Equity Investment & The Investment Decision
Real Estate Investment  Advantages <ul><li>Pride in Ownership </li></ul><ul><li>Personal control </li></ul><ul><li>Self-us...
Real Estate Disadvantages <ul><li>Illiquidity </li></ul><ul><li>Required equity capital </li></ul><ul><li>Management burde...
Trade-Offs: Risk/Return
<ul><li>Risks </li></ul><ul><ul><li>Legal : Zoning, public opinion,  </li></ul></ul><ul><ul><ul><li>public services, etc. ...
Risks <ul><ul><li>Cost risks:   </li></ul></ul><ul><ul><li>Interest rates </li></ul></ul><ul><ul><li>Estimates poor  </li>...
Return Measures <ul><li>Cash Flow ( Net Spendable ) Pro Forma: </li></ul><ul><li>Cash on Cash= Net Spendable/Down payment ...
Return Measures <ul><li>Rate of return on total capital: = NOI/Total Capital </li></ul><ul><ul><ul><li>= 14/120 = 11.7% </...
Return Measures <ul><li>Equity cap rate:  = CF before Tax/Equity </li></ul><ul><ul><ul><li>(ie., required ROE) </li></ul><...
Discounted CF Analysis <ul><li>Income Cap Rate: </li></ul><ul><ul><ul><li>NOI/Market Value </li></ul></ul></ul><ul><ul><ul...
Investment Analysis Process <ul><li>Strategy: Determine First!! </li></ul><ul><ul><ul><li>Return/Risk Objectives </li></ul...
Investment Analysis Process <ul><li>Negotiate Basic Terms with Seller </li></ul><ul><ul><ul><li>Price </li></ul></ul></ul>...
Investment Analysis Process <ul><li>Structure Tax Benefits </li></ul><ul><ul><ul><li>Cost Recovery </li></ul></ul></ul><ul...
Control <ul><li>Purchase Price & Terms </li></ul><ul><li>Form of Ownership </li></ul><ul><li>Financing amounts, rates, ter...
Negotiation <ul><li>Maximize knowledge position  First! </li></ul><ul><li>Set your initial demands far from final objectiv...
Negotiation (Cont) <ul><li>Concentrate on items that effect profits </li></ul><ul><ul><ul><li>Down payment, price, contrac...
Negotiation (Tactics) <ul><li>Standard Practice: Terms are &quot;standard practice&quot; </li></ul><ul><li>Bogey: “I only ...
Property Types <ul><li>Land </li></ul><ul><ul><li>Most Risky </li></ul></ul><ul><ul><li>Low income </li></ul></ul><ul><ul>...
Property Types <ul><li>Residential Rental (Houses,Apts,MHs) </li></ul><ul><ul><li>Management Intensive </li></ul></ul><ul>...
Property Types <ul><li>Office Buildings </li></ul><ul><ul><li>More income/less appreciation </li></ul></ul><ul><ul><ul><li...
Property Types : Shopping Centers <ul><li>Most sophisticated Investment & Management Expertise </li></ul><ul><li>Much more...
Property Types :  Industrial & Special <ul><li>Industrial </li></ul><ul><ul><li>Warehouses, factories, indust parks </li><...
Development <ul><li>Overview </li></ul><ul><ul><ul><li>Combine  land, labor, capital &  </li></ul></ul></ul><ul><ul><ul><u...
Development  <ul><li>Types:  </li></ul><ul><ul><li>Land Prep: Lots of all kinds </li></ul></ul><ul><ul><ul><li>Sell land t...
Development Process: Be ready to bail out Stages may be done simultaneously <ul><li>Idea:   Can develop over life of proje...
Redevelopment & trends <ul><li>Redevelopment:  </li></ul><ul><ul><li>Costs are high, structures - obsolete  </li></ul></ul...
Professional Help <ul><li>Real Estate Brokers:  </li></ul><ul><ul><li>Get a specialist! Has access to information </li></u...
