Principles of Real Estate
Principles of Real Estate FIN 3433
Popular in Course
Popular in Finance
This 29 page Class Notes was uploaded by Miss Candida Hoppe on Thursday October 29, 2015. The Class Notes belongs to FIN 3433 at University of Texas at San Antonio taught by Thomas Thomson in Fall. Since its upload, it has received 19 views. For similar materials see /class/231326/fin-3433-university-of-texas-at-san-antonio in Finance at University of Texas at San Antonio.
Reviews for Principles of Real Estate
Report this Material
What is Karma?
Karma is the currency of StudySoup.
Date Created: 10/29/15
7 4 Professor Thomson Fin 3433 Chapter 11 Residential Mortgage Types Borrower Decisions Mortgage Types and Borrower DeCIslons OverVIew Role ofthe secondarymarket Mortga et es Hume equity Luans Other eiee Amount of leverage luan SlZE Refinancing Defau t Primary Mortgage Market I Where loans are created originated I Retail or street market I Players I Mortgage bankers Mortgage brokers a Banks 3 I Thrilts I Oldest form I Any standard home mortgage loan not insured by FHA or guaranteed by Department ofVeterans Affairs I Revolutionized in 1940s by private mortgage insurance I New revolution in conventional mortgages Secondary Mortgage Market I Where existing home loans are resold I Wholesale market among lenders i I Importance of loan securitization 39 n Fannie Mae 39 Freddie Mac I Government National Mortgage Association GNMA or Ginnie Mae I Wholesale mortgage bankers I Other loan securitizers The Language of Conventional Mortgage Loans Conforming conventlonal noine loan Meets tne requrernents for purchase by Freddle Mac or lT EIEIEI interest rate advantage duetu liquidity at least 25 Noncorlforrnll39lg loan Does not meet GSE qLJlrernerlts in soine respect Jumbu Nuncurlfurmlng intenns ersize eunertlyever 417 EIEIEI Private Mortgage Insurance PMI I Protects lender against losses due to default I Generally required for loans over 80 of 5 value I Protects lender for losses up to 20 of loan I Example terms 2 5 percent orloan in singie uprfront premium 0 5 percent annuai premium 0 0M perrnonth Private Mortgage Insurance continued I Termination may be allowed ifloan falls below 80 of current value and borrower is in good standing I Must allow termination when loan falls to 80 of original value Homeowners Insurance Act of 1999 I Obligation to terminate when loan falls to 78 of original value Private Mortgage Insurance PMI Example I House price 100000 I Loan amount 95000 I PMI insuring top 20quot First 19000 in losses I Borrower pays down loan to 94000 I Defaults Foreclosure sale at 90000 I Lender s loss 94000 90000 4000 I Ith loss less than 19000 PMI covers it completely How FHA Insurance Works I lnsures 100 of loan I Alter foreclosure title is transferred to Housing and Urban Development HUD I Premiums Uprfrunt premium ismn luan Annuai premium based on average oaianee u 5furiuansvvith maturity at more than i5 ye s u 25 furiuans of i5 years oriess 39w FHA Mortgages Federal HOusing 39 39 I Goals ofthe National Housing Act of1949 39 Decentnorne and suitable living environment Implemented mainiytnrougn mortgage markets e errieient AIIuvvs government agencies to concentrate an Extreme needs I FHA is strictly a loan insurance program Loans are from priya e lenders FHA nas had positive casn riovv in most years Sets example for Pivii s FHA Insurance I Many FHA insurance programs 39 203D Standard LPM insurance 245 insurance ror graduated payment s ARM insurance i and 3 caps required 203k Rehab program for singie farnily nouses uity conversion mortgage HECM A I a a Q Created tne Ievei payment mortgage In uenced nousing and subdivision standards Continues to innovate HECM program FHA Example use p ice 150000 Appraised value 154000 Closing costs 7000 39 lmplies maximum loa I39II 140725 150000 x 97650015 Minimum cash down paymen 03 X 150000 4500 Total acquisition cost 150000 7000 157000 Actual down paymen 157000 14B725 8275 Veterans Affairs Guarantees I lelted t0 quallfled veterans 01mllltary service I Guarantee Loans undermiuuu 50 percent Loans uver144 IEIEI 25 