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INVESTMENT DECISION MAKING

INVESTMENT DECISION MAKING. LEARNING OBJECTIVES Identify the basic types and characteristics of investment properties. Forecast annual cash flows, net of expenses, from property operations. Forecast cash flows from the eventual sale of the property. INVESTMENT DECISION MAKING.

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INVESTMENT DECISION MAKING

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  1. INVESTMENT DECISION MAKING LEARNING OBJECTIVES • Identify the basic types and characteristics of investment properties. • Forecast annual cash flows, net of expenses, from property operations. • Forecast cash flows from the eventual sale of the property.

  2. INVESTMENT DECISION MAKING LEARNING OBJECTIVES • Calculate the net present value and internal rate of return on a proposed investment. • Calculate and interpret the basic financial ratios which apply to real estate investment decisions. • Understand the effect of leverage on the investment decision.

  3. INVESTMENT DECISIONS • Forecast cash flows from operations. • Forecast cash flow from sale. • Determine present value of expected cash flows. • Apply an investment decision criterion.

  4. REAL ESTATE INVESTMENTANALYSIS Investment Strategy • Investment Philosophy • Investment Objectives • Investment Policies

  5. CHARACTERISTICS OF INCOME PROPERTY INVESTMENTS • Property Types • Rental Income • Contract Rent • Market Rent • Purchasers as Investors • Geographic Scope

  6. FORECASTING CASH FLOWS FROM OPERATIONS • Potential Gross Income • Effective Gross Income • Operating Expenses • Net Operating Income • Non-Recurring Expenses

  7. Net Operating Income Calculation

  8. Net Operating Income Example

  9. Forecasted Cash Flows From Net Operating Income

  10. Forecasted Cash Proceeds From Sale

  11. Present Value Calculation

  12. Net Present Value (NPV) • The net present value is the present value of a project’s cash inflows, minus the present value of the cash outflows. • The cash flows are discounted at the investor’s required rate of return--in this example 12 percent.

  13. Net Present Value Calculation

  14. NPV Decision Criteria • If NPV>0, the project exceeds the investor’s required rate of return. • If NPV<0, the project does not meet the investor’s required rate of return. • If NPV=0, the project’s expected return equals the investor’s required rate of return.

  15. Internal Rate of Return (IRR) • The internal rate of return is the discount rate at which NPV = 0, the rate of return at which the present value of the cash inflows equals the present value of the cash outflows.

  16. NPV and the IRR

  17. IRR Decision Criteria • If IRR > the required rate of return, then accept. • If IRR< the required rate of return, then reject. • If IRR= the project’s expected return equals the investor’s required rate of return.

  18. NPV and the IRR • NPV: Cash flows assumed reinvested at discount rate • Generally preferred to IRR for making decisions • IRR: Cash flows assumed reinvested at the IRR rate • May provide inferior wealth maximizing ranking of alternative opportunities to the NPV • Multiple solutions possible • Easily compared to other investments and widely used

  19. The Effects of Mortgage Financing on Cash Flows, Values, and Returns • Effect on the Initial Investment • Effect on the Cash Flows from Operations • Effect on the Cash Flow from Sale

  20. INVESTMENT CRITERIAProfitability Ratios • Capitalization Rate: • Ro = NOI / Acquisition Price • Equity Dividend Rate: • Re = EDR = BTCF / Initial Equity • Mortgage Constant: • Rm = MC = DS / Initial Loan Amount

  21. INVESTMENT CRITERIAMultiplers • Net Income Multiplier: • NIM = Acquisition Price / NOI • Effective Gross Income Multiplier: • GIM = Acquisition Price / EGI

  22. INVESTMENT CRITERIAFinancial Ratios • Operating Expense Ratio: • OER = Operating Expenses / EGI • Loan-to-Value Ratio: • LTV = Mortgage Balance / Property Value • Debt Coverage Ratio: • DCR = Net Operating Income / Debt Service

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