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1. Real Estate InvestmentsReal Estate Investments
Brian Lord St. LouisBrian Lord St. Louis

2. A. Definition of Real EstateA. Definition of Real Estate
Real Estate is artificially delineatedReal Estate is artificially delineated
space references to a fixed point on thespace references to a fixed point on the
surface of the earth with a fourthsurface of the earth with a fourth
dimension of time. It is built to housedimension of time. It is built to house
an economic activity that is subject toan economic activity that is subject to
cultural preferences and restricted bycultural preferences and restricted by
the public infrastructure.the public infrastructure.

3. ConceptsConcepts
B. Space--Time ProductB. Space--Time Product
• Real estate is a space-time product, that isReal estate is a space-time product, that is
it generates income over time in exchangeit generates income over time in exchange
for the use of space. Examples:for the use of space. Examples:
apartments, football tickets, weddingapartments, football tickets, wedding
receptionsreceptions

4. D. CharacteristicsD. Characteristics
The Real Estate Market Characteristics:The Real Estate Market Characteristics:
• 1. Highly Stratified, Local Markets1. Highly Stratified, Local Markets
• 2. Heterogeneous Product2. Heterogeneous Product
• 3. Private, not Public, Transactions3. Private, not Public, Transactions
• 4. Unsophisticated Investors4. Unsophisticated Investors
• 5. Unorganized Market5. Unorganized Market

5. E. Investor MotivationsE. Investor Motivations
1. Pride in Ownership1. Pride in Ownership
2. Personal Control2. Personal Control
3. Self-use and Occupancy3. Self-use and Occupancy
4. Estate Building4. Estate Building
5. Security of Capital5. Security of Capital
6. High Operating Yield6. High Operating Yield
7. Leverage7. Leverage
8. Tax Shelter8. Tax Shelter
9. Capital Appreciation9. Capital Appreciation
10. Portfolio Diversification10. Portfolio Diversification

6. F. Investment Disadvantages andF. Investment Disadvantages and
RisksRisks
1. Illiquid1. Illiquid
2. Management2. Management
3. Depreciation of Value3. Depreciation of Value
4. Government Controls4. Government Controls
5. Real Estate Cycles5. Real Estate Cycles
6. Legal Complexity6. Legal Complexity

7. G. ParticipantsG. Participants
1. Builder/developer1. Builder/developer
2. Syndicator2. Syndicator
3. Property Manager3. Property Manager
4. Construction Lender4. Construction Lender
5. Permanent Lender5. Permanent Lender
6. Managing Equity Investor6. Managing Equity Investor
7. Passive Equity Investor7. Passive Equity Investor

8. Real Estate InvestmentsReal Estate Investments
Topic 12Topic 12
II. Overview ofII. Overview of
Investment Decision ProcessInvestment Decision Process

9. A. Framework for Real EstateA. Framework for Real Estate
Investment StudiesInvestment Studies
1. Strategy1. Strategy
• Develop an overall investment philosophyDevelop an overall investment philosophy
2. Analysis2. Analysis
• Measuring returnMeasuring return
3. Decisions3. Decisions
• Risk and return evaluationsRisk and return evaluations
4. Investment Transaction4. Investment Transaction
5. Feedback5. Feedback

10. B. Investment Analysis vs.B. Investment Analysis vs.
Feasibility AnalysisFeasibility Analysis
1. Investment and Investment Analysis1. Investment and Investment Analysis
• a. Capital Assetsa. Capital Assets
• b. Equityb. Equity
• c. Debtc. Debt
• d. NOId. NOI
• e. Lender/Equity Relatione. Lender/Equity Relation
• f. Maximizing Wealthf. Maximizing Wealth
• g. Return and Riskg. Return and Risk

11. B. Investment Analysis vs.B. Investment Analysis vs.
Feasibility Analysis (continued)Feasibility Analysis (continued)
2. Feasibility and Feasibility Analysis2. Feasibility and Feasibility Analysis
• a. Site in Search of a Usea. Site in Search of a Use
• b. Use in Search of a Siteb. Use in Search of a Site
• c. Investor Looking for the Bestc. Investor Looking for the Best
InvestmentInvestment
AlternativeAlternative
3. Investment Life Cycles3. Investment Life Cycles
• a. Property Life Cyclea. Property Life Cycle
• b. Ownership Life Cycleb. Ownership Life Cycle
• c. Investor Life Cyclec. Investor Life Cycle

