Lecture+9+FNCE+232+Financing+Decisions+Part+2

Lecture+9+FNCE+232+Financing+Decisions+Part+2 - FNCE 232...

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FNCE 232 Real Estate Investments Lecture 9 Financing Decisions – Part 2 Professor C. F. Sirmans School of Business
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Administrative Issues Real Estate Society Events
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Review from Lecture 8 In the previous lecture we reviewed some of basic concepts of mortgage financing including, 1. The Mechanics of Mortgages 2. Before-Tax Cash Flow Forecasting 3. Sources of debt financing and the underwriting process
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Lecture 9: Overview In this lecture we analyze some financing decision situations including: The Capital Structure Decision—Choice of debt and equity The Concept of Financial Leverage/Risk How sensitive is the investment decision to changes in debt financing terms?
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Lecture 9: Overview Effect of Below-Market Financing on Value Negotiating Mortgage Terms Refinancing Decision Choosing Between Alternative Mortgages
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Capital Structure Decisions: Choice of Debt/Equity Ratio Financial Leverage/Financial Risk Korpacz Leveraged Yields Survey Data Does Borrowing Change Value?
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Concept of Financial Leverage Introducing debt into that capital structure of a real estate investment will increase the expected rate of return on an investment when the expected rate of return on the total project exceeds the cost of borrowing.
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Concept of Financial Leverage To illustrate, consider the Small Apartment Case. The rate of return on the total project based on NOI and NSP is 10.2%. This the expected rate of return on an “all equity financed” investment. As long as the cost of borrowing is less than 10.2%, the expected rate of return to the equity position will increase with the introduction of debt.
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Concept of Financial Leverage In our Apartment Case, if we borrow 75% at 7% for 20 years (monthly), the expected IRR on the equity position increases to 15.2% on a before-tax basis.
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