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Equity Investment

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Equity Investment

  1. 1. Equity Investment & The Investment Decision
  2. 2. Real Estate Investment Advantages <ul><li>Pride in Ownership </li></ul><ul><li>Personal control </li></ul><ul><li>Self-use & Occupancy </li></ul><ul><li>Estate Building </li></ul><ul><li>Security of Capital </li></ul><ul><li>Operating Cash Flows </li></ul><ul><li>Leverage </li></ul><ul><li>Tax Shelter factors </li></ul><ul><li>Capital Appreciation & Inflation Protection </li></ul>
  3. 3. Real Estate Disadvantages <ul><li>Illiquidity </li></ul><ul><li>Required equity capital </li></ul><ul><li>Management burden </li></ul><ul><li>Depreciation of value </li></ul><ul><li>Government controls </li></ul><ul><li>Real estate cycles </li></ul><ul><li>Legal complexity </li></ul><ul><li>Lack of information & education </li></ul>
  4. 4. Trade-Offs: Risk/Return
  5. 5. <ul><li>Risks </li></ul><ul><ul><li>Legal : Zoning, public opinion, </li></ul></ul><ul><ul><ul><li>public services, etc. </li></ul></ul></ul><ul><ul><li>Market risks : Marketability study </li></ul></ul><ul><ul><ul><li>Will it rent? Will it sell? </li></ul></ul></ul><ul><ul><ul><li>Market study: S&D, Competition </li></ul></ul></ul><ul><ul><ul><li>Absorption rates: How fast is space being utilized </li></ul></ul></ul>
  6. 6. Risks <ul><ul><li>Cost risks: </li></ul></ul><ul><ul><li>Interest rates </li></ul></ul><ul><ul><li>Estimates poor </li></ul></ul><ul><ul><li>Labor </li></ul></ul><ul><ul><li>Weather </li></ul></ul><ul><ul><li>Possible Solutions: </li></ul></ul><ul><ul><li>Guaranteed price contracts </li></ul></ul><ul><ul><ul><ul><li>Watch out for cushion </li></ul></ul></ul></ul><ul><ul><li>General contractors: Reputable & bonded </li></ul></ul><ul><ul><li>Completion bond (Lenders may require) </li></ul></ul><ul><ul><ul><ul><li>Guarantees price </li></ul></ul></ul></ul><ul><ul><li>Cost plus contracts: Developer pays costs + fee </li></ul></ul>
  7. 7. Return Measures <ul><li>Cash Flow ( Net Spendable ) Pro Forma: </li></ul><ul><li>Cash on Cash= Net Spendable/Down payment </li></ul><ul><ul><li>=1100/10000=11% </li></ul></ul>$ 1,100.00 Cash Flow Before Tax: $ (12,900.00) Less Debt Service (P&I): $ 14,000.00 Net Operating Income: $ (37,000.00) Less Operating Expenses: $ 51,000.00 Gross Effective Income: $ (9,000.00) Less E(Vacancy): $ 60,000.00 Gross Possible Income: $ 100,000.00 Loan: (DP=$10,000) $ 20,000.00 Equity:
  8. 8. Return Measures <ul><li>Rate of return on total capital: = NOI/Total Capital </li></ul><ul><ul><ul><li>= 14/120 = 11.7% </li></ul></ul></ul><ul><li>Return on Equity (ROE) = CF Before Tax/Equity </li></ul><ul><ul><ul><li>= 1.1/20 = 5.5% </li></ul></ul></ul><ul><li>Favorable leverage: If ROE > ROR </li></ul><ul><ul><li>If unfavorable leverage: </li></ul></ul><ul><ul><ul><li>Don't buy </li></ul></ul></ul><ul><ul><ul><li>Reduce Price </li></ul></ul></ul><ul><ul><ul><li>Try to lower APR or increase term </li></ul></ul></ul><ul><ul><ul><li>Raise NOI or lower expenses </li></ul></ul></ul><ul><ul><ul><li>Restructure (ie., more equity) </li></ul></ul></ul>
  9. 9. Return Measures <ul><li>Equity cap rate: = CF before Tax/Equity </li></ul><ul><ul><ul><li>(ie., required ROE) </li></ul></ul></ul><ul><ul><li>For example: </li></ul></ul><ul><ul><ul><li>Your desired cap rate is 14% </li></ul></ul></ul><ul><ul><ul><li>CF before tax is $1,100 </li></ul></ul></ul><ul><ul><ul><li>Equity value = 1.1/.14 = $7,857 </li></ul></ul></ul><ul><ul><ul><li>Plus loan of $100K </li></ul></ul></ul><ul><ul><ul><li>Therefore property value = $107,857 </li></ul></ul></ul><ul><li>Risk measures: BEP & Debt Coverage Ratio </li></ul>
