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Lecture 11
Introduction to Real
Estate Investing
Types of Investment Opportunities
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Ownership of Income-Earning Assets
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Savings Accounts
Corporate Bonds
Gov’t Bonds
Common/Preferred Stock
Non-Financial Assets
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Commodities
Business Ventures
Luxury Items
Real Estate Investment
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Real Estate Mortgage Investment
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Interest payments derive rates of return
S & L’s, Lending Institutions, Brokerages
Owner Financing
Real Estate Equity Investment
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Income-earning capacity based on factors such as NOI, EGI,
PGI, expenses, etc.
Specific to individual investor’s return requirements
Specific Investor Objectives
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Periodic Cash Flow
Liquidity
Price Appreciation
Increase in Equity Through Mortgage Reduction
Tax Shelter
High Rate of Return Equity
Leverage
Estate Building
Inflation Hedging
Psychological Factors
Risks in Real Estate Investment
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Business or Income Risk
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Financial Risk
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Property value expected to increase when market values for
the property in fact decline
Interest/Money Market Risk
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Expenses exceed income
Principal Risk
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Unanticipated changes in the economy
Changes in Capitalization Rates
Purchasing Power Risk
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Inflationary changes in the economy
Obstacles in
Real Estate Investment
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Objective information sources about the Subject are
difficult to obtain
Comparable property data is limited
Reliable price quotations are not available on a
frequent basis
Typically only a select amount of buyers/sellers in a
market
Transactions are cumbersome, time-consuming,
inefficient, etc.
Time-consuming negotiating and bargaining
Legal factors and tax considerations
Relatively illiquid market
Lecture 11
Investment Analysis
Purpose of Investment Analysis
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Analyze property- and investor-specific items
that derive property value
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Income and Expense Factors (historical and
forecasted)
Specific investor/investment (return) objectives
Income Items in
Investment Analysis
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Contract rents (NOT market rents) for leased
periods
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Vacancy and collections based on lease
contracts
Expense Items in
Investment Analysis
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Considers debt obligations
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Before-Tax Cash Flow and After-Tax Cash
Flow
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Considers ad Valorem property taxes, operating
expenses, depreciation allowances, capital
improvement expenditures (replacement reserves)
Before-Tax Operating Income
Potential Gross Income (PGI)
Less: Vacancy/Collection Loss Allowance
Effective Gross Income (EGI)
Less: Operating Expenses/Management Fees
Before Debt Net Operating Income (NOI)
Less: Debt Service
Before-Tax Cash Flow (BTCF)
Lecture 11
Value Determination
from Cash Flow
Discount Rate v. Capitalization Rate
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Capitalization Rate
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Converts one cash flow into a value determinant
Discount Rate
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“Discounts” streams of cash flows into present
values based on the theory of “Time Value of
Money”
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Used for highly-volatile streams of cash flows
Lecture 11
Example:
Apartment Building