Equity Investment&

The Investment Decision

Real Estate Investment Advantages

Pride in Ownership Personal control Self-use & Occupancy Estate Building Security of Capital Operating Cash Flows Leverage Tax Shelter factors Capital Appreciation & Inflation Protection

Real Estate Disadvantages

Illiquidity Required equity capital Management burden Depreciation of value Government controls Real estate cycles Legal complexity Lack of information & education

Trade-Offs:Risk/Return

Risks Legal: Zoning, public opinion,

public services, etc. Market risks: Marketability study

Will it rent? Will it sell?

Market study: S&D, Competition

Absorption rates: How fast is space being utilized

Risks Cost risks: Interest rates Estimates poor Labor Weather

Possible Solutions: Guaranteed price contracts

Watch out for cushion General contractors: Reputable & bonded Completion bond (Lenders may require)

Guarantees price Cost plus contracts: Developer pays costs + fee

Return Measures Cash Flow (Net Spendable) Pro Forma:

Equity: $ 20,000.00 Loan: (DP=$10,000) $ 100,000.00 Gross Possible Income: $ 60,000.00 Less E(Vacancy): $ (9,000.00)Gross Effective Income: $ 51,000.00 Less Operating Expenses: $ (37,000.00)Net Operating Income: $ 14,000.00 Less Debt Service (P&I): $ (12,900.00)Cash Flow Before Tax: $ 1,100.00

Cash on Cash= Net Spendable/Down payment =1100/10000=11%

Return Measures Rate of return on total capital: = NOI/Total Capital

= 14/120 = 11.7% Return on Equity (ROE) = CF Before Tax/Equity

= 1.1/20 = 5.5% Favorable leverage: If ROE > ROR

If unfavorable leverage: Don't buyReduce PriceTry to lower APR or increase termRaise NOI or lower expensesRestructure (ie., more equity)

Return Measures

Equity cap rate: = CF before Tax/Equity(ie., required ROE)

For example: Your desired cap rate is 14%CF before tax is $1,100Equity value = 1.1/.14 = $7,857Plus loan of $100KTherefore property value = $107,857

Risk measures: BEP & Debt Coverage Ratio

Discounted CF Analysis Income Cap Rate:

NOI/Market ValueCompare to other opportunities

Do Cash Flow Spread sheet: Ratio Analysis Sensitivity Analysis:

What if we change the value of a variable? Scenario Analysis: Worst versus Best? Monte Carlo Analysis:

Randomly assign values & check bottom line

Investment Analysis Process Strategy: Determine First!!

Return/Risk Objectives Ownership Form Market Analysis Screening Criteria Location/Property Analysis

Generate Alternatives: Those that pass screen Use Basic Financial Feasibility Model

Develop Finance Screens (APRs, CapRates, NOI) Examine Finance Alternatives (Loans, Equity, etc)

Investment Analysis Process Negotiate Basic Terms with Seller

Price Financing Covenants Escape Clause

Do Detailed Feasibility Research Market:

Supply & Demand, Competition, Absorption, Vacancy Marketability: Property Condition Legal, Political, Environmental Management & Operations

Investment Analysis Process Structure Tax Benefits

Cost Recovery Useful Life Passive Loss Limitations

Discounted CF Analysis After-Tax CF, DCF, Adjust for Risk

Final Negotiations & Closing Management of Property Termination

Sell, merger, IPO

Control

Purchase Price & Terms Form of Ownership Financing amounts, rates, terms Tax structure & Planning Property management Property location Tenants & Lease rates & terms

Negotiation

Maximize knowledge position First! Set your initial demands far from final objective

Probe for bottom lineRaise your aspiration level/deflate your opponent's Buyer:

Start with lower price than seller wants Lukewarm attitude Point out defects Mention competitive offers

Seller: Mention other offers you have rejected Price is probably going up Negotiate most critical items first and

