Lecture+3+FNCE+232+Basis+Cash+Flow+Concepts
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Lecture+3+FNCE+232+Basis+Cash+Flow+Concepts

Course Number: FINANCE 232, Spring 2008

College/University: UConn

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FNCE 232 Real Estate Investments Lecture 3 Basic Cash Flow Concepts Professor C. F. Sirmans Office: Room 443 School of Business Office Hours: 2:30 - 3:30 Tu & Th Administrative Issues Real Estate Society--Konover Fieldtrip Real Estate Scholarships Resumes for Internships and Jobs Teaching Assistants Teaching Assistants Katherine Tunsky katherine.tunsky@huskymail.uconn.edu Office Room #: Room 401 (Business)...

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FNCE 232 Real Estate Investments Lecture 3 Basic Cash Flow Concepts Professor C. F. Sirmans Office: Room 443 School of Business Office Hours: 2:30 - 3:30 Tu &amp; Th Administrative Issues Real Estate Society--Konover Fieldtrip Real Estate Scholarships Resumes for Internships and Jobs Teaching Assistants Teaching Assistants Katherine Tunsky katherine.tunsky@huskymail.uconn.edu Office Room #: Room 401 (Business) Nicholas Seccareccia nicholas.seccareccia@huskymail.uconn.edu Office Room #: Room 401 (Business) Review From Lecture 2 What is the basic real estate investment decision? How to measure a good investment? Who are the main participants in any real estate investment? How to they interact with each other? Basic Investment Model Buy What are Cash (Out)flows at acquisition? Operate What are the <a href="/keyword/expected-cash-flows/" >expected <a href="/keyword/cash-flows/" >cash flows</a> </a> from operation? Sale What are the <a href="/keyword/expected-cash-flows/" >expected <a href="/keyword/cash-flows/" >cash flows</a> </a> from the future sale of the investment? How to make the investment decision? Basic Investment Model Some other important decisions: What is the expected holding period? How to calculate the expected rate of return? What is the required rate of return? What is the Value of the investment? Whose perspective? Equity investor Basic Investment Model How to implement the basic investment model? Two approaches: A. Compare the Value of the investment to the Costs, i.e., compute NPV OR B. Compare the expected Rate of Return to the required Rate of Return Cash Flow Analysis/Forecasting A. Acquisition Phase B. Cash Flow from Operation C. Cash Flow from Reversion Acquisition Phase What are the cash (out)flows at acquisition? Equity: Purchase price minus mortgage debt. Acquisition Costs: legal fees, brokerage fees, etc. Financing Costs: fees paid for mortgage <a href="/keyword/cash-flows/" >cash flows</a> from Operation Gross Income Net Operating Income Before-Tax <a href="/keyword/cash-flows/" >cash flows</a> After-Tax <a href="/keyword/cash-flows/" >cash flows</a> Cash Flow From Operation Potential Gross Income - Vacancy and Bad Debts Effective Gross Income - Operating Expenses = Net Operating Income - Debt Service = Before-Tax Cash Flow - Taxes from Operation = After-Tax Cash Flow PGI - VBD EGI - OE = NOI - DS = BTCF - TAXES = ATCF Cash Flow From Sale Sale Price - Selling Expenses = Net Sale Price - Unpaid Mortgage Balance = Before-Tax Equity Reversion - Tax Due on Sale = After-Tax Equity Reversion SP - SE = NSP - UM = BTER - TDS = ATER Basic Cash Flow Statement To illustrate the basic structure of the <a href="/keyword/cash-flows/" >cash flows</a> from a potential real estate investment, consider the Office Building Case See Office Building Case slides You should become familiar with the basic structure of <a href="/keyword/cash-flows/" >cash flows</a> from operation and future sale of the investment. Future lectures will analyze the cash flow forecast in detail. Forecast NOI at Market Rental Rates Rents are expected to increase 4% per year. 1 2 3 $254,800 $264,992 $275,592 (12,740) 242,060 (87,310) (13,250) 251,742 (90,230) (13,780) 261,812 (96,839) Answer to 4a: Office Building Case Market rent of $14.00 (from Question 2) is used in these calculations PGI - VAC EGI - OE NOI 4 5 $286,615 $298,080 (14,331) 272,284 (14,904) 283,176 6 $310,003 (15,500) 294,503 (109,180) $185,323 (101,337) (104,984) $170,947 $178,192 $154,750 $161,512 $164,973 Answer to 4b: Small Office Building b. Forecast the net sale price at the end of Year 5: 185,523 SP = .13 = $ 1,425,561 3% selling expense = $47,766 Net sale price = 1,425,561 - 47,766 = $1,382,794 How to forecast <a href="/keyword/cash-flows/" >cash flows</a> Several steps are required for an analysis of the <a href="/keyword/expected-cash-flows/" >expected <a href="/keyword/cash-flows/" >cash flows</a> </a> from operating and future sale of an investment. These steps are outlined on the next slide. Steps in Cash Flow Forecasting A. Market Analysis B. Lease Analysis/Structuring C. Operating Decisions D. Reversion Decisions/Exit Strategies E. Financing Decisions/Capital Markets F. Tax Effects Cash Flow Forecasting What are the <a href="/keyword/expected-cash-flows/" >expected <a href="/keyword/cash-flows/" >cash flows</a> </a> from an potential investment under the existing leases? The owner (equity investor) has what is known as a leased-fee estate. What are the <a href="/keyword/expected-cash-flows/" >expected <a href="/keyword/cash-flows/" >cash flows</a> </a> if the rents are at market rates? The owner has what is known as a fee simple estate. Note that rents on the existing leases may be different than market rates. Converting <a href="/keyword/cash-flows/" >cash flows</a> into Value/Rate of Return To convert the <a href="/keyword/expected-cash-flows/" >expected <a href="/keyword/cash-flows/" >cash flows</a> </a> into a Value or expected rate of return on an investment, we use the basic concepts of compound interest and present value. Mechanics of Valuation and Investment Decisions A. Compound Interest and Present Value B. Mortgage Mechanics C. SpreadSheet Tools/Computer Technology D. Discounted <a href="/keyword/cash-flow-model/" >cash flow model</a> s/ NPV/IRR Mechanics of Investment Decision Making Our next lecture will discuss in detail the mechanics of Real Estate Investment Decision Making using the basic concepts of compound interest and present value. Summary How to measure the <a href="/keyword/expected-cash-flows/" >expected <a href="/keyword/cash-flows/" >cash flows</a> </a> from a real estate investment? What are the cash (out)flows at acquisition? What are the mechanics of cash flow from operation? Future sale? Which participant gets which cash flow, that is, what is the cash flow to Equity investor, Mortgage Lender, Government? Assignments for Next Lecture Begin careful analysis of the Apartment Investment and Office Building Cases Mechanics of Real Estate Investing Review Problem Set 1 Conclude reading of Textbook Chapters 1, 2, 3. Continue reading Chapter 9 of Textbook

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