Lesson 7: The Investment Decision: Criteria Flashcards
what is the purpose of investment decision criteria in real estate?
to quantify certain measures to compare them to a predetermined benchmark
to rank properties according to the decision criteria of choice
will facilitate the decision-making process
what are The Rules of Thumb Techniques based on?
real estate income statement
similar to the traditional income statement that companies use in their annual financial statements
Payback Period (PB)
The number of years or period to recover your investment costs
ex: If the investment cost (cash outflow) is $60,000 and the cash inflow is $20,000 per year for 5 years, the PB is 3 years
Return on Asset (ROA)
This is the rate of return on asset, often denominated on a per annum basis
ex: If the return or profit is $20,000 for the year and the investment costs $100,000 (total costs of the investment, i.e. loan plus the down payment), the ROA is 20%
Return on Investment (ROI) or Return on Equity (ROE)
This is the rate of return on the down payment (the equity) on the asset, often denominated on a per annum basis
ex: If the return or profit is $10,000 for the year and the down payment or equity is $40,000 (i.e. cost of investment is $100,000) less loan ($60,000), the ROI or ROE is 25% (i.e. 10,000 divided by 40,000)
Gross Income Multiplier (GIM)
This is a multiplier or number of times. The GIM is calculated as follows
GIM = (Value of property) / (effective gross income)
Value of property
the Asking Price (if the property has not been sold) or Selling Price if property has been sold
effective gross income
Potential Gross Income (100% occupancy) less vacancy and Credit Losses
what do the sellers and buyers of property want regarding GIM?
Seller wants a high price (high GIM)
Buyer wants a low price (low GIM)
Net Operating Income Multiplier (NIM)
NIM = (Value of property) / (Net Operating Income)
Net Operating Income
Effective Gross Income less Operating Expenses (without depreciation also called capital cost allowance)
what do the sellers and buyers of property want regarding NIM?
Seller wants a high price (high NIM)
Buyer wants a low price (low NIM)
Overall Capitalization Rate (OCR)
This is a rate of return and not a multiplier
OCR = (Net Operating Income) / (Value of property )
what do the sellers and buyers of property want regarding OCR?
Seller wants a high price (low OCR)
Buyer wants a low price (high OCR)