percent Max guarantee 6EI EIEIEIlmpllEsluan erszau uuu Other Mortgage Types I Purchase money mortga e Mortgage given property buyer simultaneous with receipt oftitle Usually refers to a second mortgage loan from a sellerto reduce tne buyers down payment 39 Amounts t0 lnstallment payments Wltn lnterest Package m ge Also nances I ortga appliances or other personalty Other Mortgage Types Reverse MOrtgage I Many older households are income constrained I Over 80 own their home I Most have little or no mortgage debt I Most do not want to sell Other Mortgage Types Home Equity Loans I Some home equity loans are closedend xedterm loans I Mostly openend or creditline loans I Tax deductible interest g I Strength ofthe house as security provides favorable rate and longer term I Usually limited to total mortgage debt sum of all mortgage loans of 75 to 80 of 2 How the Reverse Mortgage Works Reverse mortgage loan converts nome equity to lncome Wltnout regulnng borrowerto move Regulres no paymen Regularannultydlsbursement Lump sum dlsbursement CrEdltllnE Mortallty nsllt Rlsk that loan will grow beyond value Traditional Mortgage Reverse Mortgage Building equity through amortization 1 Liquidating equity through regular disbursements Periodic ioan draws pius accruing interest increase the loan and reduce the owner s equity Principal payments reduce loan balance Recent Mortgage Forms Recent Mortgage Forms I Interestonly Mortgage v I Hybrid ARM 39 rO Wit7 beHOOi has interesteoriiy payments for 39 interest rate is fixed for some years then five to seven years ending Witn a full repayment becomes adiustabie of rincipai Payment is always fully amortizmg Fixed rate period ranges from tnree to ten years Fixed interest rate Will be nigner as tne fixed term is ionger Successfully biends tne need of borrowers for predic abie payments Witn tne need ofienders or market ievei interest rates eO amonizing nas interesteoriiy payments for up to rirteen years tnen converts to a full amortizmg payment rortne remainder of tne term as r Options ARM mailman szmmuo rm imam Io men so me easemminmsnais 55 mm in a Minimum payment increases 7 5 pereentperyear interest rate enargeu is adjustable and men is ueepiy reuueeu rurtne rirstrew muntns Typically Witn minimum payment tne iuan baianee gmws uue tu negative amDVtiZatiDn How to Forget a Bad Game of Golf I leed Interesl Vale ARM Yale pills1 597 Io balloon lnrerosr rala ARM plus 10 Opllon ARM star mm 1 25 a Prlnelpnl Balance wm UMhnolnq mm Run How to FOrget a Bad Game of Golf How to Forget a Bad Game of Golf Principal Balance mm lncmaslng Interest Hales lllonlhly Paymonl win momma lumen Halos How to FOrget a Bad Game of Golf I APR Annual Percentage Rate I APR converts regular interest expense and upfront loan fees into a single equivalent interest expense I APR is far superior to interest rate alone in comparing the cost of loans I APR has a bias for most applications I APR assumes that up front fees are spread over the full maturity of the loan Since most loans are prepaid before maturity APR will tend to understate the true cost of borrowing when up front fees are charged Do the assumptions about appreciation seem cautious enough Do the assumptions about future interest rate changes seem cautious enough Are John Jennifer and Stephen overlooking anything important Is it obvious what choice of loan type they should make or not make Example of Using APR to Compare Loan Costs Exhibll S mm um mm Hme Lum run m l m Unium mm m 1 AW lfloans A and B are never prepaid APR accurately gives the cost of each If loans A and B are prepaid before maturity loan B with higher fees will be the more costly of the two Mortgage Decisions How Much Mortgage Debt I APR rises when LTV exceeds 80 Mortgage insuranoe required Aooye 90 rates otten inorease Aooye 95 still nigner I Young households borrow heavily because additional cash is e remey useful s o en borrow less ecause additional cash is less LISer rn 2 nl E w m o o z w m 0 Mortgage Decisions Refinancing I Re nancing is an investment decision comparing bene ts to cost Net Bene t Bene t of Payment