Chapter 15 Estimating Cap Rates Band of Investments

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Chapter 15Estimating Cap RatesBand of
Investments
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Band of Investment Approach

• Used in the absence of cap rates derived directly
  from comparable sales, or to support the rational
  behind cap rates
• Recognizes the common debt/equity investment in
  real estate
• NOI is typically split between debt service and
  cash flow to equity (BTCF)
• Analogous to a weighted average cost of capital
  used in Corporate Finance

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Band of Investment
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Example

• Example Financing available at 80 LTV with a
  mortgage constant of .125Investors seek a EDR of
  8

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Rm vs Re

• Why would an investor, who assumes more risk,
  accept a lower rate than the lender, who has a
  secured position/first dibs on cash flow?
• One year (first year) analysis
• MC includes return OF capital (Principal)
• MC is fixed over term investor expects income
  growth
• Investor expects capital gain profit from sale

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Calculating Mortgage Constant

• Assume a 75,000 loan, 10-year loan term, 25-year
  ammortization, 7.5 interest rate
• What is the Mortgage Constant?

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Other Considerations

• Band of Investment is like an equity residual
  modelValue MortgageValue EquityValueValue
  DS/MC BTCF/EDR
• See Page 281

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Other Considerations

• Reliability of Band of Investment
• Similar problems as with cap rates from comps
  with additional uncertainty. (ie. Relying more
  on process the results)
• Can be used with multiple mortgages
• See page 284
• Financing -- assume typical market terms
• Most Probable Buyer
• Varies with borrower credit

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Estimating EDR

• Estimating Equity Cap Rate from Comps
• See example on page 283
• Good Luck!
• Knowing expected NOI of comps, actual loan
  terms/rates is quite difficult
• Investor surveys
• Because the debt term is usually dominate, errors
  in EDR have minimal effect on estimate

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