Equity Investment

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Equity InvestmentThe Investment Decision
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Real Estate Investment Advantages

• Pride in Ownership
• Personal control
• Self-use Occupancy
• Estate Building
• Security of Capital
• Operating Cash Flows
• Leverage
• Tax Shelter factors
• Capital Appreciation Inflation Protection

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Real Estate Disadvantages

• Illiquidity
• Required equity capital
• Management burden
• Depreciation of value
• Government controls
• Real estate cycles
• Legal complexity
• Lack of information education

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Trade-OffsRisk/Return
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• Risks
• Legal Zoning, public opinion,
• public services, etc.
• Market risks Marketability study
• Will it rent? Will it sell?
• Market study SD, Competition
• Absorption rates How fast is space being utilized

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Risks

• Cost risks
• Interest rates
• Estimates poor
• Labor
• Weather

• Possible Solutions
• Guaranteed price contracts
• Watch out for cushion
• General contractors Reputable bonded
• Completion bond (Lenders may require)
• Guarantees price
• Cost plus contracts Developer pays costs fee

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Return Measures

• Cash Flow (Net Spendable) Pro Forma

Equity 20,000.00
Loan (DP10,000) 100,000.00
Gross Possible Income 60,000.00
Less E(Vacancy) (9,000.00)
Gross Effective Income 51,000.00
Less Operating Expenses (37,000.00)
Net Operating Income 14,000.00
Less Debt Service (PI) (12,900.00)
Cash Flow Before Tax 1,100.00

• Cash on Cash Net Spendable/Down payment
• 1100/1000011

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Return Measures

• Rate of return on total capital NOI/Total
  Capital
• 14/120 11.7
• Return on Equity (ROE) CF Before Tax/Equity
• 1.1/20 5.5
• Favorable leverage If ROE gt ROR
• If unfavorable leverage
• Don't buy
• Reduce Price
• Try to lower APR or increase term
• Raise NOI or lower expenses
• Restructure (ie., more equity)

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Return Measures

• Equity cap rate CF before Tax/Equity
• (ie., required ROE)
• For example
• Your desired cap rate is 14
• CF before tax is 1,100
• Equity value 1.1/.14 7,857
• Plus loan of 100K
• Therefore property value 107,857
• Risk measures BEP Debt Coverage Ratio

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Discounted CF Analysis

• Income Cap Rate
• NOI/Market Value
• Compare to other opportunities
• Do Cash Flow Spread sheet
• Ratio Analysis
• Sensitivity Analysis
• What if we change the value of a variable?
• Scenario Analysis Worst versus Best?
• Monte Carlo Analysis
• Randomly assign values check bottom line

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Investment Analysis Process

• Strategy Determine First!!
• Return/Risk Objectives
• Ownership Form
• Market Analysis
• Screening Criteria
• Location/Property Analysis
• Generate Alternatives Those that pass screen
• Use Basic Financial Feasibility Model
• Develop Finance Screens (APRs, CapRates, NOI)
• Examine Finance Alternatives (Loans, Equity, etc)

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Investment Analysis Process

• Negotiate Basic Terms with Seller
• Price
• Financing
• Covenants
• Escape Clause
• Do Detailed Feasibility Research
• Market
• Supply Demand, Competition, Absorption, Vacancy
• Marketability Property Condition
• Legal, Political, Environmental
• Management Operations

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Investment Analysis Process

• Structure Tax Benefits
• Cost Recovery
• Useful Life
• Passive Loss Limitations
• Discounted CF Analysis
• After-Tax CF, DCF, Adjust for Risk
• Final Negotiations Closing
• Management of Property
• Termination
• Sell, merger, IPO

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Control

• Purchase Price Terms
• Form of Ownership
• Financing amounts, rates, terms
• Tax structure Planning
• Property management
• Property location
• Tenants Lease rates terms

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Negotiation

• Maximize knowledge position First!
• Set your initial demands far from final objective
  
• Probe for bottom line
• Raise your aspiration level/deflate your
  opponent's
• Buyer
• Start with lower price than seller wants
• Lukewarm attitude
• Point out defects
• Mention competitive offers
• Seller
• Mention other offers you have rejected
• Price is probably going up
• Negotiate most critical items first and

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Negotiation (Cont)

