Principles of Commercial Real Estate Finance Module 2 Slides
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    Principles of Commercial Real Estate Finance Module 2 Slides Principles of Commercial Real Estate Finance Module 2 Slides Presentation Transcript

    • Principles of Commercial Real Estate FinanceModule 2: Time Value of Money and Discounted Cash Flow; Real Estate CyclesAssociated ReadingsLinneman Text:Prerequisite I: The Basics of Discounted Cash Flow & Net Present Value AnalysesCh. 20: Real Estate CyclesGetREFM.com:Resources page, Recommended Viewing section: “Crisis of Credit” videos Aqua at Lakeshore East, Condominiums, Chicago Copyright © 2012 by Real Estate Financial Modeling, LLC. All rights reserved.
    • The Importance of Timing • Owners generally do not want to spend money before they  absolutely have to.CLICK TO EDIT MASTER TITLE STYLE • Vendors and service providers generally want to get paid as  soon as possible. • Investors want to get paid based on the transaction  documents, whose profit‐sharing terms have been  architected based on our investment objectives. • Internal Rate of Return (IRR) metric depends partly on the  timing of cash flows. GetREFM.com 2
    • Time Value of Money / Discounted Cash Flow (DCF) Model • The passage of time introduces the potential for both  positive and negative change in the value of a dollar.CLICK TO EDIT MASTER TITLE STYLE • It theoretically allows us to invest $1.00 today (Present  Value) and get a positive return on it, so that it would  be worth more than $1.00 in the future (Future Value). • It also introduces operating,  market and credit risks, all  of which could destroy part or all of the value of the  $1.00 we invest. GetREFM.com 3
    • Time Value Of Money BasicsCLICK TO EDIT MASTER TITLE STYLE Today The (Time 0) Future GetREFM.com 4
    • Time Value Of Money Crash Course • We agree in theory that $100.00 in hand today is  equivalent to a value greater than $100.00 at some point  in the future (say $104.00 at the end of 1 year), under the CLICK TO EDIT MASTER TITLE STYLE assumption that the amount by which the $100.00 base  amount is grown (4% over 1 year in this case) is the  appropriate growth estimate. 365 days Today 4.00% Growth End of (Time 0) Over 1 Year Year 1: $100.00 $104.00 GetREFM.com 5
    • Time Value Of Money Crash Course • If we were to theoretically transport ourselves to the end  of Year 1 and look backwards, to get back to the $100.00  amount at Time 0, we would apply the 4.00% growth rate CLICK TO EDIT MASTER TITLE STYLE in reverse. This is known as discounting the future  expected cash flow.  365 days Today 4.00% Reverse Growth End of (Time 0) (Discounting) Over 1 Year Year 1: $100.00 $104.00 GetREFM.com 6
    • Time Value of Money / Discounted Cash Flow (DCF) Model Time Value of Money 4% constant growth rate is assumed Year 1 Year 2 CLICK TO EDIT MASTER TITLE STYLE Today End of Year 1 End of Year 2 $100 $104.00 $108.16 Today End of Year 1 End of Year 2 Future Value of $100 -- $104.00 $108.16Future Value Derivation -- $100 x (1 + .04) $100 x (1 + .04) x (1 + .04) GetREFM.com 7
