VALUE CREATION

1
VALUE CREATION

• We forget what gives something its value that
  someone else wants it.

2
WHATS VALUE

• The worth of goods and services
• Whats Something Worth? What Someone Will Pay
  For It!
• A Correlation Between The Cost Of Labor And
  Materials Needed To And The Amount Charged Not
  Always!

3
TULIP MANIA

• Used to refer to any large economic bubble. The
  term comes from the period in the history of the
  Netherlands during which demand for tulip bulbs
  was so high that enormous prices were charged for
  a single bulb. Took place in the first part of
  the 17th century, especially in 1636-37.

4
NEED v. WANT

• Need Demand Need
• Want Need, but Want Demand
• Need Want Big Demand
• Want Can Be Fleeting
• Need is More Sustainable.

5
STORY OF THE CAVE MAN

• The Caveman Has A Need For Fresh Meat.
• The Caveman Observes That A Rock Falling On An
  Animal Kills It.
• After Many Such Observations, The Fact That A
  Rock Has The Property "Kills Animals", Becomes
  Part Of The Caveman's Knowledge Of Reality.
• Because Of This Knowledge, Rocks Become Valuable
  To The Caveman As A Tool For Getting Fresh Meat.

6
THEORIES

• INTRINSIC - The value of goods and services is a
  property built into the item itself - implies
  every item has certain worth that does not depend
  on what people think of it.
• SUBJECTIVE - For an object to have economic value
  (a price), object must be useful in satisfying
  human needs wants and must not be in unlimited
  supply.
• OBJECTIVIST - Items have built-in properties, and
  that humans make judgments of worth or value,
  based on how well the built in properties can
  meet needs. In this way, the properties are in
  the items, but the value are in the judgment of
  the user.

7
WATER/DIAMOND PARADOX

• Nothing is more useful than water but it will
  purchase scarce anything scarce anything can be
  had in exchange for it. A diamond, on the
  contrary, has scarce any value in use but a very
  great quantity of other goods may frequently be
  had in exchange for it. Adam Smith, An Inquiry
  into the Nature and Causes of the Wealth of
  Nations
• OBJECTIVIST Theory

8
REAL ESTATE VALUE

• The Subjective-Value Theory Holds That One Can
  Create Value Simply By Transferring Ownership Of
  A Thing To Someone Who Values It More Highly,
  Without Necessarily Modifying That Thing. The
  Value of Real Estate Is In Its Utility.
• SUBJECTIVE Theory

9
WINNERS CURSE

• The winner's curse is a phenomenon that occurs
  in common value auctions with incomplete
  information. Winner's curse says the winner will
  tend to overpay. The auctioned item is of roughly
  equal value to all bidders, but the bidders don't
  know the item's market value when they bid. Each
  player estimates the value before bidding. The
  winner is, of course, the bidder who bids highest
  in other words the bidder making the highest
  estimate. If we assume that the average bid is
  accurate, then the highest bidder overestimates
  the item's value. Thus, the auction's winner is
  likely to overpay.

10
WHATS AN APPRAISAL

• An Opinion of Value Not The Actual Value.
• Comparable Approach
• Income Approach
• Cost Approach.

11
RESIDUAL VALUE

• Typically The Value of Real Property Is Thought
  To Be Residual - Its Productive Capability The
  Amount Left After Receiving Payment For And Then
  Paying All Costs To Create (or Own).

12
WHATS MONEY

• Four basic functions of money
• Medium of exchange,
• Store of value,
• Standard of deferred payment, and
• Measuring unit for prices
• Money functions as the Measure of Value. In
  other words, price of goods is stated in terms of
  a monetary unit.

13
EQUITY

• In Business Accounting, Ownership Equity Is The
  Owners' Interest In All Assets After All
  Liabilities Are Paid
• In Real Estate Equity In A Property Is The
  Difference Between The Market Price Of A Property
  And The Owner's Debt
• Its The Money Left Over.

14
ITS ALL ABOUT EQUITY

• So, In Real Estate The Objective Is To Increase
  Equity.

