Real Estate Investment Flashcards
Two ways to value real estate investments
NPV
IRR
Types of real estate investments
Raw land Apartments Office buildings Warehouses Shopping centres Hotels/motels
Three components of real estate valuation calculation
Net cash flows
Equity reversion
Recapture of depreciation
How to calc net present value of real estate investment
NPV = sum t=1-n of CFATt/(1+i)^t + ERAT/(1+i)^n - EI
ERAT = equity reversion after tax EI = initial equity investment in property
What is decision rule for NPV calc
Invest if NPV > = 0
How to calculate IRR
Find discount rate equating NPV of property cash flows to zero
What is decision rule for IRR calc
Invest if IRR >= hurdle rate
What are key problems with IRR
If cash flows change signs, may have multiple IRRs
Ranking conflicts can occur when compared to NPV; NPV should take precedence (related to size/timing)
How to calc after tax cash flows
- Calc taxes = (NOI - dep - int)*tax
- CFAT = NOI - debt service - taxes
- ERAT = net selling price - mortgage balance - taxes on sale
What is recaptured depreciation
Depreciation taken in excess if actual deprecation
Asset can also appreciate in value; all depreciation is recaptured and excess is taxed as capital gains
What is cap rate
R0 = r - g
r = required rate g = expected growth in NOI
How to calculate market value of real estate investment
MV0 = NOI / (r-g) = NOI / R0
Methods to determine cap rates
Market extraction method Band of investment method Built up method Direct income capitalization approach Gross income multiplier technique
Market extraction method
R0 (ME) = NOI / MV
Band of investment method
Weighted average cost of capital (debt and equity financing)
R0 (BOI) = weighted mortgage cost + weighted equity cost
Adjust cap rate by adding sinking fund factor