Reductions i Cost of Re nancing I First approximation of bene ts sum of all future monthly payment reductions Mortgage Refinancing Example Existing mortgage Amount iuupuu Remaining term years interest rate 7 u percent Munthiy payment 898 as New mortgage mount isiuubuu Term years inter 5 5 percent Muntniy payment 817 no Expected time before paying off new ioan 6 years Cost ofre nancing 5 percent of loan amount The Effect of Personal Costs on Re nancing I Time and stress cost is signi cant for persons not comfortable with nance and business I These costs must be weighed against the nancial net bene ts I This cost probably has fallen signi cantly in rs Mortgage Re nancing Example Continued Monthly payment reduction 89883 81708 8175 Number of months for reduction six years or 72 months 1 72x 8175 588600 Cost of re nancing 005 x 100000 5000 Approximate Net Bene t of re nancing 5886 5000 886 The Effect of Income Taxes on Re nancing Mortgage interest can be deductible fortaxes Exam ie suppose tax rate on aooitionai inEDmE is 25 7nen 1 u or mortgage interest iowers taxes 3 25 Netcust or porrowing is 25 iower interest at 1D costs oniy 7 5 artertaxes I Result Bene t ofre riai icii ig is 25 less I Example Reduction from 10 interest to 9 e 25X1D75D New interestcust a 7 5x9 e 75 interest reductiun artertax 7 5n 7 e 75 u 75 m i Value The Central Idea Professor Thomson I V I Fin 3433 nvestment a ue Maximum once an inyestoris Willng to Chapter 15 pay ror ownership interest inreal property orrno gages I Real estate valuation The Effects of Time and Risk on I How are invest By comparing estimate of present yaiue to acqulslllo cost Effect of Timin on Value mum Nel Cash How I Value ofa property or mortgage thus depends on magnitude ofexpected casn flows tirning ofexpected casn ows x riskiness ofexpected cash flows cmunaw WWW In this picture why can39t we simply add up the future cash ows to nd their value Valuation Requires the Use of Time 339 For Wncn investrnentwould you pay the most7 wnyv Value of Money39Op eratio ns I A B I Compounding Operations Future yaiue of a iurnp surn Future yaiue of an annuity I Discounting Operations n 3 Present value oia lump sum Outcumessuuun Present value ofan annuity wtthcertamty How Money Works Rem ember the f Process n 1 z 3 4 39 Year BegjnmngAmnunt Interesul Vn EndingAmnunt 1 mu 2 3 4 Why Does Time Affect Value 11111 311111 1 z 3 4 Why is cash ow A worth more than cash ow B7 Ifcash owA ear be investedto y1e1d 10 per year how much is cash ow B worth Why Does Time Affect Value 11111 311111 11 1 z 3 4 3 If sh owA ear be investedto yield 10 per 39 2 ow muchis cash ow ea year during years 1 an C worth at time 07 Discounting Brings Future Values Back own the f 39 Curve Cumpuundmg D1scuunt1ng Terminology of Time Value I Present Value Pl An amount at time point 0 I Future Value Fl A single cash ow at any future time point I Payment PMT A repeating amount of cash ow Normally begins at time point 1 Sometimes at time point 0 I Ordinary annuity A Earlier name for Pmt mp sum Any future cash ow occurring y once Example of Compounding 5 years at 5 Percent per Year Initial Deposit PV 1000 Compounding Process per 3 Stamn riding Year Ammunt Interest Amuunt 1 111111 us 115 2 1115 11111525 111125 3 1111125 11111551 111575 4 111575 11111579 112155 3 312155 11161178 127628 Ending Amount FV 1000 x 127628 127628 The Math of Compounding Year 1 100x 105 105 5 5 5 mm D 2 105x105 11025 39 3 11025x10511577 g m 4 11577x10512155 m 5 12155 x 105 127528 or 1055 127528 Example of Compounding The Keystrokes 5 Y e ars at 10 Percent per Year 1 111551 Deposit PV 1000 Compounding Process 2quot 3 amn I Y m g I if 5 5 10 1000 0 ear Hunt nterest Hunt 1 100 010 110 7 g 2 110 011 121 151050 3 121 0121 1331 quot 4 1331 01331 14541 2 5 14541 01454 15105 Ending amount m 1000 X 16105 161050 w 14 1 7 A Deposits 1000 at the end ofeach year Interest rate 5 ngnmvm How would you find lhe accumulated value of a 1 31mm monlhly deposit of 8333 100012 for 5 39 39 years compounding monme at 5 0 1 00 3110250 115753 2 01050 1000 431111 121551 1157531102501050 1000 552553 555555 