equity investment & the investment decision. real estate investment advantages pride in...
TRANSCRIPT
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Equity Investment&
The Investment Decision
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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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Real Estate Disadvantages
Illiquidity Required equity capital Management burden Depreciation of value Government controls Real estate cycles Legal complexity Lack of information & education
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Trade-Offs:Risk/Return
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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
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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
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Return Measures Cash Flow (Net Spendable) Pro Forma:
Equity: $ 20,000.00
Loan: (DP=$10,000) $ 100,000.00
Gross Possible Income: $ 60,000.00
Less E(Vacancy): $ (9,000.00)
Gross Effective Income: $ 51,000.00
Less Operating Expenses: $ (37,000.00)
Net Operating Income: $ 14,000.00
Less Debt Service (P&I): $ (12,900.00)
Cash Flow Before Tax: $ 1,100.00
Cash on Cash= Net Spendable/Down payment =1100/10000=11%
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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 buyReduce PriceTry to lower APR or increase termRaise NOI or lower expensesRestructure (ie., more equity)
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Return Measures
Equity cap rate: = CF before Tax/Equity(ie., required ROE)
For example: Your desired cap rate is 14%CF before tax is $1,100Equity value = 1.1/.14 = $7,857Plus loan of $100KTherefore property value = $107,857
Risk measures: BEP & Debt Coverage Ratio
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Discounted CF Analysis Income Cap Rate:
NOI/Market ValueCompare 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
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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)
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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
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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
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Control
Purchase Price & Terms Form of Ownership Financing amounts, rates, terms Tax structure & Planning Property management Property location Tenants & Lease rates & terms
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Negotiation
Maximize knowledge position First! Set your initial demands far from final objective
Probe for bottom line
Raise your 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
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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
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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
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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
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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
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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
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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
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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
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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
Development
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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)
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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)
vs Sale: When … remember trade-offs
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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
Redevelopment & trends
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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