12. B. Investment Analysis vs.B. Investment Analysis vs.
Feasibility Analysis (continued)Feasibility Analysis (continued)
4. Ownership Life Cycle4. Ownership Life Cycle
• a. Acquisitiona. Acquisition
• b. Operationb. Operation
• c. Disposal/Terminationc. Disposal/Termination
5. Investor Life Cycle5. Investor Life Cycle
• a. Young Investora. Young Investor
• b. Middle Aged Investorb. Middle Aged Investor
• c. Older Investorc. Older Investor
• d. Institutional Investord. Institutional Investor

13. Real Estate InvestmentsReal Estate Investments
Topic 12Topic 12
III. Decision Making ApproachesIII. Decision Making Approaches
to Real Estate Investmentto Real Estate Investment

14. B. Traditional Financial DecisionB. Traditional Financial Decision
Making ApproachesMaking Approaches
1. Investment Value Approach1. Investment Value Approach
• a. Invest if: Va. Invest if: V ≥≥ CC
• b. Reject if: Vb. Reject if: V << CC
2. IRV2. IRV
• Assumes:Assumes:
– a. Productivity = NOIa. Productivity = NOI
– b. NOI is stabilizedb. NOI is stabilized
– c. Holding period is infinitec. Holding period is infinite
– d. Capital is recaptured from income, exceptd. Capital is recaptured from income, except
landland
I
Ro V

15. Stabilized NOIStabilized NOI
YYee = 10.5%= 10.5%
YearYear NOI * PV factorNOI * PV factor PVPV
11 $53,918 * .904977$53,918 * .904977 $48,795$48,795
22 56,645 * .81898456,645 * .818984 46.39146.391
33 59,352 * .74116259,352 * .741162 43,98943,989
44 62,037 * .67073562,037 * .670735 41,61041,610
55 64,698 * .60700064,698 * .607000 39,27239,272
66 67,185 * .54932167,185 * .549321 36,90636,906
Sum = $256,963Sum = $256,963

16. Stabilized NOI (continued)Stabilized NOI (continued)
Stabilized NOI = PV ofStabilized NOI = PV of ΣΣNOINOI/PV of/PV of
AnnuityAnnuity
Stabilized NOI = $256,963 / 4.292179Stabilized NOI = $256,963 / 4.292179
Stabilized NOI =Stabilized NOI = $59,868$59,868

17. Estimating REstimating Ree
Consider:Consider:
• a. Real Rate of Returna. Real Rate of Return
• b. Inflationb. Inflation
• c. Risk Premiumc. Risk Premium

18. C. Modern Capital BudgetingC. Modern Capital Budgeting
ApproachesApproaches
1. The Present Value Model1. The Present Value Model
2. Internal Rate of Return2. Internal Rate of Return
3. Modified Internal Rate of Return3. Modified Internal Rate of Return
4. Risk Analysis4. Risk Analysis
• a. Ratio and Sensitivitya. Ratio and Sensitivity
• b. Simulationb. Simulation
• c. Elasticityc. Elasticity

19. Investment PrinciplesInvestment Principles
1. The investor should buy the1. The investor should buy the
assumptions that create the yield ratherassumptions that create the yield rather
than the yield itself.than the yield itself.
2. The investor should be as2. The investor should be as
concerned about what to offer the nextconcerned about what to offer the next
buyer as with what he is buyingbuyer as with what he is buying
3. The investor should price the3. The investor should price the
property apart from the tax advantages.property apart from the tax advantages.

20. Investment PrinciplesInvestment Principles
4. The investor must compare4. The investor must compare
alternatives.alternatives.
5. The investor should understand the5. The investor should understand the
potential profit and riskpotential profit and risk in terms ofin terms of
DOLLARSDOLLARS..

21. Sources of Return from aSources of Return from a
Real Estate InvestmentReal Estate Investment
Cash flow from operationsCash flow from operations
Tax SavingsTax Savings
Equity buildup from loan amortizationEquity buildup from loan amortization
Loan refinancing proceedsLoan refinancing proceeds
Appreciation of property value (salesAppreciation of property value (sales
proceeds)proceeds)

22. The Market Revenue Model :The Market Revenue Model :
(Back Door)(Back Door)
Market Rents
Equity
Acct.
Cash
Margin
= (1 - BEP) x x BEP =
- Reserves
- Vacancy
- RE Taxes
- Operating Exp.
CTO CASH FOR DEBT
÷ ÷
Re Rm
JEA JMA
+
Justified Investment Value

