## Quiz for Chapter

If the real rate of return is 1 , what are the expected rates of inflation and the default premium associated with the following securities The one-year treasury rate 4.6 , and the one-year corporate bond rate 6.1 . a. Inflation premium 3.6 default premium 2 b. Default premium 2 inflation premium 3.6 c. Inflation premium 3.6 default premium 1.5 d. Default premium 1.5 inflation premium 3.6 2. XYZ Federal Savings has a mortgage portfolio containing mortgages with a face value of 1,500,000. They...

## The Impact Of Depreciation On Taxable Income

The impact of depreciation on taxable income is illustrated in Table 8.1. The top portion of the table, calculating net operating income (NOI) and before-tax cash flow (BTCF), is addressed in Chapter 10, Real Estate Appraisal. The bottom portion of the table, calculating after-tax cash flow (ATCF) is covered in Chapter 11, Real Estate Investment Analysis. By looking at depreciation in the left-hand column of Table 8.1, one can see that interest expense and depreciation are deducted from net...

## Breakeven Occupancy Rate

The breakeven occupancy rate is the occupancy level at which the property's income will just cover the bills. The bills that must be covered are the debt service and the operating expenses. The ratio appears in Equation 11.8. Breakeven occupancy (DS + Op Exp) PGI ( 62,185 + 47,000) 126,900 0.86 86 This tells the investor that the building needs a vacancy rate of 14 or less in order for the before-tax cash flow to be positive because if the vacancy is greater than 14 , the investor won't have...

## The Cost Approach

The first of the three approaches is the cost approach which is based on an appraisal principle called the principle of substitution. This principle states that nobody will pay more for a property than it would reasonably cost to construct a new substitute for that property. As a result the value of existing housing tends to be tied to the cost of new construction. If the two types of property were not relatively similar in value, one type of property would sell and the other would not. The...

## Final Exam

Tony had his 22nd birthday this week, and he has decided he'd like to be a millionaire by the time he retires at age 65. If Tony can set aside equal amounts each month until he retires in a 10 account, how large would his monthly payments have to be to have 1 million by the time he retires a. 8,450.05 2. I want to be a millionaire when I retire at 65 and I've just had my 57th birthday. How much do I have to set aside each month until I retire in my 10 account to have my 1 million 3. If you...

## Depreciation in Appraisal

According to the Dictionary of Real Estate Appraisal, published by the Appraisal Institute, depreciation is a loss in value due to any cause. This depreciation is applied to the replacement cost of the improvements in the cost approach as you will see in Chapter 10 on real estate appraisal. The depreciation can come in three forms physical deterioration, functional obsolescence, and economic or locational obsolescence. The first of these, physical deterioration, is probably what comes to mind...

## Sinking Fund Payment

There are two types of payments that come out of the time value of money. The first of these is called a sinking fund payment. For the sinking fund payment there is a target future value that an investor is shooting for. The sinking fund payment is the size of the payment needed to set aside at regular intervals that will accumulate the desired future value. This is an example I like to use with my college students, who are typically juniors and seniors. Assume that you want to go on a...

## Compound Growth Rates

Compound growth-rate calculations depend on the use of time value of money (TVM) calculations. (Since this is the case and TVM is not covered until Chapter 6, compound growth rates are addressed in Chapter 8.) Selling Price and Required Net Proceeds The seller of a home is interested with how much money he or she will have left after paying the broker's commission. This amount is often referred to as the net proceeds from the sale. In Chapter 8, you will see that another way to describe net...

## Important Calculator Keys

The BA II Plus calculator has many abilities that we do not address in this book. The ones we primarily focus on are the time value of money keys and the cash flow keys. The time value of money keys are in the third row from the top of the calculator and are as follows N I Y PV PMT FV . The N key stands for the number of compounding periods in the calculation. The I Y key is the interest Figure 1.6 The Texas Instruments BA II Plus calculator Texas Instruments BA II PlusTM image used with...

## The Sales Comparison Approach

The second of the three approaches is the sales comparison approach. The sales comparison is the best approach to use in valuing single-family residential property. The approach is based on the principle of substitution. Someone will not pay substantially more for a house today than a similar house sold for yesterday. The subject property is compared to a number of houses that sold recently, which are referred to as comparable sales, or comps. The houses are compared based on a number of...

## Band Of Investment Cap Rates

You will recall from Chapter 10 that the band of investment method of estimating a cap rate uses both the mortgage information and the required rate of return on equity for the investor in building the cap rate. As the expected inflation premium and the default premium associated with the mortgage increase, the mortgage constant will increase, both leading to a higher cap rate. As the required return on equity for a given investor increases, so will the cap rate using the band of investment....

## Debt Coverage Ratio

The first of these ratios is called the debt coverage ratio (DCR). This ratio is of great concern to the lender who is providing the mortgage money for the transaction. This ratio tells the investor and the lender whether the NOI is adequate to cover the annual debt service. The ratio is the NOI divided by the annual debt service. The lender will typically want this ratio to be at least 1.2. In the case of riskier investments, such as new construction, the lender may want the DCR to be at least...

## Four Major Premises

The concept of time value of money is driven home by remembering four separate major premises. These major premises are referred to several times throughout this chapter as well as in other parts of the book if you can master these four time value of money concepts, the financial world will be yours to work with and profit from. 1. The higher the discount rate, the lower the present value. 2. The sooner you get the money, the more its worth. 3. The principal balance at any point in time is...