    • Time Value of Money / Discounted Cash Flow (DCF) Model Time Value of Money 4% constant growth rate is assumed Year 1 Year 2 CLICK TO EDIT MASTER TITLE STYLE Today End of Year 1 End of Year 2 $100 $104.00 $108.16 Today End of Year 1 End of Year 2 Future Value of $100 -- $104.00 $108.16Future Value Derivation -- $100 x (1 + .04) $100 x (1 + .04) x (1 + .04) ‐ How certain are we that we will indeed get these exact cash flows? ‐ What is the likelihood that the 4% constant growth assumption is  wrong? >> Go To Excel: TVM Timeline and Calculator tab GetREFM.com 8
    • Time Value of Money / Discounted Cash Flow (DCF) Model • Just like a company listed on the stock market, an  income‐producing property can be valued based on  the expected value of its future cash flowsCLICK TO EDIT MASTER TITLE STYLE • To properly value these expected future cash flows  today, we discount them to a present value based on  all of the aforementioned risks as they apply  specifically to the contemplated transaction  • These future values are first inflated based on  escalation assumptions (Note that income and expense  assumptions are not necessarily identical) GetREFM.com 9
    • Real Estate Cycles• Cycles are prolonged periods of property supply and demand  imbalanceCLICK TO EDIT MASTER TITLE STYLE• Real estate markets are rarely near equilibrium because: • it takes so long to plan, permit, finance, build and lease new  supply • inventory is relatively imperishable (bulldozing as a remedy) • tenancies are governed by leases, often long‐term • demand grows slowly • population (around 1%, or 3MM people per year in U.S.) • employment  • On average, 1.8MM jobs created per year • ~200 GSF required per office employee GetREFM.com 10
    • The Real Estate Cycle – GenericCLICK TO EDIT MASTER TITLE STYLE GetREFM.com 11
    • The Real Estate Cycle – U.S. Commercial, 1Q2009CLICK TO EDIT MASTER TITLE STYLE GetREFM.com 12
    • The Real Estate Cycle – U.S. Commercial, 2Q2009CLICK TO EDIT MASTER TITLE STYLE GetREFM.com 13
    • The Real Estate Cycle – U.S. Commercial, 3Q2009CLICK TO EDIT MASTER TITLE STYLE GetREFM.com 14
    • The Real Estate Cycle – U.S. Commercial, 4Q2009CLICK TO EDIT MASTER TITLE STYLE GetREFM.com 15
    • The Real Estate Cycle – U.S. Commercial, 1Q2010CLICK TO EDIT MASTER TITLE STYLE GetREFM.com 16
    • The Real Estate Cycle – U.S. Commercial, 2Q2010CLICK TO EDIT MASTER TITLE STYLE GetREFM.com 17
    • The Real Estate Cycle – U.S. Commercial, 3Q2010CLICK TO EDIT MASTER TITLE STYLE GetREFM.com 18
    • The Real Estate Cycle – U.S. Commercial, 4Q2010CLICK TO EDIT MASTER TITLE STYLE GetREFM.com 19
    • The Real Estate Cycle – U.S. Commercial, 1Q2011CLICK TO EDIT MASTER TITLE STYLE GetREFM.com 20
    • The Real Estate Cycle – U.S. Commercial, 2Q2011CLICK TO EDIT MASTER TITLE STYLE GetREFM.com 21
    • The Real Estate Cycle – U.S. Commercial, 3Q2011CLICK TO EDIT MASTER TITLE STYLE GetREFM.com 22
    • The Real Estate Cycle – U.S. Commercial, 4Q2011CLICK TO EDIT MASTER TITLE STYLE GetREFM.com 23
    • U.S. Housing Market Pricing, 1890 ‐ 2006CLICK TO EDIT MASTER TITLE STYLE Source: Huffington Post GetREFM.com 24
    • U.S. Housing Market Pricing, 1970 ‐ 2010 CLICK TO EDIT MASTER TITLE STYLE GetREFM.com 25
    • Local Housing Market Pricing, 2001 – 2009• But remember, every market is uniqueCLICK TO EDIT MASTER TITLE STYLE Source: New York Times  GetREFM.com 26
    • Submarkets Are Unique, Too• Georgetown vs. Anacostia• Capitol Hill vs. U StreetCLICK TO EDIT MASTER TITLE STYLE• Kalorama vs. Rosslyn• Ballston vs. Mount Vernon Triangle• Southwest vs. Glover Park• Silver Spring vs. Tysons Corner GetREFM.com 27