23. The Capital Revenue Model:The Capital Revenue Model:
(Front Door)(Front Door)
Cost of Project
Equity
Amount
Debt
Amount
= (1 - m) x x m =
x Re x Rm
CTO ADS
+
NOI
+ Operating Expenses
+ Real Estate Taxes
+ Vacancy Allowance
PGI
PGI/Net Leasable Area =
Required Rent to be Charged

24. Example DataExample Data
1. Project Cost: $7,000,0001. Project Cost: $7,000,000
2. M = .802. M = .80
3. Loan Terms: .064, 20 yrs, annual pmts.3. Loan Terms: .064, 20 yrs, annual pmts.
• Hence, RHence, Rmm = .09= .09
4. RE Taxes = 10%4. RE Taxes = 10%
Operating Expenses = 30%Operating Expenses = 30%
Vacancy Allowance = 5%Vacancy Allowance = 5%
Market Rents = $4.00/S.F.Market Rents = $4.00/S.F.
Reserve Account = $44,000Reserve Account = $44,000
RRee = 14%= 14%

25. Example Data (continued)Example Data (continued)
1. Cost of Project:1. Cost of Project: $7,000,000$7,000,000
2. Loan to Value:2. Loan to Value: 0.8000.800
3. Mortgage Constant:3. Mortgage Constant: 0.1400.140
4. Mortgage Constant:4. Mortgage Constant: 0.1290.129
5. Operating Expenses:5. Operating Expenses: $343,000$343,000
6. Vacancy Losses:6. Vacancy Losses: $55,500$55,500
7. Net Leasable Area:7. Net Leasable Area: 260,000260,000

26. Capital Revenue Model (CRM)Capital Revenue Model (CRM)
Cost of Project:Cost of Project: $7,000,000$7,000,000
Equity Amount:Equity Amount: $1,400,000$1,400,000
Cash Throwoff:Cash Throwoff: $ 196,000$ 196,000
Debt Amount:Debt Amount: $5,600,000$5,600,000
Annual Debt Service:Annual Debt Service: $ 504,000$ 504,000
Net Operating Income:Net Operating Income: $ 700,000$ 700,000
Plus Operating Expenses:Plus Operating Expenses: $ 343000$ 343000
Plus Vacancy Losses:Plus Vacancy Losses: $ 55,500$ 55,500
Equals Potential Gross Income:Equals Potential Gross Income: $1,098,500$1,098,500
PGI/Net Leasable Area EqualsPGI/Net Leasable Area Equals
REQUIRED RENT:REQUIRED RENT: $4.225$4.225

27. Example Data (continued)Example Data (continued)
1. Cost of Project:1. Cost of Project: $7,000,000$7,000,000
2. Loan to Value:2. Loan to Value: 0.8000.800
3. Equity Dividend Rate:3. Equity Dividend Rate: 0.1400.140
4. Mortgage Constant:4. Mortgage Constant: 0.1290.129
5. Operating Expenses:5. Operating Expenses: 37.21%37.21%
6. Vacancy Losses:6. Vacancy Losses: 5.00%5.00%
7. Net Leasable Area:7. Net Leasable Area: 80,00080,000

28. Market Revenue Model (MRM)Market Revenue Model (MRM)
Market Rents:Market Rents: $1,100,000$1,100,000
Cash Retained for Equity Account:Cash Retained for Equity Account: $ 166,500$ 166,500
Less Reserves:Less Reserves: $ 44,000$ 44,000
Less Vacancy:Less Vacancy: $ 55,500$ 55,500
Equals Cash Throw-Off:Equals Cash Throw-Off: $ 67,000$ 67,000
Divided by RDivided by Ree Equals Just. Eq. Amt.: $ 478,571Equals Just. Eq. Amt.: $ 478,571
Account Allowing for Monies-Out:Account Allowing for Monies-Out: $ 943,500$ 943,500
Less Operating Expenses:Less Operating Expenses: $ 333,000$ 333,000
Less Real Estate Taxes:Less Real Estate Taxes: $ 10,000$ 10,000
Equals Cash for Debt:Equals Cash for Debt: $ 600,500$ 600,500
Divided by RDivided by Rmm Equals Just. Debt Amt.:$6,672,222Equals Just. Debt Amt.:$6,672,222

29. Market Revenue Model (MRM)Market Revenue Model (MRM)
Justified Investment Value:Justified Investment Value: $7,150,793$7,150,793