Chapter 29: Analyzing Investment Properties

If an investor has a before-tax cash flow of $18,000 and a tax liability of $2,500, what is this investor's after-tax cash flow?

$15,500

Sue's NOI is $128,000, and her operating expenses are $26,400. She has mortgage expenses of $55,250 with $48,000 of that being interest. Her property has depreciated $8,500 for the year and is in a 24% tax bracket. What is Sue's tax liability?

$17,160

If the annual income for a property is $180,000 and the capitalization rate is 9 percent, which of these figures is an accurate estimate of the property's value?

$2,000,000

Investor Tyler's property has a potential rental income of $19,000. The vacancy and collection losses for the year were $2,680. The property had operating expenses of $6,160. Tyler's mortgage expenses for the property were $7,700. What is the before-tax cash flow for Tyler's property?

$2,460

If a property has a potential income of $50,000, a vacancy loss of $4,500, and operating expenses of $23,000, what is this property's net operating income?

$22,500

What is the effective income for a company that has a potential rent income of $76,500, vacancies and collection losses worth $5,250, and operating expenses of $37,900?

$71,250

Investor Amanda's property has a potential rental income of $44,400. The vacancy and collection losses for the year were $1,230. The property had operating expenses of $5,120. Amanda's mortgage expenses for the property were $12,550. Amanda invested $200,000 cash with the property's down payment. What is the before-tax cash-on-cash return for Amanda's property?

12.75%

What is a tax shelter?

A tax shelter is any investment designed to reduce or avoid income taxes.

before-tax cash flow

After subtracting the debt service from the net operating income, you can see the before-tax cash flow.

What is the profit that an investor actually receives from income-producing property?

After-tax cash flow

does not affect net operating income?

Amenities

taxable income

An investor's tax liability from a property is based on taxable income rather than cash flow. Net Operating Income - Depreciation - Mortgage Interest

How is an investor's tax liability derived?

An investor's tax liability from a property is based on taxable income rather than cash flow. Taxable income is net operating income minus all allowable deductions, including the amount allowed for annual depreciation on the property.

Formula

Annual before-tax cash flow ÷ Total cash invested = Cash-on-cash return

Break-Even Ratio (BER)

BER is a ratio some lenders calculate to gauge the proportion between the money going out to the money coming so they can estimate how vulnerable a property is to defaulting on its debt if rental income declines. BER reveals the percent of income consumed by the estimated expenses. (Operating Expense + Debt Service) ÷ Gross Operating Income = Break-Even Ratio BER results: Less than 100% - expenses consuming less than available income Greater than 100% - expenses consuming more than available income

What is before-tax cash flow?

Before-tax cash flow is the measure of the cash received after the net operating income has been calculated and any mortgage-related expenses are paid, but before taxes are taken into consideration.

Which rate is used to determine the value of a property?

Capitalization rate

fixed expenses

Costs that do not change from month to month

variable expenses

Costs that vary in amount and type, depending on the choices you make.

What is debt service?

Debt service is the principal and interest payments made on a debt over a period of time.

How is the taxable income of a property derived?

Gross income minus building depreciation minus other allowable expenses

The effective rental income plus any income from other sources is the

Gross operating income.

What is the two-step process for estimating current operation costs?

Identify comparable properties. Compare data to published sources.

How does a pro forma income statement differ from an historical income statement?

It projects the future rather than tracks the past.

List two examples of variable expenses.

Management fees Utility expenses

Name three factors that affect net operating income.

Market rent Vacancy Expenses

What is the formula for determining taxable income?

NOI - depreciation - mortgage interest

The difference between the gross operating income and the operating expenses is the

Net operating income.

If John's investment property has an NOI of $100,000 the first year, mortgage payments of $75,000 with $60,000 in interest, and a first-year depreciation of $55,000, how much tax will John pay?

None

Property 1 has a potential rental income of $45,000. The vacancy for the year resulted in $12,000 in collection losses. The property had operating expenses of $15,000. What is the net operating income for this property?

