Real Estate Ch 18

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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


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