Download Real Estate Investment: Understanding Cash Flows, Lease Jargon, and Building Measurements and more Exercises Real Estate Management in PDF only on Docsity!
Introduction to Investment
- Cash is King!
a) The ultimate goal of any real estate investment is to generate cash flows.
b) Three types of cash flows to consider:
c) Income taxes and real estate: In this class, we will ignore income taxes and focus only on before-tax cash flows.
As a general rule, however, income taxes generally don’t alter real estate investment decisions.
Two exceptions:
Low income housing tax credits
Historic preservation tax credits
- Common Lease Jargon (see handout in Downloads section of the website)
a) Rent Base rent
Asking rent
Contract rent
Market rent
b) Rent adjustments Indexed leases
Step leases
Percentage leases and overage rent
c) Expense Allocations Gross (full-service) lease
Net (hybrid) lease
Double-net lease
Triple-net (absolutely-net) lease
Expense stops
Common area maintenance (CAM) charges
- Pro Forma Operating Statement
a) The pro forma is the key tool used in calculating cash flows from operations. The primary goal of this statement is to calculate Net Operating Income (NOI) and Before-tax Cash Flow (BTCF).
Net Operating Income
b) Layout of the pro-forma
Potential Gross Income (PGI)
- Vacancy & Collection Allowance (V&C)
Effective gross income (EGI)
Net Operating Income (NOI)
- Annual Debt Service (ADS)
Before-tax cash flow (BTCF)
c) Example: Calculate the NOI for an office building with the following characteristics: The building has a total of 15,840 square feet GLA. Of this, 10,800 square feet rent for $12 psf, while the remaining 5, square feet rent for $10 psf. All leases are gross leases. The vacancy and collection loss allowance is 10% of PGI. Operating expenses include: Property taxes $15, Insurance 12, Utilities 13, Cleaning & maintenance 23, Management expenses 8, Reserves for replacement 8, The purchase price of the building is $885,000. Financing is available for 75 percent of the purchase price at 9 percent interest amortized over 30-years with monthly payments. Monthly debt service = $5,341 Annual debt service = $64,
b) Using Cap Rates
Cap rates are typically used to compare different investment alternatives to see if their price is in line with current earnings.
If other similar properties in the market are selling at a 10 percent cap rate, does this appear to be a good investment?
Cap rates can also be used to estimate the value of a property.
If other similar properties in the market are selling at a 10 percent cap rate, how much is this building worth?
c) Cap Rate Limitations
The primary value of cap rates is their simplicity.
Cap rates do not account for a property’s
Risk
Income growth over time
Example: Consider two properties, each with $100,000 in NOI expected next year. The NOI for property A is expected to grow by 3 percent per year, while property B’s NOI is expected to grow by 5 percent per year.
Which property will sell for a higher price?
Which will have a higher cap rate?
b) Operating expense ratio
Measures how expensive it is to operate the property.
c) Breakeven ratio
Frequently called the default ratio.
d) Debt coverage ratio
e) Limitations of ratio analysis
Ratios are good for measuring against benchmarks, but should not be used as hard and fast rules.
The main problem is that they ignore changes in the sizes of and in the timing of cash flows.
Better method: Discounted cash flow analysis (taught in RE618).
- Thoughts about Small Property Investment
b) Two key investment rules to remember:
You make all your money the day your purchase a property.
The best real estate deals you ever do are the ones you don’t.
c) Do your research:
Pick and neighborhood and learn it really well
Build a database of properties in the neighborhood
Owner or renter occupied
Sale price
Physical characteristics
Size, bedrooms, bathrooms, condition, etc.
Rent charged & how long vacant
