Broker Chapter 15 Investment Real Estate Copyright Gold Coast Schools 1
Learning Objectives Matching an investor with the right property Evaluating the sites and improvements of income properties Determining the type of lease terms most appropriate for property Evaluating different financing alternatives Copyright Gold Coast Schools 2
Learning Objectives Analyzing the financial aspects of an investment using ratios and discounted cash flow methods List the characteristics that affect an investments site s value List at least 8 structural components of an income property building and the types of problems a broker might observe Copyright Gold Coast Schools 3
Learning Objectives Distinguish between the terms gross leasable area and net leasable area Describe the difference between a percentage lease and a net lease Calculate the additional rent required from financing a tenant improvement Describe the difference between simple interest and add-on interest Itemize 3 methods an investor can use to reduce the annual debt service on a mortgage Copyright Gold Coast Schools 4
Learning Objectives Describe the priorities of leases compared with mortgages on the same property List at least 6 problem areas that a broker must scrutinize when reviewing an owner s operating statement Construct an annual operating statement for an income property Copyright Gold Coast Schools 5
Learning Objectives Calculate the appropriate financial and investment ratios used to evaluate a one-year statement Describe the process used to estimate the after-tax equity reversion Calculate the appropriate financial and investment ratios used to evaluate a one-year statement Copyright Gold Coast Schools 6
Learning Objectives Describe the process used to estimate the after-tax equity reversion Calculate the present value of a series of unequal cash flows Calculate an investments net present value Describe the differences between net present value and internal rate of return Copyright Gold Coast Schools 7
Learning Objectives List at least 6 types of risk List at least 6 categories of information that a broker should understand about an investor Copyright Gold Coast Schools 8
Basic Investor Situation Investor's needs Existing asset portfolio (anything valuable that affects the investor's interest in real estate investment) Liabilities (debts and existing obligations) Contingent liabilities (retirement needs, education for children, weddings, etc.) Risk preferences Copyright Gold Coast Schools 9
Basic Investor Situation Earning potential Real estate management capability Specific investment goals Investors experience Copyright Gold Coast Schools 10
Basic Property Characteristics Return Risk level Business risk Static risk flood, fire, etc; insurable Dynamic risk changes in economy, supply, demand not insurable Financial risk Capital risk Regulatory risk Copyright Gold Coast Schools 11
Basic Property Characteristics Inflation risk Liquidity Income taxes Management requirements Copyright Gold Coast Schools 12
Rent Determination Area determination Determination of base rent Importance of explicit dollar rent charges Percentage rent Base rent + %age of gross sales over a predetermined amount Problem of monitoring provisions Rent concessions Copyright Gold Coast Schools 13
Expenses Expense stops Owner agree to pay expenses to certain threshold Tenant/s pay any expense over the expense stop Pass-through expenses Reimbursable/nonreimbursable expenses Expense caps Pro rate expenses Based on tenant s %age of total building space Based on tenants %age of occupied space Copyright Gold Coast Schools 14
Types of Leases Gross lease residential and some office Percentage lease retail Tenant pays a base rent plus A percentage of sales over a predetermined threshold Net lease some office and retail Tenant pays an agreed upon rent per square foot per year plus Property taxes, insurance and maintenance Called a net, net, net or triple net lease Copyright Gold Coast Schools 15
Types of Leases Escalator Lease Index Lease Rent changes base on a published index E.g. Consumer Price Index Step-up lease Copyright Gold Coast Schools 16
Recourse vs. Nonrecourse Provisions Exculpatory clause Buyer defaults lend can only look to the property Lender cannot attach buyers assets Lender has no recourse against buyer Nonrecourse loan Copyright Gold Coast Schools 17
Structural Characteristics Type and condition Roof HVAC system Nature and Capacity Electrical system Telephone service Internet Services/Bandwith Capacity Nature and condition of elevator Copyright Gold Coast Schools 18
Structural Characteristics Insulation level Utilities Adequacy of storm drainage system Condition of appliances Condition of drives and parking areas Survey of land and buildings Environmental Verify all current property expenses Identify imminent capital expenditure needs Copyright Gold Coast Schools 19
Financial and Investment Ratios Debt service coverage ratio Risk ratio showing how many times the net operating income covers the debt service Operating expense ratio NOI Debt Service Operating Expenses EGI Provides for comparison with similar properties Copyright Gold Coast Schools 20
Financial and Investment Ratios Cash breakeven ratio: Operating Expenses Reserves + Debt Service PGI Occupancy level to meet cash requirements Equity dividend ratio: Cash on cash return BTCF Equity Copyright Gold Coast Schools 21
Investment Return Standards Equity Dividend Ratio BTCF Equity (Down payment) Capitalization ( cap ) Rate Net Operating Income Value Copyright Gold Coast Schools 22
Financial and Investment Ratios Loan Constant Effects of borrowing on return Annual Debt Service Original Mortgage Balance Positive leverage results from the capitalization rate being higher then the loan constant Negative leverage occurs when the loan constant is higher then the capitalization rate Copyright Gold Coast Schools 23
Positive Leverage Annual Loan Constant Capitalization Rate Annual Debt Service (ADS) Original Mortgage Amount Net Operating Income (NOI) Value Greater than Annual Loan Constant Equity Dividend Rate Before Tax Cash Flow (BTCF) Equity Greater than Cap. Rate
Risk Analysis Major risk ratios Debt service coverage ratio Cash breakeven ratio Sensitivity analysis best case, worst case and most likely case scenarios Copyright Gold Coast Schools 25