Unit 9: Investment Real Estate Flashcards
Nature of Investment (general)
Outlay of an investor’s money in hopes of income and profit.
Goal - high ROI
Equity is
the investor’s money
ROI is on
Cash invested
Yield is
Annual percent ROI
Leverage
Using other people’s money to buy an assett
Positive and Negative Leverage
Positive - Return greater than cost
Negative - Return less than cost
Maxium Leverage
The highest rate of return from the highest LTV.
Example, using 100k to buy 1 property outright, or breaking it up to finance 4 properties
Appreciation
The ability to sell property without losing initial cash investment
Stocks- how it stacks up
Partial ownership of a company, originally to raise money, now traded on secondary market. Dividends as profit. Vote on company decisions. Rate of Return: Yes Tax Advantage: No Leverage: Maybe Equity Buildup: Yes
Bonds- how it stacks up
Issued to raise money, are a loan from you to company, will be paid back, not much interest. Bought and sold on secondary market.
Rate of Return: Yes
Tax Advantage: Maybe
Leverage: No
Equity Buildup: No
Mutual Funds- how it stacks up
Professional mgmt & diversification (group of company stocks, not just 1)
Pooling assets of many investors, pursuing investment objective, gives buying power to individuals that they could never have gotten alone.
Rate of Return: Yes
Tax Advantage: No
Leverage: No
Equity Buildup: No
Insurance and Annuities- how it stacks up
Tax deferred growth, income for life, death benefit. Annuity: Take a series of payments or a lump sum.
Life Insurance - Pay for life, beneficiaries get $ upon your death.
Depends on paying ability of ins co.
Rate of Return: Yes
Tax Advantage: No
Leverage: No
Equity Buildup: Maybe
Cash and Cash Equivilent- how it stacks up
Treasury bills, money market mutual funds, Cert deposit, passbook savings. Keeps cash liquid.
Rate of Return: No
Tax Advantage: No
Leverage: No
Equity Buildup: No
Retirement Plans- how it stacks up
Tax deferred investments - retirement plans and municipal bonds. Traditions & Roth IRA, 401k, CESA, Profit Sharing
Rate of Return: Yes
Tax Advantage: Yes
Leverage: No
Equity Buildup: Yes
Real Estate - how it stacks up
Rate of Return: Yes
Tax Advantage: Yes
Leverage: Yes
Equity Buildup: Yes
Advantages of Real Estate
- Relatively high yields (profit)
- Growth, tax savings, principal reduction - Leveraging opportunities - creative financing
- Income tax flexibility
- depreciate over 27.5 years residential
- 39 years commercial - High degree personal control - rent, refi, terms of sale
- Equity build up - principal reduction and value growth
- Hedges against inflation - rents and value tend to rise with the market
Real estate disadvantages
- Illiquidity
- Large capital requirements - aquisition, reserves, mortgage
- Necessary CONSTANT MANAGEMENT - MAJOR
- Landlordism
- Risk
Types of Real Estate Investments - Residential
Single family
Condo
Multi Family
Types of Real Estate Investments - Commercial
Retail Retail Commercial Shopping Center Offices Industrial - manufacturing, distribution, assembly Hotels/motels Special Purpose Land Agriculture Business Opportunities
Business Broker
A licensee who specializes in the sale, purchase, or lease of businesses
Investment prop Analyalysis - Relationship to market
Look at Local and National Economy
Investment prop Analyalysis - Location
SITUS indicates the influence on value created by location
Destination Properties
Origin Properties - export activities out of area
Investment prop Analyalysis - Physcial Characteristics: Building
- REPLACEMENT COST sets max price
- Investment value influenced by:
Exterior condition
Interior condition
Buildting Operating expenses
NOT market activity - looking for buy and hold
Investment prop Analyalysis - Physcial Characteristics:
Physical Characteristics - site
Sqft, front footage, acre,
Look at topography
Highest and best use
Legal Characteristics of investment prop
Sole Proprietorship Tenancies in Common Limited Partnerships Sub S or Sub C coprt Real Estate Investment Trust (REIT)
Risk Characteristic
- Legal Risk
- Litigation
- Business risk - budet v actual
- Financial - can you pay?
- Interst rate risk - goes way up on your ARM
- Liquidity - what if you need cash?
- Market risk - drops market value, increased vacancie, increased rate
Potential Gross Income - PGI
Total annual income that a property COULD produce if 100% occupied and no vacancy or collection losses are incurred.
- If leased, based on current rent
- If vacant, based on market rent
Vacancy and Collection Loss
Income lost due to vacancy or default on rent
Usually a percentage of square footage in relation to the rest of the building
Other Income (OI)
Income received other than rent - common areas vending laundry parking space sigage for your retail tenants to pay to use
Effective Gross Income
The anticipated income restulting from the resulting Potential gross income less vacancy and collections, with Other Income Added int
PGI - V&C + OI = EGI
Operating Expenses -fixed and variable
Recurring expenses that are essintial to continuous operation & use of property
Fixed: Don’t change with occupancy
- Taxes
- Building Insurance
Variable - DO change with occupancy
- Utilities
- Payroll and admin
- Manaagement
MORTGAGE NOT INCLUDED IN OPERATING EXPENSES
Reserve
NON CASH set aside for replacement of short term items
Net Operating Income
Income produced AFTER V&C and operating expenses, but BEFORE deducting Mortgage, depreciation or income taxes.
Net Operating Income =
Effective Gross Income - Operating Expenses
Whole Math Formula
- Start with PGI
- Subtract the V&C
- Add in OE
4.This gives you your EFFECTIVE GROSS INCOME
5.Now subtract the OPERATING EXPENSES from the EFFECTIVE GROSS INCOME - This gives you your NET OPERATING INCOME
Now you can find your CAP RATE
Operating Expense Ratio - percentage expenses of Effective Gross Income
To find that percent,
Divide the Operating Expense by the EGI
So if it’s 40%, then 60% would be your Net Operating Income.
CAP RATE
INCOME
___________
Rate x Value
So you need 2 of the 3 of these to find the othe one
Gross Rent Multiplier
Gross Rent Is MONTLY
Sales Price divided by monthly gross rent =gross rent multiplier
Gross rent multiplier x monthly gross rent = value
Gross Income Multiplier
Gross Income is ANNUALY
Sales Price divided by annual gross income is = Gross Income Multiplier
Gross Income multiplier x annual gross income = value
3 Approaches to Value
- Sales Comp Approach
- Cost Depreciation Approach
- Income Approach - income producing properties
Reconcilliation of 3 Approaches to Value
- Appraiser will prioritize most appropriate approach
2. Will NOT average all 3.
