1 / 17

Chapter 10: Investment and Risk Analysis

Chapter 10: Investment and Risk Analysis. Motivations for R/E Investment Return (cash flow) Appreciation (inflation hedge) Diversification Tax Benefits. Investment Styles or Strategies. Sector Investing Contrarian Investing Market Timing Growth Investing Value Investing

tanek
Download Presentation

Chapter 10: Investment and Risk Analysis

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Chapter 10: Investment and Risk Analysis Motivations for R/E Investment • Return (cash flow) • Appreciation (inflation hedge) • Diversification • Tax Benefits

  2. Investment Styles or Strategies • Sector Investing • Contrarian Investing • Market Timing • Growth Investing • Value Investing • Strategy as to Size of Type • Strategy as to Tenants • Arbitrage Investing • Turnaround Investing • Trophy of Blue Chip Investing

  3. Projecting Cash Flows Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Rents 100 102 104 106 108 Vacancy 5 5555 Net Rent 95 97 99 101 103 Op. Exp. 3839404041 NOI 57 58 59 61 62 Usually include the debt service Debt Ser. 3030303030 Eq Div(BTCF) 27 28 29 31 32 Equity Dividend = Before Tax Cash Flow (BTCF)

  4. Common Investment Ratios: • Price per square foot (or price per acre) • Capitalization Ratio = NOI/Price • Eq. Dividend Ratio = Equity Dividend/Eq. Inv. • Debt Coverage Ratio = NOI/Debt Service Estimating the future sales price • Projected inflation rate • Projected cap rate Final Cash Flow: Sales Price (estimated) Less: Mortgage Balance Before Tax Cash Flow from Sale

  5. Measures of Investment Performance • Net Present Value (NPV) • Profitability Index = PV of Cash Flow/EQ Inv. • Internal Rate of Return (IRR) • Adjusted (Modified) IRR: Makes assumptions about how the cash flows are reinvested

  6. Example of Modified IRR Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 NOI 57 58 59 61 62 Debt Ser. 3030303030 BTCF 27 28 29 31 32 Eq. Inv. -60 IRR 38.2% NPV(15%) $50.5 Calculate what each BTCF grows to @6% - BTCFs 34 33 32.5 33 32 - Total @ end of 5 yrs = 164.5 I = 22.3%; n=5, PMT=0; PV=-60; FV = 164.5 Modified IRR (@6%) = 22.3%

  7. Risk Analysis Types of Risk in R/E Investment • Business Risk • Financial Risk – Leverage risk • Liquidity Risk – can’t sell the project • Inflation Risk • Management Risk • Interest-Rate Risk • Legislative Risk • Environmental Risk

  8. Sensitivity Analysis • Change a single assumption at a time • Scenarios • Partitioning of IRR: How much of return is due to operations and how much from capital gains • Risk vs. Return

  9. Real Estate Taxes Real Estate Taxes & Interest are Deductible • Principle residence and second home. • Investment real estate Gain on Sale of Principle Residence is excluded from tax up to a max. of $250K (or $500K if MFJ). A principle residence may be sold no more than once every 2 years.

  10. Calculation of Gain on Sale • Sales Price • Less: Selling Expenses • Net Selling Price • Original Cost (or Basis) • Plus: Improvements • Less: Accumulated Depreciation • Adjusted Basis • Net Selling Price • Less: Adjusted Basis • Gain on Sale

  11. Calculating Depreciation: • Residential Property: 27.5 years, straight line • Commercial Property: 39 years, straight line Depreciate only building costs, not land. Passive loss rules: • Real estate income is defined by the tax laws as passive income. • Passive losses can be offset only against passive gains. • Exception 1: Middle income taxpayers (AGI<120K) can deduct up to 25,000 of rental losses against regular income if they actively manage the property. • Exception 2: R/E professionals can deduct passive rental losses against regular income.

  12. Maximum capital gain rate on federal taxes is 20% for assets held for at least 1 year. Investment Analysis Example Consider the purchase of an Apartment House (in $1.000s) Purchase Price $3,300 Mortgage 2,600 Equity 700 NOI 570 Cap Rate 17%

  13. Calculating Before-Tax Cash Flows Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 NOI 570 580 590 610 620 Debt Ser. 500500500500500 BTCF 70 80 90 110 120 Sales Price 3,100 Less: Mortgage Balance (1,000) BTCF (from sale) 2,100

  14. After-Tax Cash Flows from Operations Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 NOI 570 580 590 610 620 - Interest 500 500 500 500 500 - Dep. 60 60 60 60 60 Taxable Inc. 10 20 30 50 60 Tax (50%) 5 10 15 25 30 BTCF 70 80 90 110 120 Less: Tax 5 10 15 25 30 ATCF 65 70 75 85 90

  15. Calculating After-Tax Cash Flow from Sale Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Sales Price 3,100 Less: Mortgage Balance (1,000) BTCF (from sale) 2,100 Now Calculate Taxable Gain: Sales Price 3,100 Original Cost Basis 3,300 Less: Accumulated Depreciation 300 Adjusted Basis 3,000 Taxable Gain (Price – Adj Basis) 100 Tax (20%) 20 After-Tax Cash Flow from Sale 2,080

  16. Investment Analysis Yr 0 Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 BTCF -700 70 80 90 110 2,220 ATCF -700 65 70 75 85 2,170 Before-Tax IRR (BTIRR) 33.2% After-Tax IRR (ATIRR) 31.6% NPV Before-Tax (@15%) $647 NPV After-Tax IRR (@15%) $586 After-Tax Present Value of Equity @15% $1,286 Value of the Debt (Mortgage) $1,000 Total Value of the Property $2,286

  17. Homework Problems: 10-2, 10-6 (pages 330 – 331)

More Related