

12.98

170000/1310000

Given the following information, calculate the going-in (entrance) capitalization rate for the apartment complex based on a projected acquisition price of $1,310,000, the projected returns below, and assuming the entire building is projected to be sold at the end of Year 3 for a Gross Sales Price (GSP) of $1,550,000.

• Year 1 NOI: $170,000

• Year 2 NOI: $195,000

• Year 3 NOI: $300,000

• Year 4 NOI: $305,000

• Year 5 NOI: $310,000

2451612.90

190000/.0775

Given the following information, calculate the direct cap value for the apartment complex based on the projected returns below, a discount rate (opportunity cost) of 10.25%, an overall (market) cap rate of 7.75%, an exit (terminal) cap rate of 8.75%, and assuming the entire property is projected to be sold at the end of Year 3 with selling expenses of 3.00%

• Year 1 NOI: $190,000

• Year 2 NOI: $200,000

• Year 3 NOI: $195,000

• Year 4 NOI: $280,000

• Year 5 NOI: $330,000

$2459204.36

cf0= 0

cf1= 110000

cf2= 255000

cf3= 255000 + 2729189.19 (NSP) = 2984189.19

NSP= 255000 (NOI4) / .0925 = 2756756.76

-selling expenses 27567.57

= 2729189.19

NPV:

I= 10.75

NPV→ cpt

Given the following information, calculate the Discounted Cash Flow (DCF) Value for the apartment complex based on the projected returns below, a discount rate (opportunity cost) of 10.75%, an overall (market) cap rate of 7.25%, an exit (terminal) cap rate of 9.25%, and assuming the entire property is projected to be sold at the end of Year 3 with selling expenses of 1.00%

• Year 1 NOI: $110,000

• Year 2 NOI: $200,000

• Year 3 NOI: $255,000

• Year 4 NOI: $255,000

• Year 5 NOI: $305,000

3050230.77

step 1: Ghost year 6

190000 + 3% = 195700

step 2: divide ghost year by going out rate

195700/.065 = 3010769.23

step 3: subtract selling expenses of 5% to get NSP

3010769.23 - 150538.46 = 2860230.77

step 4: add to NOI year 5 to get TCF5

190000+2860230.77

An income-producing property has a forecasted Year 5 Net Operating Income (NOI) of $190,000. You estimate the projected NOI growth rate for the property to be 3.00% per year.

What is the total cash flow (unlevered total cash flow) for the property at the end of Year 5, assuming the property is sold at that time?

Enter the answer below as a positive number rounded to the nearest penny, without dollar sign.  There is a $1 rounding tolerance. 

Property Analysis & Market Assumptions (use only what is needed):

• Year 5 NOI: $190,000

• Projected Annual NOI Growth Rate: 3.00%

• Overall (Market) Cap Rate: 6.00%

• Going-out (Terminal) Cap Rate: 6.50%

• Discount Rate (Opportunity Cost): 9.25%

• Selling Expenses: 5.00%

59461.14

step 1: ghost (year 4 NOI / exit rate) - 2% selling expenses = NSP

(195000/.079) - 49367.09 = 2418987.34

step 2: CF

cf0= -2205000

cf1=155000

cf2=160000

cf3= 155000+2418987.34

NPV:

IRR= 9

NRV→ cpt

You are evaluating an industrial warehouse with the following 5-year NOI forecast: Year 1: $155,000 | Year 2: $160,000 | Year 3: $155,000 | Year 4: $195,000 | Year 5: $230,000

Investment Data:

• Purchase Price: $2,205,000

• Market (For Appraisal) Cap Rate: 7.40%

• Equity Required at Time Zero: $680,000

• Loan Payoff Amount: $1,400,000

• Expected Terminal Cap Rate: 7.90%

• Unlevered Discount Rate: 9.00%

• Levered Discount Rate: 10.00%

You plan to execute a full sale of the asset at the end of Year 3. Selling costs are 2.00%.

Calculate the projected Unlevered NPV using the Purchase Price.

You are evaluating a retail shopping center with the following 5-year NOI forecast: Year 1: $150,000 | Year 2: $160,000 | Year 3: $165,000 | Year 4: $195,000 | Year 5: $280,000

Investment Data:

• Purchase Price: $2,215,000

• Market (Appraisal) Cap Rate: 7.40%

• Equity Required at Time Zero: $680,000

• Annual Debt Service: $100,000

• Loan Payoff Amount (End of Y3): $1,450,000

• Expected Terminal Cap Rate: 7.90%

• Unlevered Discount Rate: 8.00%

• Levered Discount Rate: 11.00%

You plan to execute a full sale of the asset at the end of Year 3. Selling costs are 2.00%.

Calculate the Levered NPV.

Income approach (rationale)

Value = the present value of the income (future incoming payments) a property is expected to produce. Applies to existing CRE properties.

Income capitalization / "capitalize"

Another name for the income approach. To capitalize = to convert future income into a present value.

Two approaches to income valuation

1) Direct capitalization (using an overall cap rate) and 2) Discounted cash flow (DCF) analysis.

Direct capitalization

Finds value as a multiple of first-year NOI. The multiple (via the cap rate) comes from sales of comparable properties.

Discounted cash flow (DCF)

Project net cash flows over a standard holding period, then discount ALL expected future cash flows at the required return (IRR) to get value.

What both income methods require

An estimate of the property's net operating income (NOI).

Reconstructed operating statement

The appraiser's own estimate of a property's income and expenses (and therefore NOI), rather than the owner's reported numbers.

Potential gross income (PGI)

Rental income assuming 100% occupancy. Also called potential gross revenue (PGR) or gross rents (GR).

