Powerpoint class 6 Flashcards
Why Investment Value Differs from Market Value
Investors have different required returns
–> Different risk assessment/opportunity cost of invested equity
Investors have different expectations about future:
–> rental rates
–> vacancies
–> operating expenses
–> etc.
Operating expenses
Keep property operating & competitive
Do not increase value or extend useful life
Examples: minor roof repairs, air conditioner servicing, lawn maintenance, utilities, etc.
Capital Expenditures
Increases market value of property/extend life
Examples: roof replacement, air-conditioner replacement, installation of new landscaping
Why do investors borrow?
Limited financial resources/wealth
Leverage amplifies equity returns (& risk)
Also permits more portfolio diversification
Cash flow effect of borrowing
Net operating income
− Debt service
= Before-tax cash flow (BTCF)
Questions to ask ourselves regarding cash flow estimates
Are income & expenses items appropriate?
Have trends for each item been carefully considered?
What about comparable properties?
What are the social & legal environments?
which are the only income and expenses that we should include?
Include only income & expenses that relate directly to income producing ability of property
what should we consider regarding trends?
Should not just extrapolate recent trends
Importance of rental rate growth & vacancy assumptions
what should we do with comparable properties?
Should obtain as much information as possible on comparable/substitute properties
what should we know about social & legal environments?
Zoning, land use, & environmental controls change quickly at state & local levels
How has subject’s neighborhood been changing?
Are local public officials pro or anti-growth?
Trends in property taxes?
How are all CFs & income tax consequences considered when using partnerships & limited liability companies?
all CFs & income tax consequences are allocated and “flow through” to individual investors
further analysis is usually required to determine expected CFs & returns earned by various equity investors
–>
Profitability ratios we need
Capitalization rate (Ro)
Equity dividend rate
Multipliers we need
Net income multiplier
Effective gross income multiplier (EGIM)
Financial risk ratios we need
Operating expense ratio
Loan-to-value ratio (LTV)
Debt coverage ratio (DCR)
Debt yield ratio (DYR)
Capitalization rate formula
NOI / Acquisition price
Equity Dividend rate formula
BTCF / Equity Investment
Net Income Multiplier formula
Acquisition price / NOI
Effective gross income multiplier formula
Acquisition price / Effective gross Income (EGI)
Operating expense ration formula
OE / EGI
Loan-to-value ratio formula
Mortgage amount / property value
debt coverage ratio formula
NOI / Debt service
this should ideally be over 1
Debt yield ratio formula
NOI / Loan amount
Pros of Ratios & Multipliers
Quick & relatively easy to compute
Intuitive
Facilitates comparison with similar properties
No explicit assumptions about future
Cons of Ratios & Multipliers
No clear benchmarks for acceptable range
Only a partial view of performance
No explicit assumptions about future