Accumulated Value of an Annuity ue Deposits 1000 at the begmnmg ofeach year Interest rate 5 W l 2 2 s i sm l SLUSU End SLUSUU z 311112 su Lusu YE 321525 3 115763 11IZSEI LUSH Amnunt Slim 4 1215 51 11576311UZSU1U5U 431U1 5 117628 121551 11576311nzsu1n5n 35311191 5801 91 Wnat VWI Be the Future Value of Your 401k Deposit 1000 per year beginning at age 25 The Keystrokes n mun n8 QQQQQ 7 The Math of Present Value 1 100 105 095238 2 09523s105 0907029 3 090703 39 105 863838 4 82270 5 082270105 0783526 0r 11055 0783526 PVUfSl27 28 ve years 39um nuw discuunted at 5 PV 1276 28 x I 78526 SLUUU ID 1276 28 Q A 1000now7 B Q What ifthey could buy me future 127528 For 9007 B For 1100 Practice Problem I You have been offered an investment the most you should be Willing to pay today y x PVF 10 3 years 4000 x 0 751315 3005 I Keysvolkes ID I 4 IUD 2005 Present Value of an Annuity 1275 28 5525 52 5 5 1276 28 0 D U 552562 Annuity vs Annuity Due 1275 28 1275 28 Annuity n 1 2 4 1175 13 1275 28 Annuity due 0 1 2 Value ofthe annuity due Solutions A 5SZS Zgtltl 05 B Switchcalculaturtu Begin Made Practice Problem What is the value ofa 20 year het lease that pays 54000 per yearifyou discount at 10 A A l iultyx PVFA 10 20 years 5000 x 0 51350 Keystrokes 20 10 05000 00 Q Q 358 Q Q Practice Problem I We is the presentvalue 0f4 000 a the end oreaoh year for4 years lfyouropportunlty cost 1s 10 A Aril iultyx PVFA 10 4 years 4000 x 3109005 12079 Keystrokes 10 1r l promise to pay 4000 a year for 30 yrs and you a iehoerwho expects a 10 retum what is maximum amount that you would ioah me to toah PMT x PVFATH a 000 x 9 42091 374707 05 or371708 Keystrokes 3U 10 30 years 4 4000 0 37708 A Real Estate Application of Time Value 10000 100000 5 In II D 100000 Solutions 1 Find the st ufstx different cash ows and sum Lbsresults 100000 3 Salve as a Eumbmed Pmeblem 10000 S olutions 560000 Fmd the PVs of Six different cash ows cpcxt arm a a y calculatur Spreadsheet See Chapter Appendix Calculator Solution for Uneven Cash Flows Lee Vista Set calculator for one payment per year clear calculator WW Enter zero for initial cash outlay 0 Q oosuwa a S Q aquot quots1 9 I Enter dlscountrate 14 3524 Firide 39 YieldInternal Rate of Return 5n 39 8 u 4 54m 301L110 46447986 Purchased for 95000 SBSIIEIEI Sl SHIELDED sluuuuu l Purchased for 105000 5 SIUSIIEIEI 10000 100000 872 Longer Maturity Makes PV More ensitive to the Discount Rate YieldIRR Depends on the Selling Price Purchase rurluupun and sellruraupuu 100000 10000 mm 5 i Q C Q Q mm a 31 Purchase rurlElElpElEl and sellrurllupuu 5 100000 10000 110000 h i Required eld Affects Value Vis a At a required yield dlscount rate oflA percent tne va ue of Lee vista was 464480 saunas Question vvnat is its value at tnese required ylelds lEl percent 539 E4l l2 percent 5DD ZB4 lB percent 432 DEB l8 percent 401628 uuuwaSUB U 54m n 2345 e 3 Information on Required YieldslRRs I Many real estate investors think of required yields as composed oftwo parts ERJ R RPJ R is a relevant rate tree orderault risllt cornrnonlytne TennyearU 8 Treasury rate RP is risllt premium rora particularproperty 14 Professor Thomson Fin 3433 Chapter 10 Real Estate inance The Laws and Contracts is 1 Some Effects of Mortgage Debt j I More households can own their home I Businesses can use their cash for core activities I Investors can leverage and diversify s investment meowners can obtain credit on better terms than consumer debt home equity credit lines 39 ax favored Longertenn Lowerinterest rate Two Elements of a Witgage Loan I Note Exact terms of the nancial obligation I Mortgage Pledges the property as security for the note 1r u I Adjustable rate continued Margin Lenders marxup 2nd td Bun basis pdints bp Average is extremely stable at277 7 278 bp 39 Change Date Date that interest rate changes h tirne index rate ummunly is tne iast published rate days tur Example berurethe nange date Teaser rate initial temporanlyreduced interest rate The Note Interest Rates I Fixed rate 3657day interest daily rate is 1365 of annual rate contrasts with commercial mortgage loans at 360day interest 39 