## Calculations

45,000 x .10 4,500 12 375 30 12.50 x 15 187.50 Twelve days of interest at 12.50 per day. Real estate taxes The same amount that is a credit to the buyer is a debit to the seller. See the calculation under the buyer's statement. Table 9.4 Seller's closing statement - Interest 9 1 - 9 15 Real estate taxes Insurance Recording Commission 15.00 7,380.00 405.90 53,338.40 69,661.60 123,000.00 123,000 1,000 123 - 3.30 405.90 Amount due seller

## Potential Gross Income

The cash flow analysis begins with the cash flows from operations. Investors will typically analyze the cash flows over their projected holding period for the property. That may be three years, five years, ten years, or more. (Later in the chapter we look at cash flow from the sale of the property.) The cash flow from operations estimate begins with the potential gross income (PGI) of a piece of investment property. This is the amount of income that the property could generate in one year,...

## Buyers Statement

The buyer's closing statement is designed to inform the buyer, or buyers, how much additional cash they need to bring to the closing. A typical blank buyer's closing statement is illustrated in Table 9.1 below. Before moving on to the next paragraph, look at the blank statement and try and determine which line items would show up as debits on the buyer's statement and which items would show up as credits on the buyer's statement. A little later in the chapter we use Table 9.1 in a closing...

## The Income Approach

There are several forms of the income approach. These include the gross rent multiplier GRM , income capitalization, and discounted cash flow. The gross rent multiplier is the most effective form of the income approach for valuing single-family residences. The gross rent multiplier is calculated, or extracted, from a comparable sale. The comparable should have been rented at the time of the sale to be the best comparable. The GRM is equal to the sale price of the comp divided by the gross...

## Depreciation in Investment Property

Depreciation in an investment property scenario is quite a different thing from depreciation in appraisal. In the previous section it was stated that depreciation is a loss in value due to any cause. For investment property, depreciation is a theoretical wearing out of the property that is deducted from income for taxation purposes. Uncle Sam, the IRS, says that investors can deduct the value of this depreciation from their income so that the investors' tax liability will be reduced. Uncle Sam...

## Pgi

Note that IRV is simply a variation on the part, percent, whole format that is mentioned in Chapter 1 of this book. The income, or NOI, is a part, the R, or capitalization rate, is a percent, and the value is the whole. You are called on to appraise a six-unit apartment building in which all apartments are rented for 1,100 per month. The building and local market for similar buildings are both experiencing a 6 vacancy rate. Operating expenses for the coming year are expected to be 27,000. A...

## Market Extracted Cap Rates

Maybe the tenant of one of the comps is the U.S. Postal Service which has signed a 30-year lease. In that case the income is almost like the income on a treasury security. Rather than saying our cap rate should reflect default or some other type of risk, maybe we should be using a risk-free cap rate. Hopefully you are getting the feeling of how capitalization rates can be risk-adjusted rates and how different types of risk are applicable to different types of...

## Tax Rate And Mill Rate

Let's move on to what is referred to as the tax rate. The tax rate can be stated a number of different ways. Some states refer to it in a percentage format, or dollars per hundred. Other states use the term mill rate. One mill equals 1 1,000 of a dollar, or a tenth of a cent per dollar. Still other states use measure of dollars per thousand. In order to obtain the tax rate or mill rate, we need the aforementioned tax levy and the total assessed value within the taxing district. Tax rate...

## Example

Locate on Figure 4.7 the following tract of land the SE 1 4 of the SE 1 4 of the SW 1 4. How many acres are in the tract of land It contains 640 x 1 4 x 1 4 x 1 4 10 acres of land. Locate the N 1 2 of the SW 1 4 in Figure 4.7. How many acres does it contain It contains 640 x 1 4 x 1 2 80 acres. The subdivision plat system is also called the lot and block system. Within an urban area, it would become unwieldy to continue breaking the description of a 75-foot by 150-foot lot down using the SW 1 4...

## Partitioning of IRR

Another way we can measure the risk of an investment is to partition the IRR into two parts. We are interested in seeing how much the IRR is dependent on the cash flows from operations and how much of the IRR is dependent on the cash flow from the sale of the building. When a larger portion of the IRR comes from the cash flow from the sale, that would be considered a riskier investment than one in which a larger percentage of the IRR comes from the cash flows from operations. The cash flows...

## Iiii

Make an informed decision about the payment plan that I would prefer. The cash flows are diagramed in Figure 6.1, and we assume that my interest rate is 5 . To find the future value of this annuity, we could take each payment individually and calculate its future value, that is, take the first payment and compound it forward to the end of period three, take the second payment and compound it forward, and then take the third payment with no compounding since it is already at the end of period...

## How Many Acres In A Square Mile Of Land

The units of measure used in real estate math calculations can be varied. Lot sizes and building sizes use feet, or more precisely, square feet as a basic unit of measure. If we take a storage shed measuring 6 feet by 6 feet, its area would be 6 feet x 6 feet 36 feet2 or 36 square feet. Notice that both the 6 is squared and the unit of measure, or feet, is squared. You will see both lot sizes and building sizes described in number of square feet, which is a measure of size for the area of a lot...

## Noi Math Problems

79,200 - 4,752 77,448 27,000 47,448 The NOI of the building for the coming year is obtained by deducting the annual operating expenses from the EGI and is summarized in Equation 10.14. NOI EGI - operating expenses 77,448 - 27,000 47,448 The NOI estimation is also summarized in Table 10.2. Now that the NOI is in place, we need to estimate the capitalization rate R , which is simply the NOI value, or sale price, of the comparable. The cap rate estimate is illustrated in Equation 10.15. The final...