CRE Ch 14: After-Tax Investment Analysis & Corporate Real Estate

Question 1

State the three key differences between accrual and cash flow accounting for real
estate investments.

Answer 1

Item Accrual Cash Flow
Depreciation Expense
Reduce Taxable Income
by Depreciation Expense (DE)
None
Capital Expenditures Capitalized and included in DE Cash outflow
Debt Amortization Interest Only Principal and Interest

Question 2

State how to compute taxable income and income tax due for real estate investments.

Answer 2

Taxable Income = Net Operating Income (NOI) - Interest (I) - Depreciation
Expense (DE)

Income Tax Due = Taxable Income Income Tax Rate

Question 3

State how to compute PBTCF, EBTCF, and EATCF

Answer 3

Property-level Before-tax Net Cash Flow (PBTCF) = Net Operating Income (NOI) -
Capital Improvement Expenditures

Equity-before-tax Cash Flow (EBTCF) = PBTCF - Debt Service (Both Interest and
Principal)

Equity-after-tax Cash Flow (EATCF) = PBTCF - Debt Service (Both Interest and
Principal) - Income Tax = EBTCF - Income Tax
Note: EATCF can also be calculated using the equation Equity After Tax Cash Flow
(EATCF) = Net Income After Tax - Capital Improvement Expenditures + Depreciation
Expense - Debt Amortization

Question 4

State how to compute the tax upon sale of a real estate property.

Answer 4

Tax Upon Sale
= (Resale Price - Gross Book Value) Capital Gains Tax (CGT)
+ Accumulated Depreciation Recapture Tax

Question 5

State the assumption of the PBT approach. How is property value computed with the
PBT approach?

Answer 5

PBT approach assumes marginal investors, IV = MV

To calculate the property value, we simply look at the investor’s cash flows and
discount by the relevant current market rate of return based on similar projects

Question 6

State the advantages of the PBT Approach

Answer 6

Simple, because it avoids the need to estimate marginal tax rates (because it is
before-tax)

Also avoids the need to estimate impacts of leverage (because it is property level
and not an equity cash flow)

Avoids parameter estimation needed for tax/leverage calculations

Mistakes are less likely because property-level before-tax calculations are more
reliable and understood compared to equity/after-tax calculations

Question 7

Describe the value additivity principle.

Answer 7

Value additivity principle - the value of a property must equal the sum of the
values of all claims on the property’s cash flows

The most common way to split cash flows using the value additivity principle is to
split up the property and financing cash flows
Adjusted Present Value (APV) = NPV(Property) + NPV(Financing)

Question 8

NPV(Financing) is typically largest for which of the following investors:

Tax advantaged

Marginal investor

Tax disadvantaged

Answer 8

The tax disadvantaged investor typically has the largest NPV(Financing) because of
the largest benefit from their tax deduction (see the Clarence example in the video
series for more info!).

Question 9

State two reasons leverage reduces the effective tax rate.
[Note: This was seen on the “IRR summary” tab of the TIA spreadsheet]

Answer 9

1. Leverage shifts the composition of the investor’s IRR away from ordinary income
   (35%) and towards the capital gain component (15%)
2. Leverage magnifies the effect of the depreciation tax shields