Monthly charge is iiZ of stated annual rate I Adjustable rate 39 index rate Marketrdeterrnined rate beyond control of either borrower or lender U 5 Treasury cdnstant Maturity Rate anirt institutidn east at Funds index LlEiOR Hume rnurtgage rate index The Note Interest Rates continued I Adjustable rate continued interest rate caps Lirnit on changes in interest rate charged PEriDdiE iretime impdrtantduestidn Dues cap appiytd tne teaser rate7 Payment caps Limit on payment changes ratherthan interest rate Chan e5 can resuitin negative amdrtizatidn unpaid interest added td tne paianee Payments I Always in arrears end I Virtually always monthly I Various arrangements for xedrate loan Level payment ofmonth Partially amortized term for amortization term to ma urity balloon loan interest only nonarnortizing sometimes called a ulletquot loan Negative amortization WAIT Right of Prepayment I Traditional No right of prepayment unless explicitly provi I Modern statutory case Right of prepayment unless explicitly prohibited 2 i n ummemmme yea I mm I meet I Loans with right of prepayment All conforming and FHAVA loans Home equity credit lines H 4 e mu The39Note Right of The Note Right of Prepay n continued Prepayment c ntinued I Loans with restricted right of I Loans with restricted right of prepayment prepayment subprime home loans Subprime home loans Jumbo home loans Most income property mortgage loans Jumbo hom l ans Most income property mortgage loans I Prepayment pena ie maintenance defeasance Percentage of outstanding balance The Note Other Terms I Nonrecourse loan No personal liability Exculpatory clause Singierpurpose single asset bankruptcy remote entity for borrower I Demand clause Right oflender to require prepayment I Inclusion of mortgage clauses by reference Important Mortgage Clauses I Description ofthe property I Insurance clause I Escrow cause I Acceleration clause I Dueonsale clause I Hazardous substances clause I Preservation and maintenance clause z 21 u Title theory Mortgage a temporary transfer oftitle Lien theory Mortgage a lien Historic difference was lender s claim to rents and possession in case ofdefault anlvnwl mu sum Hr rMmaue x J Eoimwei 397 ma um mu ul mm m luau I y anr When ThingsGo Wrong a m Nonfor P so ns sto Default I Default Failure to meet requirements ofthe note or mortgage Technical default Any violation ofterms Substantive default Three missed payments 90 days I Counseling and consumer debt reorganization I Temporary reduction of payments I Assisted sale I Deed in lieu of foreclosure Advantages quick quiet cheap Disadvantages other liens remain bankruptcy can nullify and wipe out mortgage Foreclosure More Foreclosure continued I Legal process ofterminating all claims of gt I De ciencyjudgment Judgment against ownership and all liens inferior to mo gagor for unrecovered balance foreclosing lien Exam ie Risk or raiiing to notiry a ciairnant Netfureclusure au iuri price iEIEI EIEIEI Presence orsupenoriiens iZEI EIEIEI Costly and tirne consurni Q a a 1 g a I Importance of lien priority I Recourses ofthe defaulted mortgagor Equity orreoern ton 39 statutory rignt or redemption Judicial foreclosure Courtradrnii39iistei39ed public auction Poweroisaie Public auction conducted by tmstee or mortgagee prererreo by lenders Power of Sale States I Possible threat to lender s ability to eclose I Three forms of bankruptcy Liquidation Court supervised workout Acquiring Property with Debt without a Mortgage Exist39 ing e alumnus i i I Subject toquot borrower does not sign mortgage note No personal liability for mortgage loan Property still is subject to the mortgage 4quot H as r Wm M J J b m I Assumption Buyer adds signature to note Personal liability for loan Property subject to mortgage a v mm Mama I WM m Mquot mm Fin 3433 Chapter 16 Additional Material Interest Due I Interest Due is the mirror image of interest earned I In Principles of Finance you learned that interest earned Is 39 lntereS rate ArnOLJnt Deposited I Interest due is 39 Interest rate ArnOLJnt Borrowed Periodic Interest Rate I The periodic interest rate is the Note