Final Flashcards
Capitalization Rate
Cap Rate = Net Operating Income/Asset Value
the cap rate in effect is a way o quoting the price of a property as its value per dollar of current income
Net Income Multiplier
Net Income Multiplier=$1/Cap Rate
Text book: the number by which you multiply net operating income in order to calculate the valu eo f aproperty
Teo: the value of $1 annual net operating income generated by a property
helps us determine how much we should pay for a property
Key Questions for Evaluating Real Estate Opportunities
- What is the implied capitalization rate and Net Income Multiplier (for the project or the property)
- What is the market capitalization rate and net income multiplier?
- what should the market price be? (based on the market cap rate and the market net income multiplier)
- How much net income would justify a given price (based on the market cap and the market net income multiplier?)
- Is our overall market research correct?
Return on Assets
ROA = Annual Income/Asset’s Market Value
this doesn’t change with leverage
is the income from an asset expressed as a percentage of the asset’s value
Return on Equity
ROE = Income After Financing Costs/Investor’s Equity
Tips for Getting a Loan (Teo)
- Build a solid personal relationship with your lender
- Build a solid professional relationship with your lender
- Do everyone’s homework for them
Tips for Getting a Loan Garry Eldrid (7 Cs)
- Credit Score and Credit Record
- Capacity
- Cash Reserves and sources of down payment
- collateral
- character and personal characteristics
- competency and experience
- compensating factors
Tips for Dealing with Adversity
When your loan is in trouble
- Seek to Understand
- Discuss differences in all terms
- Cross collateralize
- alternative structures
When your loan gets rejected
- Don’t take it personally
- sometimes their hands are tied - don’t overlook that they might be right
- use it as a learning opportunity
- what steps can i take to improve my strength as a borrower- remember the bank’s appetite for such stuff changes over time
- never burn a bride
Loan to Value
LTV = Loan Amount/ Property Value
usually max is around 70-80%
Loan to Cost
LTC=Loan Amount/Project Cost
Usually max around 70-95%
Debt Service Coverage Ratio
DSCR = Net Operating Income/Annual Debt Service
usually max 1.2-1.5
banks want to make sure you have more than enough to cover your loan payments
Debt Service
the periodic payments, generally consisting of interest and principal, specified in your loan agreement
= Loan Amount * Loan Constant
Loan Constant
= -pmt(IR, Period, 1)
the payment amount needed to service each $1 of borrowed money at a given rate over a given amortization period
allows you to quickly calculate your debt service
Debt Service = Loan Amount * Loan Constant
Loan Amount = Net Operating Income / (Loan Constant * DSCR)
Loan Amount * DSCR = the net operating income the bank requires for each dollar they lend you
The four main sources of real estate investment returns
- Cash flow from operating a property
- appreciation of the property’s value
- loan amortization (the decrease in the loan balance between when you initially took out the loan and when you sell the property
- tax shelter (the savings you experience on your income taxes because of real estate)
Direct Capitalization Analysis
Find the simple profit (NPV) using the perpetuity formula to calculate the value of the project and subtract the cost
NOI/Interest rate
Cash Throw Off
Cash Throw Off = NOI - Annual Debt Service
How much cash will the property produce after debt service at the end of each year
Equity Analysis
Equity = Total Project Cost - Loan Amount
How much cash we have to bring to the table
Cash on Cash Returns
Cash on Cash Return = Cash Throw Off/ Equity
cash throw off expressed as a percentage of the equity you invest in the deal
Basic principles of partnership structures
- Is the investor entitled to a minimum return ? (aka preferred return or hurdle rate)
- in what priority are the cash flows from the project distributed? Does the investor have first claim on the cash
- How are cash flows divided?
Partnership Structures
- Operating Cash flow vs. reversion cash flow
- pro-ratta (in proportion) entrepreneur gets less proportion to investment
- Pari Passu (with equal step) (Entrepreneur and investors have equal claims to cash flow. doesn’t usually happen, usually investor comes first)
- investor’s preferred or hurdle rate (cumulative vs non cumulative)
- look back returns
- entrepreneurs promote or catch up return (entrepreneur gets a large layout after paying investors)
Building Wealth Through Real Estate
- Look for real appreciation
- inflation of real estate value
- cash flow from operations
- equity gains amplified by leverage
- cash flow returns amplified by leverage
- Mortgage payoff
- increases in net operating income from inflation
- Increases in cash flow from financing
- refinancing to extract equity
- buying at or below market prices
- selling at or above current market prices
- creating value through smarter management
- Creating value through renovation