15
MANAGEMENT

• The Purpose Of Management Is To Create Value

ASSETS
DEBT
EQUITY
16
BALANCE SHEET

• PRODUCT SIDE
• Goods Services
• Revenue Expenses
• Human Resources
• Marketing
• Strategic Planning
• COO

• CAPITAL SIDE
• Capital Management
• Debt Equity
• Cost of Capital
• Capital Markets
• CFO

17
DEBT v EQUITY

• Equity is Soft Debt is Hard
• Equity is Forgiving Debt is Insistent
• Equity is a Pillow Debt is a Sword

18
DEBT LEVERAGE

• Financial leverage takes the form of a loan or
  other borrowings, the proceeds of which are
  reinvested with the intent to earn a greater rate
  of return than the cost of interest.

19
EFFECTS OF LEVERAGE

• Increases potential gain from investment or
  project
• Also increases the potential loss
• Interest and principal payments may be higher
  than the investment returns
• Increased risk may still lead to the optimal
  outcome for the entity or person making the
  investment
• Managing risk by strategies including leverage,
  is a discipline known as financial engineering.

20
DEBT

• Risk of Payoff
• Low Debt Low Risk Low to Mid Range Returns
• Higher Debt Higher Risk Higher Range Returns.

21
USE OF LEVERAGE

• You Dont Have Enough Cash
• Your Opportunity Costs Are Higher Then Debt
  Costs
• Allows You To Spread Your Equity
• You Can Own More Then You Have Cash For Which
  Helps Create Diversity.

OF DEBT
RETURN
CASH
DEBT
22
LEVERAGE EXAMPLE

23
COMMON MISTAKES

• The Markets Always Go Up
• Leverage Always Increases My Return, Therefore
• I Should Always Borrow.
• Interest Rate of Borrowing Is Your Hurdle Rate,
  If Your Returns Will Beat It Sufficient For The
  Risks, Then Borrow.

24
DIVERSIFICATION

• Diversification Can Make Certain Risk Disappear
  Thus Make Higher Levels of Total Risk Tolerable.
• Portfolio Strategy

25
REAL ESTATE ECONOMICS

• Asset Prices Rents Are Determined By Market
  Participants
• Demand For Housing Depends On Number Of and
  Incomes Of Households Annual Ownership Costs
• Commercial Demand Is Determined By Rent As Well
  As and Size Of Firms
• Economic Growth Then Increases All Equilibrium
  Variables While Contraction Decreases All
  Variables.

26
ASSET v PROPERTY

• Asset is any economic resource controlled by an
  entity as a result of past transactions or events
  and from which future economic benefits may be
  obtained. Examples include cash, equipment,
  buildings, and land.

27
REAL ESTATE

• An Immovable Asset - a type of property
  differentiated from personal property.

28
ASSET/PROPERTY MARKET
As Rents Increase So Does Inventory
Rent
Property Market Rent Determination
Asset Market Valuation
Price
Inventory/Stock
Property Market Inventory
Asset Market Construction
Construction
As Prices Increase So Does Construction
29
WHERES VALUE INCREASE
VALUE
DEVELOPMENT
RAW LAND
ENTITLEMENTS
30
PUBLIC POLICY IMPACT

• Regulation (zoning, general plan, CIP,
  re-development programs)
• Taxation
• Financial Institutions and Regulations
• General Plan Amendments, Rezoning and Use
  Permits.

31
CAPITALIZATION RATES

• Measure of the ratio between the net income
  produced by an asset (usually real estate) and
  its capital cost (the price paid to own the
  asset). The rate is calculated in a simple
  fashion as follows
• Net Income / Capital Cost
  Capitalization Rate

32
VALUE JUDGEMENT

• BUILDING A
• NOI 100,000
• CAP Rate .10
• Value 1.0M
• Local/Regional Mixed Credit Tenants

• BUILDING B
• NOI 100,000
• CAP Rate .06
• Value 1.66M
• National Credit Tenants

33
VALUE CREATION IN PRACTICE

• How to construct a profitable/successful exit
  strategy
• Hold vs. Sell strategies (long term income vs.
  short term gains)
• Portfolio balancing strategies
• Refinance to realize appreciation gains
• Restructure to remove capital

34
VALUE CREATION IN PRACTICE

• Transactions to reduce or defer taxable
  gains/income
• Equity participants as a value realization
  strategy
• Intangible value(s) from ownership or control of
  improved property
• Buy/sell agreements (strategies) amongst equity
  participants
• Preferred positions and equity kickers as value
  realization options