Rate divided by the periods per year I The monthly interest rate charged can then be compute as Ratel1200 1 W Interest Due Example I You borrowed 250000 last month at 6 3 7 much interest is due now i I 250000 63751200 132813 I lfyou make a payment more than 132813 you will be amortizing your loan I lfyou make a payment less than 132813 you wil have negative amortization or more pleasantly called positive accrual I Your loan contract will specify the use of ents on your loan Typically money will rst be used to make up any arrears in payments or any penalties you have incurred I lfyou are paying according to schedule your payment will rst be applied to interest ue I Any amount ofyour payment that exceeds the interest due will be used to amortize a down the39 39al Amortization Example I For the previous Interest Due example say you made of payment of1500 the principal Your new principal amount would e I 25000000 17188 24982812 Professor Thom son I Rationale Chapter 9 yaiue ofa property is tne presentyaiue of its anticipated income I Olten called income capitalizationquot Valuathn Usmg Capllalze to conyert ruture income ll itO a the Income present yaiue Approach Direct capitalization with an overall 17 1 Direct capitalization with an overall at 39 rate r e Discount all future cash ows at Find value as a multiple offirstyearnet required yield discount rate lllcome NOD Multipller is obtained from sales of comparable properties 2 Discounted cash ow DCF 39 DCF models require proper net Cagh 0W5 for a Standard an estimate ofthe expected holding period noiding period say l0 years estirn s ofnet casn flows oyertne entire Discount at required yieid discount rate eweded holding period including the net income from sale tne appraiserto seiect tne appropriate yieid required lRR at which to discount all future cash ows m Example Centre Point Office Building Reconstructed Operating Statement mi Exhibit 91 Pmpxtymrsmsafga 39wesmtzsAanth isl nmandS thsecuzid Cuntmchznts emsMimnwmmmmswnpxmm quot PG Pmannal Gmss Iquot me Ammdmmkztxemmcizases 2 x u i VC Vacancy amp Collection Loss Vacarcyandcallzconnlasses may 5 O m wmm muf mmmmwym MI Miscellaneous Income Capztxlexpimms 5ufe achvegmmcmnzeachym EGI Effective Gross Income OE Operating Expenses j CAPX Capital Expenditures NO Net Operating Income Potential Gross Income PGI Potential Gross Income Centre Poi nt 39 Potential gross income Rental income FirStFIoor assuming100 oceupancy g 1000 Sq it Suites 74 X 1800 X12 rnos 80400 Second Floor L 800 Sq ft Suite572ti800MZrn05 I 8005 ft Suite Xi 400MZrnOS I Important issue Contract rent or market rent 43200 5 00 Potential Gross Income 51986 400 93000 i80000 a r Types of Leases I Straight lease Level lease payments I Stepup or graduated lease Rent increases on a predetermined schedule Comparable I Indexed lease Rent tied to an In ation index Consumer Price Index Union wage I Example Survey ofrental rates for second Iloor of ces in Centre Point Remmu iai 520 Hui 540 Hui pan s n 790 Sin 900 mdex em 39 q unil i I Percentage lease Rent includes percentage oftenant s sales Effective Gross Income I VC vacancy and collection loss is based on39 I Miscellaneous incom Garage rentals and parkll39lg fees Hlstorlcal expenence Laundry and yenolng rnacnlnes Clubnouse rentals Competan propertles ii l tne rn ural vacancy r Z 939 e ate Vacancy rate tnat ls expected W a stable orequlllbrlurn rnarxet Operating Expenses I Operating Expen Orolnary and regular expenoltures necessary to keep a property runctlonlng cornpetltlyely leeu Expenses tnat do not varletn occupan y Potential gross income PGD 180000 Vacancy amp collection loss VC 18000 ns e prupe taxes Effecl39ve 9r SS 39quot quotquote EGO 162000 Vanabe Expenses tnatyary Wltn occupancy I Ullll lE Malntenanse anusupplles Trasn and garbage remuvai I Do not include age payrnents Tax depreclat tures CAPX I CAPX Expenditures that materially increase value of structure or prolong its life lOl l Capltal expenoltures Roof replacement Addltlons HVAC Replacement Resurfacan otparlxlng areas Tenantlrnproyernents HC 39 gt J 39 7 77 Special Problem in