Real Estate Flashcards
Real estate
the practice of investing in real property or real estate-related assets
as a means to diversify a portfolio beyond traditional investments such as stocks and bonds.
Basic forms of real estate investments
Private debt (mortgages)
Private equity (direct ownership)
Public debt (MBS/Collaterized mortgage O)
Public equity (shares in RE corps/REITS)
Advantages of Real Estate as an alternative investment
Potential for Steady Income
Portfolio Diversification (reduce overall portfolio risk.)
Appreciation Potential (source of long-term wealth accumulation.)
Inflation Hedge (preserve purchasing power.)
Tax Benefits (deductions for mortgage interest/property taxes/depreciation)
Leverage Opportunities (amplify returns if the property appreciates)
Control over Investment
Tangible Asset (sense of security for some investors.)
Potential Issues with Real Estate
Illiquidity
High Initial Investment
Property Market Fluctuations
Property Management Challenges
Location Risks
Regulatory and Legal Risks (zoning laws/tenant rights/property tax changes)
Expense and Overhead Costs (taxes, insurance, maintenance, and repairs)
Concentration Risk
Real estate valuation models
Comparable sales approach (Market Approach)
Income Capitalization approach (Income approach)
Cost Approach
Gross Rent Multiplier (GRM)
Residual Land valuation Method
Comparable Sales Approach (Market Approach)
determines the value of a property by comparing it to recently sold properties with similar characteristics (size, location, condition, etc.)
buyer would not pay more for a property than the cost of the existing property with the same utility
Comparable sales approach (Market Approach) STEPS
Identify comparable properties (comps) that have recently sold in the same area.
Adjust the sale prices of the comps for differences in features
Calculate an average adjusted value of the comps to estimate the fair market value of the subject property.
Income Capitalization Approach (Income Approach)
used for income-generating properties (e.g., rental apartments, commercial buildings), this method values a property based on its potential to generate income
convert the anticipated benefits from ownership into a value estimate
Income Capitalization Approach (Income Approach) BASIC STEPS
- Estimate NOI (rent – operating expenses)
- Estimate cap rate ( r-g)
- Direct capitalization method
- Value = income/capitalization rate ( assuming constant growth)
Or Value = PV of future cash flows ( assuming changes in cash flows)
Cost Approach
estimates the value of a property by calculating the cost to rebuild or replace the property minus depreciation.
Costs include:
Building materials, labor to build, tenant improvements, and various “soft” costs, etc.
Cost Approach STEPS
Determine the replacement or reproduction cost of the property, considering construction materials, labor, and other associated costs.
Deduct depreciation, which can be either physical (wear and tear), functional (outdated features), or external (economic factors).
Add the estimated land value to arrive at the final property value
Gross Rent Multiplier (GRM)
This simple method is commonly used for quick estimates of residential property values, particularly rental properties.
The GRM is calculated by dividing the property’s sale price by its gross rental income (without deducting expenses).
The resulting ratio (GRM) is then applied to the subject property’s rental income to estimate its value.
Residual Land Valuation Method
This approach is employed primarily for land development projects. It determines the value of the land by subtracting the development costs and desired profit margin from the expected future selling price of the developed property.
The residual land value represents the maximum price a developer should pay for the land to achieve the desired return.
