Chapter 18

Question 1

How do we get to NOI?

Answer 1

Potential gross income (PGI)
− Vacancy & collection loss (VC)
= Effective gross income (EGI)
− Operating expenses (OE)
− Capital expenditures (CAPX)   
= Net operating income (NOI)

Question 2

How to we get to EGI?

Answer 2

Potential gross income (PGI)
− Vacancy & collection loss (VC)
= Effective gross income (EGI)

Question 3

If EGI is $200K and Operating expenses: 40% of EGI, Capital expenditures: 5% of EGI, what is NOI?

Answer 3

200 - 80 - 10 = $110K NOI

Question 4

What’s the leveraged version of NOI?

Answer 4

Before Tax Cash Flow (BTCF) = NOI - Debt service (PMT)

Question 5

Debt service

Answer 5

The annualized payments towards a loan

Question 6

What’s another name for BTCF?

Answer 6

Leveraged operating cash flow

Question 7

How do you solve for equity?

Answer 7

Purchase price - net loan proceeds (NLP).

NLP = Loan amt - loan costs.

Question 8

Purchase price = $500K
Loan amount = $200K with two discount points.
What is the equity you have upon purchase?

Answer 8

$500K - $196K = $304K in equity. As you pay your loan back, your equity goes up!

Question 9

Why do we use BTCF instead of after-tax? What tax are we referring to?

Answer 9

The tax referred to is income tax! This is because income taxes are dependent on state of residence and income class and can differ between investors.

Question 10

Cap rates differ by ________ , ________ ______ , and _______

Answer 10

Markets; property types; property class (quality of property)

Question 11

A higher risk will lead to a (higher/lower) cap rate. Why?

Answer 11

Higher. Because the property is risky, CF is risky. This means that you will pay less for the property relative to the CF you expect (bc they aren’t as guaranteed!)

Question 12

A higher quality property will lead to a (higher/lower) cap rate. Why?

Answer 12

It is the flip-side of risk. A higher quality property –> higher quality tenants –> more foreseeable EGI. Additionally, operating expenses are more consistent bc the building isn’t falling apart –> easier to predict NOI.

Question 13

What does cap rate fail to distinguish between that EDR does?

Answer 13

Equity and debt!

Question 14

BTER is the levered equivalent of ________ ?

Answer 14

NSP

GSP (gross sales proceeds)
- SC (sales costs)
= NSP (net sales proceeds)
- RLB (remaining loan balance)
= BTER (before tax equity ratio)

Question 15

Equity Dividend Rate (EDR) is the levered equivalent of ________ ?

Answer 15

Cap rate.

EDR = BTCF / Equity
Cap Rate = NOI / Acquisition price

Question 16

Which rate, ratio, or multiplier is the “cash-on-cash” rate, or what Curtis calls the “checking acct. rate?” Why does it have this name?

Answer 16

Equity Dividend Rate (EDR). Curtis says “checking account rate” because this is actually what the investor will receive after loan payments, etc.

Question 17

If I put $100K down on a $500K house, my NOI is $10K and my debt service is $5K, what are my cap rate and EDR? Hint: BTCF

Answer 17

Cap rate =$10K/ $500K = 2%
EDR = (10K-5K)/$100K = 5%
Although the property will only generate 2% returns, I will be earning 5% on my $100K investment.

Question 18

Net Income Multiplier (NIM)

Answer 18

Reciprocal of cap rate. Acquisition cost/NOI. Rarely used because it’s basically just cap rate.

Question 19

Effective Gross Income Multiplier (EGIM) and when is it used?

Answer 19

Acquisition cost / EGI. Used to compare similar properties with very similar expenses. This ratio doesn’t take expenses into account!

Question 20

Operating Expense Ratio (OER)

Answer 20

OE / EGI. Used to determine differences in operating expenses between comparable properties. Could be a concern or opportunity!

Question 21

Which rate, ratio, or multiplier is the nominal investor’s dividend?

Answer 21

BTCF. It’s the residual cash flow after debts are paid.

Question 22

Debt Coverage Ratio (DCR)

Answer 22

NOI / Debt service. This determines the “cushion” a commercial investment has to pay back its debt.

Question 23

You are borrowing from Bonybones Lending and have found two properties. A has a DCR of 1.2 and B has a DCR of 1.6. Which option do you take?

Answer 23

I take B because the cushion is greater to pay back debt!

Question 24

BTCF vs. BTER

Answer 24

BTCF: NOI - debt service, this is the “investor’s dividend” or the cash-on-cash rate.
BTER: This is the terminal cash flow at the end of the holding period upon sale.

Question 25

PVin (levered and unlevered)

Answer 25

Levered: BTCF (all yrs) + BTER, discounted to present value. This is the money the investor takes home.
Unlevered: NOI + NSP. This doesn’t take debt or remaining loan balance into account.

Question 26

BTCF = ? if we don’t borrow any money

Answer 26

NOI