Income Property Analysis e CAPX Reconstructed Operating Statement 39 Most appraisers Abuve Lme treat CAPX as 01 1 3 5 NO L See Exhibit 94 institutiunai Beluw Lme inves mrs usuaiiy EGI treat CAF X as bEiDW iine expense M Net Cash Fluw um N01 Sources of Industrv Expense Data Sources of Industry Expense Data institute of Reai Estate Management iREM Wemmna Coum of Shoppmg Centers W iCSC WWW icsc oro Urban Land institute ULi WWW uii org Locai market participants Detaiied infurmatiun un apartments emcee Shupping centers federaiiy assisted nuusrng and condominiums wraps and pianned E cummunities Buiiding Owners and Managers Associatio BOMA WWW boma org Large affine buiidings First Income Appraisal Method NOi is property s dividend Direct Fanitali atinn tnut investor s dividend fundamentai NOI Basic value equation V 0 Where does this come from rer rmmremssneme v v a u acanm Ea edian Loss What gives us reason to rely on in How do we implement the approach Netnvevaunv incame First Income Valuation Method Direct Capitalization V N 011 R 0 t Basic value equation Warninglllllll R0 is a cap R0 is NOT a discount ralellll Direct anitali ati nn The following ratio tends to he very stable in real estate across similarincomeproducing piopem39es V M N01 Therefore given the ineomewol ofone ofthcsc piopem39es we can stimate the value V as follows V MOXNOI Income Capitalization There are reasons to believe Mo is ielated to required yields ofinvestors onnection that is easiest to pursue through the reciprocal ofIVIo as follows Steps in Direct Capitalization 1 Obtain estimates of cap rates RE v from the market using the direct market extractionquot equation N01 Selling sz 2 Divide the subject NOI1 by a weighted aver e o the abstracted Rus to obtain an estimate of value for the subject Incomef nnitnli ntinn continued Inplace ofMo use R inineome capitalization For V Mo x N01 We substitute Direct Capitalization for Centre Point Case Step 1 Extract Ru from the market Exhibit ls imparasle Firstyar NOl Sale Price K PnceJNO A Santana 7 swarm nnw lnz B ll4nnn e lznunnn ms ms 0 lnunnn 7 971mm Elm 971 D 72mm 7 71min nlnl 99 E 9mm 7 Bl uuu my lEIl Average unaa lEIl m 39 39 is i i Direct Capitalization for Centre Point Case Other Sources of Cap Rates I Real Estate Research Corporation s Real Estate Report wwwrerccom 2 Compute estimated market value using rst year NOI RealtyRatescom wwmealgratescom Grubb amp Ellis www9rubbelliscom CoStar wwwcostarcom Other appraisers and market participants Value 900000 0 099 Important Points About Cap Rates I Direct capitalization only uses rst year I RD Overall rate of capitalization or OI but Ru re ects all future cash ows goingin cap ra e Transaction prices of the comparables reliec I RE A ratio ofinitial cash ow to value the Value 0mm 055 0W5 Future 05 ows a d cha ges m met in turn the cap rates extracted from these value aiso are important WCWSeS do 50 55 we I Not a yielddiscount rate Important Points About Cap Rates 1 W I Assume the followin rst ear cash I Direct capitalization may sometimes be oira y uperior to valuation by DCF Fewerexplicit assumptions must be made ei id ofyeari 910650 Fewerexplicit forecasts must be made COS ofsa e 00 0 Going rmIRR W1175 90 00 7 89100 16650 7900000 900000 0099 00185 7 ca rate a reclahon rate Effect of Appreciation on Cap Rate Gross Income Multiplier Example of Centre Point SUppoge reqwed one year RR 5 M 75 I Quick indicator ofvalue for smaller rental Suppose incorne growth results in a sale price at s end or vear1 ot930i000 Pmpemes What 5 the rewiring cap meg 3 I Requires no operating expense information Total yearl cash flows I Critical assumptions 89100 9301000 1 10191100 gt Roughlv equal operating expense percentages I P ll 75 dlscount 911946 50 055 PropemeS Resultan cap rate i 00 n 9111946 9 77 2 A ume market rentS are pald Conclusi required yield constanti more I Used for properties with shortterm leases 9 apartments and rental houses I GIM Sale price Effective gross income on appreciation irnplies lower cap rat 1 39 4m 7 W ulna Gross Rent Multiplier Example Problems with Valuation by Direct