  10. 10. Discounted CF Analysis <ul><li>Income Cap Rate: </li></ul><ul><ul><ul><li>NOI/Market Value </li></ul></ul></ul><ul><ul><ul><li>Compare to other opportunities </li></ul></ul></ul><ul><li>Do Cash Flow Spread sheet: </li></ul><ul><li>Ratio Analysis </li></ul><ul><li>Sensitivity Analysis: </li></ul><ul><ul><li>What if we change the value of a variable? </li></ul></ul><ul><li>Scenario Analysis: Worst versus Best? </li></ul><ul><li>Monte Carlo Analysis: </li></ul><ul><ul><li>Randomly assign values & check bottom line </li></ul></ul>
  11. 11. Investment Analysis Process <ul><li>Strategy: Determine First!! </li></ul><ul><ul><ul><li>Return/Risk Objectives </li></ul></ul></ul><ul><ul><ul><li>Ownership Form </li></ul></ul></ul><ul><ul><ul><li>Market Analysis </li></ul></ul></ul><ul><ul><ul><li>Screening Criteria </li></ul></ul></ul><ul><ul><ul><li>Location/Property Analysis </li></ul></ul></ul><ul><li>Generate Alternatives: Those that pass screen </li></ul><ul><li>Use Basic Financial Feasibility Model </li></ul><ul><ul><ul><li>Develop Finance Screens (APRs, CapRates, NOI) </li></ul></ul></ul><ul><ul><ul><li>Examine Finance Alternatives (Loans, Equity, etc) </li></ul></ul></ul>
  12. 12. Investment Analysis Process <ul><li>Negotiate Basic Terms with Seller </li></ul><ul><ul><ul><li>Price </li></ul></ul></ul><ul><ul><ul><li>Financing </li></ul></ul></ul><ul><ul><ul><li>Covenants </li></ul></ul></ul><ul><ul><ul><li>Escape Clause </li></ul></ul></ul><ul><li>Do Detailed Feasibility Research </li></ul><ul><ul><ul><li>Market: </li></ul></ul></ul><ul><ul><ul><ul><li>Supply & Demand, Competition, Absorption, Vacancy </li></ul></ul></ul></ul><ul><ul><ul><li>Marketability: Property Condition </li></ul></ul></ul><ul><ul><ul><li>Legal, Political, Environmental </li></ul></ul></ul><ul><ul><ul><li>Management & Operations </li></ul></ul></ul>
  13. 13. Investment Analysis Process <ul><li>Structure Tax Benefits </li></ul><ul><ul><ul><li>Cost Recovery </li></ul></ul></ul><ul><ul><ul><li>Useful Life </li></ul></ul></ul><ul><ul><ul><li>Passive Loss Limitations </li></ul></ul></ul><ul><li>Discounted CF Analysis </li></ul><ul><ul><ul><li>After-Tax CF, DCF, Adjust for Risk </li></ul></ul></ul><ul><li>Final Negotiations & Closing </li></ul><ul><li>Management of Property </li></ul><ul><li>Termination </li></ul><ul><ul><ul><li>Sell, merger, IPO </li></ul></ul></ul>
  14. 14. Control <ul><li>Purchase Price & Terms </li></ul><ul><li>Form of Ownership </li></ul><ul><li>Financing amounts, rates, terms </li></ul><ul><li>Tax structure & Planning </li></ul><ul><li>Property management </li></ul><ul><li>Property location </li></ul><ul><li>Tenants & Lease rates & terms </li></ul>
  15. 15. Negotiation <ul><li>Maximize knowledge position First! </li></ul><ul><li>Set your initial demands far from final objective </li></ul><ul><ul><ul><li>Probe for bottom line </li></ul></ul></ul><ul><li>Raise your aspiration level/ deflate your opponent's </li></ul><ul><li>Buyer: </li></ul><ul><ul><ul><li>Start with lower price than seller wants </li></ul></ul></ul><ul><ul><ul><li>Lukewarm attitude </li></ul></ul></ul><ul><ul><ul><li>Point out defects </li></ul></ul></ul><ul><ul><ul><li>Mention competitive offers </li></ul></ul></ul><ul><li>Seller: </li></ul><ul><ul><ul><li>Mention other offers you have rejected </li></ul></ul></ul><ul><ul><ul><li>Price is probably going up </li></ul></ul></ul><ul><ul><ul><li>Negotiate most critical items first and </li></ul></ul></ul>
