Reading 40 - Private Real Estate Investments Flashcards

Question

Beginning Jan1, renovation began on a shopping center. The NOI is forecast to be $6Million. Absent renovations, NOI would have been $10Million. After this yr, NOI Is expected to increase 4% annually. Assuming all renovations are completed by the seller at their expense, estimate the value of the shopping center assuming a 12% required rate of return.

Answer 1

**_Value after renovation:_** = Stabilized NOI / cap rate = 10,000,000 / (12%-4%) = $125,000,000 **_Present Value of NOI during renovation:_** N=1,I = 12, PMT = 0, FV = 4,000,000, -\> PV = 3,571,429 **_Total Value of shopping center:_** Value after renovation = 125,000,000 Loss in value during reno = _-3,571,429_ Total Value = 121,428,571

Answer 2

Is the ratio of the sales price to the property's expected gross income in the year after purchase

Answer 3

It ignores vacancy rates and operating expenses

Answer 4

= cap rate + growth rate

Answer 5

**_Present Value of NOI:_** N = 4, I = 13, PMT = 1,000,000 , FV = 0, -\> PV = 2,974,471 **_Terminal Value after yr4:_** V₄ = NOI₅/ cap rate = 1,200,000 / (13%-3%) = 12,000,000 **_Present Value of Terminal Value:_** N = 4, I = 13, PMT = 0, FV = 0, -\> PV = 7,359,825 **_Total Value of Wharehouse today:_** PV of forecast NOI = 2,973,471 PV of terminal value = 7,359,825 = sum = 10,334,296

Answer 6

Once the lease expires, rent will be adjusted to the current market rent

Answer 7

the contract(term) rent and the reversion are appraised seperately using different cap rates

Answer 8

**_PV of Term Rent:_** N = 2, I = 6, PMT = 200,000 , FV = 0, -\> PV = 366,679 **_Value of Reversion to ERV:_** V₂= ERV₃ / ERV cap rate = 300,000 / 7% = 4,285,714 **_PV of Reversion to ERV:_** N = 2, I = 7, PMT = 0 , FV = 4,285,714, -\> PV = 3,743,309 Sum the two Present Values = 366,679 + 3,743,309 = 4,109,988

Answer 9

1. One source (layer) of income is the contract (term) rent that is assumed to continue in perpetuity 2. The second layer is the increase in rent that occurs when the lease expires and the rent is reviewed

Answer 10

1. Project income from existing leases 2. Lease renewal assumptions 3. Operating expense assumptions 4. Capital expenditure assumptions 5. Vacancy assumptions 6. Estimated resale price 7. Appropriate discount rate

Answer 11

1. The discount rate does not adequately capture risk 2. Income growth exceeds expense growth 3. The terminal cap rate and the going-in cap rate are not consistent 4. The terminal cap rate is applied to NOI that is atypical 5. The cyclicality of real estate markets is ignored.

Answer 12

The cost approach involves estimating the market value of the land, estimating the replacement cost of the building, and adjusting for depreciation and obsolescence. Is often used for unusual properties or properties where comparable transactions are limited

Answer 13

1. Estimate the market value of the land. Often done using the sales comparison approach 2. Estimate the building's replacement cost 3. Deduct depreciatiom including physical deterioration, function obsolescence, locational obsolescence and economic obsolesence ## Footnote **= land value + (replacement building cost _+ developer’s profit_) – deterioration – functional obsolescence – locational obsolescence – economic obsolescence**

Answer 14

1. Lease review and rental history 2. Confirm the operating expenses by examining bills 3. Review cash flow statements 4. Obtain environmental report 5. Perform a physcial/engineering inspection to identify structural issues 6. Have property surveyed 7. Verify payment of taxes, insuraance and other expenditures

Answer 15

Growth Rate = Discount Rate - Going-in cap rate = 7.25% - 5.25% ►2.00%

Answer 16

Because properties do not transact very frequently, it is more difficult to create transaction-based indices as is done for publicly traded securities. Appraisal-based indices can be constructed even when there are no transactions by relying on quarterly or annual appraisals of the property. Of course when there are no transactions, it is also difficult for appraisers to estimate value.

Answer 17

return = _NOI - cap ex + (end MV - beg MV)_ beg MV

Answer 18

1. _Repeat-Sales Index_ - relies in repeat sales of the same property. A regression is then developed to allocate the change in value to each qtr 2. _Hedonic Index_ - requires only one sale. A regression is developed to control for the difference in property characteristics such as size, age and location

Answer 19

1. Debt Service Coverage Ratio (DSCR) 2. Loan-to-vale (LTV)

Answer 20

**_Loan Amount support by LTV ratio_** = (1,200,000 \* 80%) = 960,000 **_Using DSCR, debt payment property will support_** : 135,000 / 1.5 = 90,000 The implied loan amount = 90,000 / 10% = 900,000 Since 900,000 At 900,000, the LTV = 900,000/1,200,000 = 75% At 900,000, the DSCR = 135,000/90,000 = 1.5

Answer 21

**_Calculate the first yr cash flow_** = NOI - Debt service = 135,000 - 90,000 **_Equity Dividend Rate_** = first yr cash flow / equity = 45,000 / 300,000 = 15%

Answer 22

**_Remember_** : on a gross lease the owner of the building pays the operating expenses, on a net lease the renter does At the maximum the rent on a net lease basis would be (20-8) = 12 In reality, it will be even lower than this due to the risks of unexpected operating expenses

Answer 23

Direct capitalization applies a capitalization rate or an income multiplier to the forecasted first-year NOI. Thus, expected increases (growth) in NOI in the future must be implicit in the multiplier or cap rate. In contrast, when doing a DCF, the future cash flows are projected each year until sale of the property. Then each year’s cash flow and the expected resale proceeds are discounted using a discount rate. Thus, the future income pattern, including the effect of growth, is explicit in a DCF. Furthermore, DCF often considers other cash flows that might occur in the future that are not reflected in NOI, such as capital expenditures.