Exhibit 96 39 39 39 aquot M quot mm l f lnadeouate data on comparable sales due to t o c 39 Above or beluvvernarket leases quotSJ W Wm 59 3775 g Dirtenng length or leases and rent escalatluns seaweesmtmn SISEJEEI moo smjm anneal molt61 55 5m 5 L Dirtenng distributions or operating expenses AmgeGM 553 39 between lan lurd and tenant ittenng pnces between institutional and private Indlcatedyalue 553 x EGI investors torsirnilarproperties ofsubJed 53 x162000 Result Discounted cash flow DCF analysis can 95360 or 096000 be preferable 11mm ms has lPGn Pu nwa was cosmosivci mm quot39 39 1M Ida mu I39VE ux mun M 7 Yx mu noun can 9 u 15 quotIn vme ass out w war m3 1 xunn xunn nswxss 7w 1 we we nsnnms mo Sale pnce at end uerar 5 N015 4 1U3Z 1EI tun 39 2 was wzs mum we 1 on on b yum mm mm mot Where R atemnal mugmngruufv 39 39 s max wunn mum usuxnz 616327 cap rate slightly htgherthzn RE i w Sale pnce SP 1033000 stcmxthatepremedtaxe echequredmeldmmuketfmnlevered v eSettmg expenses SE 58 no mmmsafm m 5k Net sate proceeds NSF 0 974700 Fax simys ufmlevexedwdds see RERC wwwme mm 39 quot fValue Indicators Which Appraisal Method Should be u Used to Value Each of These I Problem Cannot estimate cap rates without actua sales I Solution 1 Since incomeproducing real estate has both equity and debt nancing think ofthe cap rate as a weighted average of equity cap rate and mortgage cap rate I Equity cash ow OI Debt service Before tax cash ow I Loan cash flow B Monthly payment X 12 Which Appraisal Method Should be Used to Value Each of These Purchase price 7 Loan 57c Equity R equity dividend rate Loan cash flow aloan n Loan constant Loanrtorvalue ratio Loan amount a Price Equity Equity cap rate Loan cap rate mem Fin 3433 Professor Thom son hapter 2 Value and Real Estate Decisions mm Elements of an Investment Decision Future Bene ts N anlViaViElal Future Net Cash Fiuws Time Opemtians I An investment decision is one that entails signi cant costs now in return for bene ts in the future Significant time into the future significant irrevers oie costs riovv Normal Business Decisions vs Real Estate Decisions I Normal business decisions i Chuuse Ways to erierate ousi ness Chuuse marketing strategies urchannels rgariizatieriai structure uipmerit Chuuse he ieeatieri Rent urbuv Example choice ofa personal residence portant to internalize information on the non nancial actors I Decision is intuitive but no less ofa valuation decision Prooi Houses do have prices I r r 39 The Spectrum of Risk in Investments i hum2 msmmmi am ii iiwmni mm raurmimimv imimi aw mbu nln rwnmmn wmw m ruliilhmmmm a mmm 0033 rim39 raisinV w Signi cance of The Spectrum of Cost Uncertainty Cost Risk vs Cash Flow Risk I Cost risk is immediate and therefore can have greater impact on va us I Each risk requires special expertise cost risk is evaluated by engineers and building contractors Cash ow risk is evaluated by brokerS market researchers or appraisers mm 2 magnum by Lawmu aiwumamir Risk Investment and Yield I Two investment choices Vacant residential lot which can Sell ll lOl le yearfor5l1000 2 Treasurybonds that Will mature in one year paying 50000 Which would you pay the most for Why Hiuhumwnviw i Risk Investment and Yield continued Ways of Managing Real Estate R39sk I lfyou purchase the lot for 40000 and sell I Avoid risky ventures in a year for 50000 how much has your I Study real estate as an ongoing interest money growquot I Do not accept advice on an uninformed basis I lfyou purchase the Treasury securities for 48000 how much does your money I Get experience in a type of investment ow Workiore enenced persons What do we can these growth rates Make only srnallyscale investments I Assure a long holding period 39 Price risk Cash flow or bene t Stream risk Two Concepts of Real Estate Value I Price 157000 I Financ39ng 90 percent orpnce I Investment value Value to a particular 30 years 5 75 percent individual 824 59 I Closing costs 9420 I Appraised value Value to a typical investor or probable selling price mum 271 w it 3M mum 1b m Stil mlli a Pawn psiimam ni ful Pica m win la imam Wm MW 23M EDEZEDE