  16. 16. Negotiation (Cont) <ul><li>Concentrate on items that effect profits </li></ul><ul><ul><ul><li>Down payment, price, contract period </li></ul></ul></ul><ul><li>Employ conservative concession policy </li></ul><ul><ul><ul><li>Don't give in or reciprocate/ </li></ul></ul></ul><ul><ul><ul><li>No sportsmanship/ </li></ul></ul></ul><ul><ul><ul><li>Never concede first </li></ul></ul></ul><ul><ul><ul><li>Never accept a radical counteroffer without analysis </li></ul></ul></ul><ul><li>Use intermediaries when to your advantage </li></ul><ul><ul><ul><li>With agent, more time to analyze </li></ul></ul></ul><ul><ul><ul><li>Advisor: Openly discuss concerns </li></ul></ul></ul><ul><li>Try for better deal for both parties: </li></ul><ul><li>Place proof burden & satisfaction on them </li></ul><ul><ul><ul><li>Prove to you that it is an attractive opportunity </li></ul></ul></ul>
  17. 17. Negotiation (Tactics) <ul><li>Standard Practice: Terms are &quot;standard practice&quot; </li></ul><ul><li>Bogey: “I only can afford $7,500 in cash&quot; </li></ul><ul><li>Good guy/Bad guy: </li></ul><ul><ul><ul><li>One makes strong demands ... </li></ul></ul></ul><ul><ul><ul><li>Opponent is more susceptible to good guy's weaker demands </li></ul></ul></ul><ul><li>Deadline: Always use them! </li></ul><ul><li>Nibbling: Get additional minor concessions after major agreement </li></ul><ul><li>The tie-up: Get the property off the market while you're making decision </li></ul>
  18. 18. Property Types <ul><li>Land </li></ul><ul><ul><li>Most Risky </li></ul></ul><ul><ul><li>Low income </li></ul></ul><ul><ul><li>Interest, taxes, insurance </li></ul></ul><ul><ul><li>Interest deduct income only </li></ul></ul><ul><ul><li>No depreciation </li></ul></ul><ul><ul><li>20-30% ROR for risk </li></ul></ul><ul><ul><li>Consider </li></ul></ul><ul><ul><ul><li>Access/Slope </li></ul></ul></ul><ul><ul><ul><li>Zoning </li></ul></ul></ul><ul><ul><ul><li>Public services & Utilities </li></ul></ul></ul><ul><ul><li>Return=capital appreciation </li></ul></ul>
  19. 19. Property Types <ul><li>Residential Rental (Houses,Apts,MHs) </li></ul><ul><ul><li>Management Intensive </li></ul></ul><ul><ul><li>Good financing </li></ul></ul><ul><ul><li>Tax shelter </li></ul></ul><ul><ul><li>High appreciation </li></ul></ul><ul><ul><li>Know location & physical condition </li></ul></ul><ul><ul><li>Check neighborhood & proximity to services </li></ul></ul><ul><ul><li>Good first step for real estate </li></ul></ul><ul><ul><li>Some income -- mostly capital appreciation </li></ul></ul>
  20. 20. Property Types <ul><li>Office Buildings </li></ul><ul><ul><li>More income/less appreciation </li></ul></ul><ul><ul><ul><li>Appreciation can be improved w/ maintenance </li></ul></ul></ul><ul><ul><li>Needs more knowledge for leasing & </li></ul></ul><ul><ul><ul><li>Property management </li></ul></ul></ul><ul><ul><li>Types: Downtown vs Suburban </li></ul></ul><ul><ul><li>Medium vs HiRise vs Garden (Low) </li></ul></ul><ul><ul><li>Locations: Highways / Shopping Centers </li></ul></ul><ul><ul><li>Better construction </li></ul></ul><ul><ul><li>Low tenant turnover ratios </li></ul></ul><ul><ul><li>Prestigious clients </li></ul></ul>
  21. 21. Property Types : Shopping Centers <ul><li>Most sophisticated Investment & Management Expertise </li></ul><ul><li>Much more income than appreciation/Few Foreclosed! </li></ul><ul><li>Owned by wealthy investors (TIAA/CREF=Mall of Amer) </li></ul><ul><li>Types: </li></ul><ul><ul><li>Neighborhood center: ( Strip): Food, drugs, etc, Built around supermarket/drugstore: 50K Gross leaseable area </li></ul></ul><ul><ul><li>Community center: + Clothing, furniture, bank, prof: 150K GLA </li></ul></ul><ul><ul><li>Regional center : Full-line Dept store (Anchor): </li></ul></ul><ul><ul><li>Reit & Insur=Ownership; 400K GLA </li></ul></ul><ul><ul><li>Super Regional Centers : Major metro area: 2 anchors, </li></ul></ul><ul><ul><ul><li>100-200 stores, Usually % of profits </li></ul></ul></ul>
