Real Estate Investments
Topic 12
I. The Nature & Scope of
Real Estate Investments
A. Definition of Real Estate

Real Estate is artificially delineated
space references to a fixed point on the
surface of the earth with a fourth
dimension of time. It is built to house an
economic activity that is subject to
cultural preferences and restricted by
the public infrastructure.
Concepts

B. Space--Time Product
• Real estate is a space-time product, that is
it generates income over time in exchange
for the use of space. Examples:
apartments, football tickets, wedding
receptions
D. Characteristics

The Real Estate Market Characteristics:
•
•
•
•
•
1.
2.
3.
4.
5.
Highly Stratified, Local Markets
Heterogeneous Product
Private, not Public, Transactions
Unsophisticated Investors
Unorganized Market
E. Investor Motivations
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1. Pride in Ownership
2. Personal Control
3. Self-use and Occupancy
4. Estate Building
5. Security of Capital
6. High Operating Yield
7. Leverage
8. Tax Shelter
9. Capital Appreciation
10. Portfolio Diversification
F. Investment Disadvantages and
Risks
1.
 2.
 3.
 4.
 5.
 6.

Illiquid
Management
Depreciation of Value
Government Controls
Real Estate Cycles
Legal Complexity
G. Participants
1. Builder/developer
 2. Syndicator
 3. Property Manager
 4. Construction Lender
 5. Permanent Lender
 6. Managing Equity Investor
 7. Passive Equity Investor

Real Estate Investments
Topic 12
II. Overview of
Investment Decision Process
A. Framework for Real Estate
Investment Studies

1. Strategy
• Develop an overall investment philosophy

2. Analysis
• Measuring return

3. Decisions
• Risk and return evaluations
4. Investment Transaction
 5. Feedback

B. Investment Analysis vs.
Feasibility Analysis

1. Investment and Investment Analysis
•
•
•
•
•
•
•
a. Capital Assets
b. Equity
c. Debt
d. NOI
e. Lender/Equity Relation
f. Maximizing Wealth
g. Return and Risk
B. Investment Analysis vs.
Feasibility Analysis (continued)

2. Feasibility and Feasibility Analysis
• a. Site in Search of a Use
• b. Use in Search of a Site
• c. Investor Looking for the Best Investment
Alternative

3. Investment Life Cycles
• a. Property Life Cycle
• b. Ownership Life Cycle
• c. Investor Life Cycle
B. Investment Analysis vs.
Feasibility Analysis (continued)

4. Ownership Life Cycle
• a. Acquisition
• b. Operation
• c. Disposal/Termination

5. Investor Life Cycle
•
•
•
•
a.
b.
c.
d.
Young Investor
Middle Aged Investor
Older Investor
Institutional Investor
Real Estate Investments
Topic 12
III. Decision Making Approaches
to Real Estate Investment
B. Traditional Financial Decision
Making Approaches

1. Investment Value Approach
• a. Invest if: V  C
• b. Reject if: V  C

2. IRV
I
• Assumes:
– a. Productivity = NOI
o
– b. NOI is stabilized
– c. Holding period is infinite
– d. Capital is recaptured from income, except
land
R
V
Stabilized NOI
Ye = 10.5%
Year NOI * PV factor
PV
1 $53,918 * .904977
$48,795
2
56,645 * .818984
46.391
3
59,352 * .741162
43,989
4
62,037 * .670735
41,610
5
64,698 * .607000
39,272
6
67,185 * .549321
36,906
Sum = $256,963

Stabilized NOI (continued)
Stabilized NOI = PV of NOI/PV of
Annuity
 Stabilized NOI = $256,963 / 4.292179
 Stabilized NOI = $59,868

Estimating Re
 Consider:
• a. Real Rate of Return
• b. Inflation
• c. Risk Premium
C. Modern Capital Budgeting
Approaches
1.
 2.
 3.
 4.

The Present Value Model
Internal Rate of Return
Modified Internal Rate of Return
Risk Analysis
• a. Ratio and Sensitivity
• b. Simulation
• c. Elasticity
Investment Principles
1. The investor should buy the
assumptions that create the yield rather
than the yield itself.
 2. The investor should be as concerned
about what to offer the next buyer as
with what he is buying
 3. The investor should price the
property apart from the tax advantages.

Investment Principles
4. The investor must compare
alternatives.
 5. The investor should understand the
potential profit and risk in terms of
DOLLARS.

Sources of Return from a
Real Estate Investment
Cash flow from operations
 Tax Savings
 Equity buildup from loan amortization
 Loan refinancing proceeds
 Appreciation of property value (sales
proceeds)

The Market Revenue Model :
(Back Door)
Market Rents
Equity
Acct.
Cash
x BEP =
Margin
= (1 - BEP) x
- Reserves
- Vacancy
- RE Taxes
- Operating Exp.
CTO
CASH FOR DEBT

Re

Rm
JEA
JMA
+
Justified Investment Value
The Capital Revenue Model:
(Front Door)
Cost of Project
Equity
= (1 - m) x
Amount
x m=
Debt
Amount
x Re
x Rm
CTO
ADS
+
NOI
+ Operating Expenses
+ Real Estate Taxes
+ Vacancy Allowance
PGI
PGI/Net Leasable Area =
Required Rent to be Charged
Example Data

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1. Project Cost: $7,000,000
2. M = .80
3. Loan Terms: .064, 20 yrs, annual pmts.
• Hence, Rm = .09
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4. RE Taxes = 10%
Operating Expenses = 30%
Vacancy Allowance = 5%
Market Rents = $4.00/S.F.
Reserve Account = $44,000
Re = 14%
Example Data (continued)
1.
 2.
 3.
 4.
 5.
 6.
 7.

Cost of Project:
$7,000,000
Loan to Value:
0.800
Mortgage Constant:
0.140
Mortgage Constant:
0.129
Operating Expenses:
$343,000
Vacancy Losses:
$55,500
Net Leasable Area: 260,000
Capital Revenue Model (CRM)
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Cost of Project:
Equity Amount:
Cash Throwoff:
Debt Amount:
Annual Debt Service:
Net Operating Income:
Plus Operating Expenses:
Plus Vacancy Losses:
Equals Potential Gross Income:
PGI/Net Leasable Area Equals
REQUIRED RENT:
$7,000,000
$1,400,000
$ 196,000
$5,600,000
$ 504,000
$ 700,000
$ 343000
$ 55,500
$1,098,500
$4.225
Example Data (continued)
1.
 2.
 3.
 4.
 5.
 6.
 7.

Cost of Project:
$7,000,000
Loan to Value:
0.800
Equity Dividend Rate:
0.140
Mortgage Constant: 0.129
Operating Expenses:
37.21%
Vacancy Losses:
5.00%
Net Leasable Area: 80,000
Market Revenue Model (MRM)
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Market Rents:
$1,100,000
Cash Retained for Equity Account:
$ 166,500
Less Reserves:
$ 44,000
Less Vacancy:
$ 55,500
Equals Cash Throw-Off:
$ 67,000
Divided by Re Equals Just. Eq. Amt.: $ 478,571
Account Allowing for Monies-Out:
$ 943,500
Less Operating Expenses:
$ 333,000
Less Real Estate Taxes:
$ 10,000
Equals Cash for Debt:
$ 600,500
Divided by Rm Equals Just. Debt Amt.:$6,672,222
Market Revenue Model (MRM)
(continued)

Justified Investment Value: $7,150,793