Contract rent vs. market rent

Key PGI question for the appraiser: should the forecast use contract rent (from signed leases) or current market rents?

Rent comparables

A survey of rents on similar space in the market, used to estimate (or check) the subject property's rental rates.

Office rent quote convention

Office rent is most commonly quoted per square foot per year, for both investors and tenants.

Vacancy & collection loss (VCL)

Income lost to empty space and to tenants who don't pay. Subtracted from PGI.

Miscellaneous income (MI)

Non-rent income from the property (e.g., parking, laundry, fees). Added to get EGI.

Effective gross income (EGI)

The income actually expected to be collected: PGI minus vacancy & collection loss, plus miscellaneous income.

Operating expenses (OE)

Recurring costs of running the property (management, maintenance, taxes, insurance, utilities, etc.). Subtracted from EGI.

Above-line treatment of CAPX

Treating capital expenditures as a deduction BEFORE arriving at NOI (i.e., NOI is calculated after CAPX).

Net operating income (NOI)

The property's "dividend." The projected stream of NOI is the fundamental determinant of a property's value.

Overall cap rate (Ro)

The ratio of a property's first-year NOI to its sale price. WARNING: Ro is a cap rate, NOT a discount rate.

Direct market extraction

Getting cap rates from the market by comparing the NOI and selling prices of comparable properties that recently sold.

Steps in direct capitalization

1) Extract cap rates (Ro) from comparable sales. 2) Divide the subject's first-year NOI by a weighted average of those cap rates to estimate value.

Defining the "market" for comps

Choosing which comparable sales count as the market is critically important, because the cap rate and value come straight from them.

Why Ro reflects ALL future cash flows

Direct cap uses only first-year NOI, but comparable sale prices reflect the value of all future cash flows, so cap rates extracted from those sales do too.

Effective gross income multiplier (EGIM)

Sale price ÷ EGI. A quick value indicator for smaller rental properties that needs no expense info. Assumes similar expense ratios across properties and that market rents are paid. (FYI only: not on Exam 3.)

Terminal (going-out) cap rate (Rt)

The cap rate used to estimate the sale price at the end of the holding period. A required assumption in DCF, usually set slightly higher than Ro.

Net sale proceeds (NSP)

Sale price minus selling expenses.

Discount rate (unlevered DCF)

Presumed to reflect the required yield in the market for unlevered investments of similar risk.

Reconciliation of value indicators

Weighing the value estimates from different methods (e.g., direct cap and DCF) to reach one final value estimate.

Direct cap vs. DCF: which is better?

Direct cap needs fewer explicit assumptions and forecasts, but it implicitly assumes the subject property's future cash flows (growth and risk) look like those of the comparables.

Equity

Money that represents OWNERSHIP of the property.

Debt

Money LOANED to the owner(s) to buy the property.

Capital stack

The layers of financing used to buy a property. From top (riskiest, last paid) to bottom (safest, first paid): sponsor equity, common equity, preferred equity, mezzanine debt, junior debt, senior debt.

Sponsor equity

Equity put in by the sponsor/organizer (usually the GP) who puts the deal together and manages it.

Common equity

Equity from passive investors (usually LPs). Paid after all debt and any preferred equity.

Preferred equity

Equity that gets paid before common equity, but after all debt.

Senior debt

The first-priority loan with the first lien on the property. Lowest risk, so lowest interest rate.

Junior debt

A loan subordinate to (paid after) the senior debt.

Mezzanine debt

Debt between senior debt and equity in the stack. Higher interest than senior debt, cheaper than equity. Often secured by a lien on the ownership entity rather than the property.

Why investors pool equity

Real estate investments are so large that investors almost always pool their equity capital.

Ways to pool equity

General partnership, limited partnership, C corporation, S corporation, limited liability company (LLC), tenancy-in-common (TIC), and REIT.

Benefits of pooling equity

Buy interests in larger properties, portfolio diversification, economies of scale (acquisition, management, sale), access to cheaper debt, and the expertise of the syndicator's management team.

Costs of pooling equity

Investors often give up management control, and must pay the sponsor (fees, salary and/or a disproportionate share of equity), which lowers return on equity, all else equal.

Factors in choosing an ownership form

1) Federal income tax rules, 2) desire for limited liability, 3) management control, 4) ability to access debt and more equity, 5) ability to share risk with other investors (incl. special allocations), 6) ability to sell one's interest.

Multiple levels of ownership

CRE often has layered ownership. Example: an office building owned by an LP whose two members are an LLC and a publicly traded REIT.

Conduit / pass-through (flow-through) taxation

The entity itself pays no income tax; income passes through to the owners, who pay it. Avoids double taxation.

Double taxation

Income is taxed once at the entity (corporate) level and again when distributed to owners. A problem with C corporations.

Special allocations

Dividing cash flow and taxable income in proportions other than ownership share (not pro rata), as set out in a partnership agreement.

General partnership (GP)

Pass-through taxation; all partners can make operating decisions (leverage, when to sell); no separation of ownership and control, so fewer conflicts of interest; special allocations allowed.

General partnership: liability

All general partners are personally liable for ALL partnership debts (contracts, lawsuits, other partners' wrongful acts). Result: fairly uncommon, and ones that exist have few partners.

Limited partnership (LP)

Has two kinds of partners: a general partner (sponsor, control, unlimited liability) and limited partners (passive, limited liability). Flow-through tax treatment.

General partner (in an LP)

Sponsors/organizes the venture, usually a knowledgeable builder, broker or investor. Has control and unlimited liability, but the GP can itself be a corporation or LLC to limit that.