• Concentrate on items that effect profits
• Down payment, price, contract period
• Employ conservative concession policy
• Don't give in or reciprocate/
• No sportsmanship/
• Never concede first
• Never accept a radical counteroffer without
  analysis
• Use intermediaries when to your advantage
• With agent, more time to analyze
• Advisor Openly discuss concerns
• Try for better deal for both parties
• Place proof burden satisfaction on them
• Prove to you that it is an attractive opportunity

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Negotiation (Tactics)

• Standard Practice Terms are "standard practice"
• Bogey I only can afford 7,500 in cash"
• Good guy/Bad guy
• One makes strong demands ...
• Opponent is more susceptible to good guy's weaker
  demands
• Deadline Always use them!
• Nibbling Get additional minor concessions
  after major agreement
• The tie-up Get the property off the market while
  you're making decision

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Property Types

• Land
• Most Risky
• Low income
• Interest, taxes, insurance
• Interest deduct income only
• No depreciation
• 20-30 ROR for risk
• Consider
• Access/Slope
• Zoning
• Public services Utilities
• Returncapital appreciation

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Property Types

• Residential Rental (Houses,Apts,MHs)
• Management Intensive
• Good financing
• Tax shelter
• High appreciation
• Know location physical condition
• Check neighborhood proximity to services
• Good first step for real estate
• Some income -- mostly capital appreciation

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Property Types

• Office Buildings
• More income/less appreciation
• Appreciation can be improved w/ maintenance
• Needs more knowledge for leasing
• Property management
• Types Downtown vs Suburban
• Medium vs HiRise vs Garden (Low)
• Locations Highways / Shopping Centers
• Better construction
• Low tenant turnover ratios
• Prestigious clients

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Property Types Shopping Centers

• Most sophisticated Investment Management
  Expertise
• Much more income than appreciation/Few
  Foreclosed!
• Owned by wealthy investors (TIAA/CREFMall of
  Amer)
• Types
• Neighborhood center (Strip) Food, drugs, etc,
  Built around supermarket/drugstore 50K Gross
  leaseable area
• Community center Clothing, furniture, bank,
  prof 150K GLA
• Regional center Full-line Dept store (Anchor)
• Reit InsurOwnership 400K GLA
• Super Regional Centers Major metro area 2
  anchors,
• 100-200 stores, Usually of profits

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Property Types Industrial Special

• Industrial
• Warehouses, factories, indust parks
• Almost all income
• Not easily converted increases risk
• Low risk overall if you have a client
• Near highways
• Special Use
• Need expertise RE the application
• Risky Be ready to substitute
• Loans are hard to get banks ??
• Requires time commitment

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Development

• Overview
• Combine land, labor, capital
• Entrepreneurial ability
• Good developers can visualize good uses of
  space
• Creation of space for play, living working
• LT MotiveIncome, Mgt, Community/
• ST MotiveCap Gain
• Redevelopment Restoration of older structure

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Development

• Types
• Land Prep Lots of all kinds
• Sell land to other developers
• Erect improvements on land
• Who Develops?
• Part-time
• Proprietorship
• Corporation, etc.
• Joint ventures (ie., 2 developers)

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Development ProcessBe ready to bail outStages
may be done simultaneously

• Idea Can develop over life of project
• Preliminary Feasibility Rough cut analysis
• Are computer programs Go if profit looks good
• GainControl Ground lease(ties you up), option,
  seller fin
• Feasibility Analysis Design
• Detailed analysis, Check site, market, legal,
  financial
• Finance Need cash ASAP, should have already
  talked
• Construction Problems cost overruns
  contractor fails
• Marketing Lease (dont lease too early rates
  change)
• vs Sale When remember trade-offs

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Redevelopment trends

• Redevelopment
• Costs are high, structures - obsolete
• ITCs, grants
• Popular trend
• Trends
• Mixed use development One structure
• Planned unit development (PUD)
• New towns/Village concept Integrated approach
  work, shop, play, live

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Professional Help

• Real Estate Brokers
• Get a specialist! Has access to information
• Appraisers consultants Can do DCF
• Property managers
• Has rental vacancy rates, op. expenses, etc
• Morgage bankers
• Arrange deals financing alternatives
• Tax advisers and attorneys
• Others
• Comm banks, Engineers, Architects, Contractors