Overhead Set #5:
Typical Downtown Office Building--1986
 Size: 450,000 ft2
 Land: 15% of total property value
 Depreciation: straight-line over 19 years
 Debt: 75% loan-to-value; interest only; 9%
 Price: $170.78/ft2
 Effective Gross Rent: $21.73/ft2
 Net Operating Income: $14.17/ft2
5:1
Gross Potential Income
-Vacancy/Bad Debt
Effective Gross Income
-Operating Expenses
Net Operating Income
-Debt Service
Before-Tax Cash Flow
+Principal Repayment
-Depreciation
Taxable Income (Loss)
Tax Bill (Savings)
--------------------9,778,500
3,402,000
6,376,500
5,187,443
1,189,059
0
3,438,071
(2,249,014)
(1,124,507)
After-Tax Cash Flow
2,313,564
5:2
Important Calculations
1. Effective Gross Rent: $21.73*450,000 = $9,778,500
2. Net Operating Income: $14.17*450,000 = $6,376,500
==> note that operating expenses are the difference between
these two figures (approximately 35% of effective gross)
3. Debt Service
a. Property Value: $170.78*450,000 = $76,851,000
b. Mortgage Amount: $.75*$76,851,000 = $57,638,230
c. Interest Payment: $.09*$57,638,230 = $5,187,443
==> you now know before-tax cash flow; it is positive at $1.2
million
5:3
Important Calculations
4. Principal Repayment: $0, as loan is interest only
5. Depreciation Deduction
a. Depreciable Basis: .85*$76,851,000 = $65,323,350
b. Annual deduction: $65,323,350/19 = $3,438,071
5:4
Important Calculations
==> while actual before-tax cash is positive, the large
depreciation deduction allows the owner to claim the
project is losing money; the taxable loss is $2.2 million
==> at the 50% top marginal bracket then in effect, the value
of this taxable loss is $1.1 million
==> after-tax cash flows attributable to ownership of this
building is $2.3 million, assuming full use of loss offsets
5:5
Treatment of Activities That Increase the
Depreciable Basis
1. Original Depreciation--i.e., no new tenant improvements
a. Depreciable Basis=(.85)*(76,851,000)=$65,323,350 as computed
above
b. Annual Deduction=$65,323,350/19 = $3,438,071 (in 1986)
2. Now consider the impact of $1,000,000 in new tenant
improvements that increase the depreciable basis
a. New Basis: +$1,000,000
b. 1,000,000/19=$52,632
==>new line #9 = $3,438,071+$52,632=$3,490,703
5:6
Gross Potential Income
-Vacancy/Bad Debt
Effective Gross Income
-Operating Expenses
Net Operating Income
-Debt Service
Before-Tax Cash Flow
+Principal Repayment
-Depreciation
Taxable Income (Loss)
Tax Bill (Savings)
----9,778,500
3,402,000
6,376,500
5,187,443
1,189,059
0
3,438,071
(2,249,014)
(1,124,507)
9,778,500
3,402,000
6,376,500
5,187,443
1,189,059
0
3,490,703
(2,301,644)
(1,150,822)
ATCF
2,313,564
1,339,881
where $1,339,881=$1,189,059+1,150,822-$1,000,000
5:7
Note: actual BTCF is $1,189,059, but do not let that affect the
taxable income calculation if the item cannot be
immediately expensed so that the base for taxation is
reduced on a dollar-for-dollar basis
Note: this is not a real estate specific issue; cash flow is
$1,000,000 lower in any industry; real estate specific rules
apply to what is immediately expensible and what must be
capitalized or amortized.
5:8
Impact of Taxes:
– Depreciation
– Loan Points
– Effective Tax Rate = [1 - BTIRR/ATIRR]
Impact of Leverage
– Positive or Negative
– Breakeven Interest Rate
ATIRRDebt = ATIRRProperty
ATIRRDebt = BTIRRDebt(1-)
BTIRRDebt = [ATIRRProperty / (1-)]
5:9
Investment Analysis
 Should a property be purchased?
 How long should it be held?
 How should it be financed?
 What are the tax implications?
 How risky is the investment?
5:10
Measure of Investment Performance
1. Price/SF
2. Cap Rate = NOI / Sale Price
3. Break-even Ratio = (Operating Exp + Debt Serv)/Gross Inc
4. Equity Dividend Rate = BTCF / Equity
5. Debt Coverage Ratio = NOI / Debt Service
6. Net Present Value (NPV)
7. Internal Rate of Return (IRR)
BEWARE:
(BTCF + Principal Repayment) / Equity
(BTCF + Tax Effect) / Equity
5:11