Investors are concerned with
market factors:
-occupancy rates
-tax influences
-risk level
-measuring returns
Lenders are concerned that
cash flows can cover payments
Equity is
funds (money) invested by an "owner" or person buying property
Debt is
money provided by a lender with real estate used as collateral
If supply and demand for a specific property are out of balance
effects on vacancies changes cash flow projections, thus investment decisions
Why is the real estate market so cyclical?
-large market
-highly competitive
-fragmented owners: even the biggest don't control the market
Highest and Best Use =
highest $ (noi / square feet)
Demand comes from
potential tenants
Supply comes from
investors willing to rent space
Absorption, or space "absorbed" by the market, is
the amount of space leased by tenants for the year
Inventory of Space =
historical inventory + new construction - demolition
Does square foot per employee matter?
Yes
Why is demand of square feet difficult to measure?
-economic climate can result in different headcount per square footage ratio
-diversification in business type effects headcount per square footage ratio
Increased density =
(higher headcount per square footage ratio) = consolidation = plant closures
Supply is more easily measured by
-actual inventory
-future inventory
-demolition
Base rent is
the actual rent a tenant pays per square foot
Market rent is
what you need to pay right now to rent space under current rental situations
What does it tell you when the base rents are lower than the market rent?
this is good
What does it tell you when the base rents are higher than the market rent?
this is bad
How are your future cash flows projected?
-CPI adjustments
-Expense stops
-Combination of both
CPI adjustments are
agreed upon increases to the base rent based on CPI
Expense stops are
expenses "built in" to base rent but tenant pays for anything over
What are the risks to cash flows?
-inflation
-increase in fuel costs
-tenants deciding to open a business i.e. a car wash
How is sale price estimated?
Option 1: estimate the rate you think properties are going to increase in value: use inflation rate as guide, then compare to projected growth in NOI
Option 2: Using "terminal CAP rate
What is the "terminal CAP rate"?
1) Apply the adjusted "Going in" CAP rate to the expected NOI at the end of the holding period
2) Adjust the going in CAP to account for depreciation
3) Compare to value derived from estimate, make judgement call
Before Tax Cash Flows (BTCF) =
referred to as "equity dividend"
= NOI - mortgage payments
Equity Dividend Rate (EDR)
BTCF / Equity
Equity =
purchase price - mortgage amount borrowed
Debt Coverage Ratio (DCR) =
0
Internal Rate of Return (IRR) is
a more appropriate measure of your return using:
-projected cash flows
-holding period
-selling price
Why is the equity dividend rate (EDR) not very meaningful?
it does NOT take into consideration future cash flows, which you hope to improve
Non-leveraged IRR is
the IRR on the cash flows including purchase and sales price
Leveraged-IRR
takes into consideration your equity, before tax cash flows, but you must deduct the mortgage balance to determine final year cash flows
Tax Liability on Cash flows is determined by
taxable income X owners' marginal tax rate
Marginal Tax Rate is
the rate at which the owners' "additional income" from the investment will be taxed
What are the two reasons taxable income differs from BTCF?
-only the interest portion of the payment is deductible from NOI for tax purposes
-you can take the allowance for depreciation
Taxable Income =
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