Potential Income Less Vacancy and Collection Losses Effective Income Less Operating ExpensesNet Operating Income $45,000- $12,000 = $33,000 - $15,000 $18,000

List three examples of fixed expenses.

Real estate taxes Insurance premiums Advertising

What is the formula for determining tax liability?

Taxable income x tax bracket percent

What is gross rental income?

The amount of revenue a property would generate if it had no vacancies.

Define cash flow?

The cash received minus the cash paid out over a given period of time.

Net Operating Income (NOI)

The income projected for an income-producing property after deducting losses for vacancy and collection and operating expenses.

What does a debt coverage ratio measure?

The investor's ability to pay the property's monthly mortgage payments from the cash generated from renting the property.

In addition to the demographic makeup of the population and the median income of families in a particular area, what will the market rents for retail space depend on?

The percentage of income families in the area usually spend on the purchase of goods and services from the retail companies in their area.

What is the equity dividend rate?

The ratio of annual before-tax cash flow to the total amount of cash invested, expressed as a percentage. Equity dividend rate is also known as cash-on-cash return.

Operating Ratio

This is the percentage of effective gross income that is consumed by the operating expenses. Combined Ratio - Investment Income Ratio

What is a capitalization rate designed to do?

To reflect the recapture rate of an investor's original investment over the economic life of the investment to give that investor an acceptable rate of return on his or her investment.

How does an operating statement differ from a typical income statement?

Unlike at typical income statement which shows operating revenues when they are earned and operating expenses when they are incurred, a real estate operating statement usually presents cash inflows and outflows from operations and is broadened to include non-operating cash flows, such as those that come from debt service, income taxes, and capital expenditures.

pro forma income statement

a financial statement that shows the projected results of the operations of a firm over a specific period

cash-on-cash return

also called the equity dividend rate, is the ratio of annual before-tax cash flow to the total amount of cash invested, expressed as a percentage.

Estimating a property's recent operating history is most accurately accomplished by looking

at comparable properties.

Market Rent

economic rent, is the price that a specific type of property is likely to draw under the current market conditions. The market rent could be higher or lower than the amount the property is actually renting for under its current lease. The rent depends on several factors:

Income Multipliers

express the relationship between price and either gross or net income.

Deriving the Before-Tax Cash Flow (BTCF)

if an investor has a property that has a net operating income of $52,000 and mortgage expenses equal to $28,000, then the investor has a cash flow of $24,000. NOI Mortgage expenses BTCF $52,000-$28,000=$24,000

transfer costs

includes the gift and estate taxes and the costs of avoiding taxes, such as the cost of documents, planning, trusts, and other professional fees

Physical durability

is a calculation of the building's remaining physical life, which is based on how well the building was originally designed coupled with how well it has been maintained over its life.

Functional efficiency

is an assessment of how well a property does the job it is supposed to do.

tax shelter

is any investment designed to delay, reduce or avoid income taxes. In real estate investment, as a property appreciates in value, the investor is allowed a paper deduction for depreciation. Mortgage interest is also a deductible allowance.

capitalization (CAP) rate

is designed to reflect the recapture rate of an investor's original investment over the economic life of the investment to give that investor an acceptable rate of return on his or her investment. Income ÷ Rate = Value

Cash flow

is equal to the cash received minus the cash paid out over a given period of time.

net operating income

is simply the difference between the gross operating income and the operating expenses. If an investor has no income taxes and no non-operating expenses, this would be the cash flow to the investor. But this is hardly ever the case.

after-tax cash flow

is the amount of cash that remains after all the operating expenses have been paid, the obligations to the lender have been satisfied and income tax responsibilities have been met.

Before-tax cash flow

is the measure of the cash received after the net operating income has been calculated and any mortgage-related expenses are paid, but before taxes are taken into consideration.

Debt service

is the principal and interest payments made on a debt over a period of time.

Debt Coverage Ratio

measures the investor's ability to pay the property's monthly mortgage payments from the cash generated from renting the property.

operating expenses

that are shown in the next section of the example will show all the cash expenditures that are needed to maintain and operate the property. As you can see, these expenses include property taxes, insurance, utilities, advertising, repairs and maintenance, and other fees.