Real Estate Ch 18
cons of ratios & multipliers
-no clear benchmarks for acceptable range -partial view of performance -assumptions about future not explicit
pros of ratios & multipliers
-quick & east to compute -intuitive -facilitates comparison with similar properties -no explicit assumptions about future
important points about cap rates
1. not discount rate or IRR, simply a ratio of current income (1st year NOI) to market value or acquisition price 2. an increase in cap rates over time indicates a decrease in property values 3. decreases with increasing rents 4. increase with perceived risk of investment * higher for low class properties *higher for retail & office vs. apartment
NOI formula
PGI - VC + MI = EGI - OE - CAPX = NOI
capitalization rate formula
Ro = NOI / acquisition point Ro is return on funds supplied by both equity investors and lender, it measures overall income producing ability of property
equity formula
acquisition price -net loan proceeds
effective gross income multiplier formula
acquisition price / effective gross income - use only among properties with similar operating expenses and CAPX
net loan proceeds formula
amount of loan - total up front financing costs paid by borrower at closing to obtain the loan
equity dividend rate (EDR) formula
before tax cash flow / equity investment -residual cash flow return to equity investment -commonly called "cash on cash" return
2 profitability ratios
capitalization rate (Ro) & equity dividend rate (EDR)
cash flow multipliers
effective gross income
difference between EDR and Ro
effects of mortgage financing have been subtracted from both the numerator and denominator of EDR
loan to value ratio (LTV)
mortgage balance / acquisition price -measures degree of financial leverage -lenders generally want LTV of first mortgage loan to be no greater than 65-75% of acquisition price
before tax cash flow (BTCF) formula
net operating income (NOI) - debt service
debt coverage ratio (DCR)
net operating income / debt service -risk assessment ratio used by most lenders -indicates amount of cash flow cushion above what is needed to service debt
financial risk ratios
operating expense ratio (OER), loan to value ratio (LTV), debt coverage ratio (DCR)
operating expense ratio (OER)
operating expenses / effective gross income - seasoned analysts watch for deviations from normal
why do investors borrow?
-limited financial resources/ wealth -amplify returns on equity (&risk) -portfolio diversification
