1. Real Estate Investments
Topic 12
I. The Nature & Scope of
Real Estate Investments

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

3. Concepts
 B. Space--Time Product
• Real estate is a space-time product, that is
it generates income over time in exchange
for the use of space. Examples:
apartments, football tickets, wedding
receptions

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

5. E. Investor Motivations
 1. Pride in Ownership
 2. Personal Control
 3. Self-use and Occupancy
 4. Estate Building
 5. Security of Capital
 6. High Operating Yield
 7. Leverage
 8. Tax Shelter
 9. Capital Appreciation
 10. Portfolio Diversification

6. F. Investment Disadvantages and
Risks
 1. Illiquid
 2. Management
 3. Depreciation of Value
 4. Government Controls
 5. Real Estate Cycles
 6. Legal Complexity

7. G. Participants
 1. Builder/developer
 2. Syndicator
 3. Property Manager
 4. Construction Lender
 5. Permanent Lender
 6. Managing Equity Investor
 7. Passive Equity Investor

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

9. A. Framework for Real Estate
Investment Studies
 1. Strategy
• Develop an overall investment philosophy
 2. Analysis
• Measuring return
 3. Decisions
• Risk and return evaluations
 4. Investment Transaction
 5. Feedback

10. B. Investment Analysis vs.
Feasibility Analysis
 1. Investment and Investment Analysis
• a. Capital Assets
• b. Equity
• c. Debt
• d. NOI
• e. Lender/Equity Relation
• f. Maximizing Wealth
• g. Return and Risk

11. B. Investment Analysis vs.
Feasibility Analysis (continued)
 2. Feasibility and Feasibility Analysis
• a. Site in Search of a Use
• b. Use in Search of a Site
• c. Investor Looking for the Best Investment
Alternative
 3. Investment Life Cycles
• a. Property Life Cycle
• b. Ownership Life Cycle
• c. Investor Life Cycle

12. B. Investment Analysis vs.
Feasibility Analysis (continued)
 4. Ownership Life Cycle
• a. Acquisition
• b. Operation
• c. Disposal/Termination
 5. Investor Life Cycle
• a. Young Investor
• b. Middle Aged Investor
• c. Older Investor
• d. Institutional Investor

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

14. B. Traditional Financial Decision
Making Approaches
 1. Investment Value Approach
• a. Invest if: V  C
• b. Reject if: V  C
 2. IRV
• Assumes:
– a. Productivity = NOI
– b. NOI is stabilized
– c. Holding period is infinite
– d. Capital is recaptured from income, except
land
I
Ro V

15. Stabilized NOI
 Ye = 10.5%
Year NOI * PV factor PV
1 $53,918 * .904977 $48,795
2 56,645 * .818984 46.391
3 59,352 * .741162 43,989
4 62,037 * .670735 41,610
5 64,698 * .607000 39,272
6 67,185 * .549321 36,906
Sum = $256,963

16. Stabilized NOI (continued)
 Stabilized NOI = PV of NOI/PV of
Annuity
 Stabilized NOI = $256,963 / 4.292179
 Stabilized NOI = $59,868

17. Estimating Re
Consider:
• a. Real Rate of Return
• b. Inflation
• c. Risk Premium

18. C. Modern Capital Budgeting
Approaches
 1. The Present Value Model
 2. Internal Rate of Return
 3. Modified Internal Rate of Return
 4. Risk Analysis
• a. Ratio and Sensitivity
• b. Simulation
• c. Elasticity

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

20. Investment Principles
 4. The investor must compare
alternatives.
 5. The investor should understand the
potential profit and risk in terms of
DOLLARS.

21. Sources of Return from a
Real Estate Investment
 Cash flow from operations
 Tax Savings
 Equity buildup from loan amortization
 Loan refinancing proceeds
 Appreciation of property value (sales
proceeds)

22. The Market Revenue Model :
(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:
(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 Data
 1. Project Cost: $7,000,000
 2. M = .80
 3. Loan Terms: .064, 20 yrs, annual pmts.
• Hence, Rm = .09
 4. RE Taxes = 10%
Operating Expenses = 30%
Vacancy Allowance = 5%
 Market Rents = $4.00/S.F.
 Reserve Account = $44,000
 Re = 14%

25. Example Data (continued)
 1. Cost of Project: $7,000,000
 2. Loan to Value: 0.800
 3. Mortgage Constant: 0.140
 4. Mortgage Constant: 0.129
 5. Operating Expenses: $343,000
 6. Vacancy Losses: $55,500
 7. Net Leasable Area: 260,000

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

27. Example Data (continued)
 1. Cost of Project: $7,000,000
 2. Loan to Value: 0.800
 3. Equity Dividend Rate: 0.140
 4. Mortgage Constant: 0.129
 5. Operating Expenses: 37.21%
 6. Vacancy Losses: 5.00%
 7. Net Leasable Area: 80,000

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

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