Transcript Chapter 1 Introduction to Real Estate Decision Making

Analyzing Income-Producing Properties
Chapter 16
Analyzing Income-Producing Properties
• Advantages of Real Estate Investment
– Attractions of real estate as an investment
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Cash flow from operations
Appreciation
Portfolio diversification
Financial leverage
Analyzing Income-Producing Properties
• Disadvantages of Real Estate as an Investment
– Large amount of capital required
– Risk, particularly liquidity risk
– Changing market conditions (overbuilding)
Analyzing Income-Producing Properties
• Financial Decision Making
– Goal is wealth maximization
– Using the NPV rule
– Using the IRR rule
Analyzing Income-Producing Properties
• The Discounted Cash Flow Model
– Initial equity investment
– Forecasting after-tax cash flow (ATCF)
• Calculating net operating income
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Potential gross income (PGI)
Vacancy and credit losses (VCL)
Effective gross income (EGI)
Operating expenses (OE)
Net operating income (NOI)
Analyzing Income-Producing Properties
• The Discounted Cash Flow Model
– Before-tax cash flow (BTCF)
• NOI less Debt Service
– Taxes from Operation
• NOI
• Interest Expense
• Depreciation (DEP)
– 27.5 years for residential, and 39 years for
nonresidential
• Taxable Income
• Marginal Tax Rate
– After-tax cash flow (ATCF)
Analyzing Income-Producing Properties
• After Tax Equity Reversion (ATER)
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Gross sale price
Less Selling expenses
= Net sale proceeds
Mortgage Balance outstanding
Before-tax equity reversion (BTER)
Analyzing Income-Producing Properties
• After Tax Equity Reversion (ATER)
– Before-tax equity reversion (BTER)
– Taxes due on sale (TDS)
– After-tax cash on sale (ATER)
Analyzing Income-Producing Properties
• Taxes Due on Sale (TDS)
– Net Sale Procedes (SP - Selling Expense)
– Book value (Adjusted Basis)
• Original Investment - Depreciation Charged
– Taxable Capital Gain
– Taxes due on sale (TDS) (cap gains tax rate)
– After-tax cash on sale (ATER)
Analyzing Income-Producing Properties
• Other Performance Measures
– Cash-on-cash return
– Operating expense ratio
– Debt coverage ratio
Analyzing Income-Producing Properties
• REITs
– As an alternative to direct investment in real
estate