  22. 22. Property Types : Industrial & Special <ul><li>Industrial </li></ul><ul><ul><li>Warehouses, factories, indust parks </li></ul></ul><ul><ul><li>Almost all income </li></ul></ul><ul><ul><li>Not easily converted … increases risk </li></ul></ul><ul><ul><li>Low risk overall if you have a client </li></ul></ul><ul><ul><li>Near highways </li></ul></ul><ul><li>Special Use </li></ul><ul><ul><li>Need expertise: RE + the application </li></ul></ul><ul><ul><li>Risky: Be ready to substitute </li></ul></ul><ul><ul><li>Loans are hard to get … banks ?? </li></ul></ul><ul><ul><li>Requires time commitment </li></ul></ul>
  23. 23. Development <ul><li>Overview </li></ul><ul><ul><ul><li>Combine land, labor, capital & </li></ul></ul></ul><ul><ul><ul><ul><li>Entrepreneurial ability </li></ul></ul></ul></ul><ul><ul><ul><li>Good developers can “visualize ” good uses of space </li></ul></ul></ul><ul><ul><ul><li>Creation of space for play, living & working </li></ul></ul></ul><ul><ul><ul><li>LT Motive =Income, Mgt, Community/ </li></ul></ul></ul><ul><ul><ul><ul><li>ST Motive =Cap Gain </li></ul></ul></ul></ul><ul><ul><ul><li>Redevelopment: Restoration of older structure </li></ul></ul></ul>
  24. 24. Development <ul><li>Types: </li></ul><ul><ul><li>Land Prep: Lots of all kinds </li></ul></ul><ul><ul><ul><li>Sell land to other developers </li></ul></ul></ul><ul><ul><li>Erect improvements on land </li></ul></ul><ul><li>Who Develops? </li></ul><ul><ul><li>Part-time </li></ul></ul><ul><ul><li>Proprietorship </li></ul></ul><ul><ul><li>Corporation, etc. </li></ul></ul><ul><ul><li>Joint ventures (ie., 2 developers) </li></ul></ul>
  25. 25. Development Process: Be ready to bail out Stages may be done simultaneously <ul><li>Idea: Can develop over life of project </li></ul><ul><li>Preliminary Feasibility: Rough cut analysis </li></ul><ul><ul><ul><li>Are computer programs: Go if profit looks good </li></ul></ul></ul><ul><li>GainControl: Ground lease(ties you up), option, seller fin </li></ul><ul><li>Feasibility Analysis & Design : </li></ul><ul><ul><li>Detailed analysis, Check site, market, legal, financial </li></ul></ul><ul><li>Finance: Need cash ASAP, should have already talked </li></ul><ul><li>Construction: Problems: cost overruns & contractor fails </li></ul><ul><li>Marketing: Lease (don’t lease too early rates change) </li></ul><ul><li> vs Sale: When … remember trade-offs </li></ul>
  26. 26. Redevelopment & trends <ul><li>Redevelopment: </li></ul><ul><ul><li>Costs are high, structures - obsolete </li></ul></ul><ul><ul><li>ITCs, grants </li></ul></ul><ul><ul><li>Popular trend </li></ul></ul><ul><li>Trends: </li></ul><ul><ul><li>Mixed use development: One structure </li></ul></ul><ul><ul><li>Planned unit development (PUD) </li></ul></ul><ul><ul><li>New towns/Village concept: Integrated approach: work, shop, play, live </li></ul></ul>
  27. 27. Professional Help <ul><li>Real Estate Brokers: </li></ul><ul><ul><li>Get a specialist! Has access to information </li></ul></ul><ul><li>Appraisers & consultants: Can do DCF </li></ul><ul><li>Property managers: </li></ul><ul><ul><li>Has rental & vacancy rates, op. expenses, etc </li></ul></ul><ul><li>Morgage bankers: </li></ul><ul><ul><li>Arrange deals & financing alternatives </li></ul></ul><ul><li>Tax advisers and attorneys </li></ul><ul><li>Others: </li></ul><ul><ul><li>Comm banks, Engineers, Architects, Contractors </li></ul></ul>
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