Negotiation (Cont) Concentrate on items that effect profits

Down payment, price, contract period Employ conservative concession policy

Don't give in or reciprocate/ No sportsmanship/ Never concede first Never accept a radical counteroffer without analysis

Use intermediaries when to your advantage With agent, more time to analyze Advisor: Openly discuss concerns

Try for better deal for both parties: Place proof burden & satisfaction on them

Prove to you that it is an attractive opportunity

Negotiation (Tactics)

Standard Practice: Terms are "standard practice" Bogey: “I only can afford $7,500 in cash" Good guy/Bad guy:

One makes strong demands ... Opponent is more susceptible to good guy's weaker demands

Deadline: Always use them! Nibbling: Get additional minor concessions after major agreement The tie-up: Get the property off the market while you're making

decision

Property Types Land

Most Risky Low income Interest, taxes, insurance Interest deduct income only No depreciation 20-30% ROR for risk Consider

Access/Slope Zoning Public services & Utilities

Return=capital appreciation

Property Types

Residential Rental (Houses,Apts,MHs) Management Intensive Good financing Tax shelter High appreciation Know location & physical condition Check neighborhood & proximity to services Good first step for real estate Some income -- mostly capital appreciation

Property Types Office Buildings

More income/less appreciation Appreciation can be improved w/ maintenance

Needs more knowledge for leasing & Property management

Types: Downtown vs Suburban Medium vs HiRise vs Garden (Low) Locations: Highways / Shopping Centers Better construction Low tenant turnover ratios Prestigious clients

Property Types : Shopping Centers

Most sophisticated Investment & Management Expertise Much more income than appreciation/Few Foreclosed! Owned by wealthy investors (TIAA/CREF=Mall of Amer) Types:

Neighborhood center: (Strip): Food, drugs, etc, Built around supermarket/drugstore: 50K Gross leaseable area

Community center: + Clothing, furniture, bank, prof: 150K GLA Regional center: Full-line Dept store (Anchor):

Reit & Insur=Ownership; 400K GLA Super Regional Centers: Major metro area: 2 anchors,

100-200 stores, Usually % of profits

Property Types : Industrial & Special

Industrial Warehouses, factories, indust parks Almost all income Not easily converted … increases risk Low risk overall if you have a client Near highways

Special Use Need expertise: RE + the application Risky: Be ready to substitute Loans are hard to get … banks ?? Requires time commitment

OverviewCombine land, labor, capital &

Entrepreneurial ability

Good developers can “visualize” good uses of space

Creation of space for play, living & working

LT Motive=Income, Mgt, Community/

ST Motive=Cap Gain

Redevelopment: Restoration of older structure

Development

Development

Types: Land Prep: Lots of all kinds

Sell land to other developers

Erect improvements on land

Who Develops? Part-time Proprietorship Corporation, etc. Joint ventures (ie., 2 developers)

Development Process:Be ready to bail outStages may be done simultaneously

Idea: Can develop over life of project

Preliminary Feasibility: Rough cut analysis Are computer programs: Go if profit looks good

GainControl: Ground lease(ties you up), option, seller fin

Feasibility Analysis & Design: Detailed analysis, Check site, market, legal, financial

Finance: Need cash ASAP, should have already talked Construction: Problems: cost overruns & contractor fails Marketing: Lease (don’t lease too early rates change)

vs Sale: When … remember trade-offs

Redevelopment: Costs are high, structures - obsolete ITCs, grants Popular trend

Trends: Mixed use development: One structure Planned unit development (PUD) New towns/Village concept: Integrated approach:

work, shop, play, live

Redevelopment & trends

Professional Help Real Estate Brokers:

Get a specialist! Has access to information Appraisers & consultants: Can do DCF Property managers:

Has rental & vacancy rates, op. expenses, etc Morgage bankers:

Arrange deals & financing alternatives Tax advisers and attorneys Others:

Comm banks, Engineers, Architects, Contractors