Analyzing Income-Producing Properties Chapter 16

Analyzing Income-Producing Properties

Chapter 16


• Advantages of Real Estate Investment– Attractions of real estate as an investment • Cash flow from operations

• Appreciation

• Portfolio diversification

• Financial leverage


• Disadvantages of Real Estate as an Investment– Large amount of capital required

– Risk, particularly liquidity risk

– Changing market conditions (overbuilding)


• Financial Decision Making– Goal is wealth maximization– Using the NPV rule– Using the IRR rule


• The Discounted Cash Flow Model– Initial equity investment– Forecasting after-tax cash flow (ATCF)• Calculating net operating income

– Potential gross income (PGI)

– Vacancy and credit losses (VCL)

– Effective gross income (EGI)

– Operating expenses (OE)

– Net operating income (NOI)


• The Discounted Cash Flow Model– Before-tax cash flow (BTCF)

• NOI less Debt Service– Taxes from Operation

• NOI• Interest Expense• Depreciation (DEP)

– 27.5 years for residential, and 39 years for nonresidential

• Taxable Income• Marginal Tax Rate

– After-tax cash flow (ATCF)


• After Tax Equity Reversion (ATER)– Gross sale price– Less Selling expenses– = Net sale proceeds– Mortgage Balance outstanding– Before-tax equity reversion (BTER)


• After Tax Equity Reversion (ATER)– Before-tax equity reversion (BTER)– Taxes due on sale (TDS)– After-tax cash on sale (ATER)


• Taxes Due on Sale (TDS)– Net Sale Procedes (SP - Selling Expense)– Book value (Adjusted Basis)• Original Investment - Depreciation Charged

– Taxable Capital Gain– Taxes due on sale (TDS) (cap gains tax rate)– After-tax cash on sale (ATER)


• Other Performance Measures– Cash-on-cash return– Operating expense ratio– Debt coverage ratio


• REITs– As an alternative to direct investment in real

estate

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Analyzing Income-Producing Properties Chapter 16