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Investment value is particular to an investor taxes

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Unformatted text preview: es? Management? Discount Rates? Dr. Eriksen Lesson 10: RE Investment 4 5 6 2 Real Estate Fundamentals Texas Tech University Typical RE Investment Problems Large Initial Costs (Purchase) Benefits Spread over Future Years RE Investment Example Apartment Building Costs $1 million Anticipate $50,000 per year in Cash Flow Sell Property in 5 years for $1.2 million Should you Invest? Well It Depends… Two Tools to Aid Decision Process Internal Rate of Return (if > alt return, then invest) Net Present Value (if > 0, then Invest) Internal Rate of Return (IRR) Basic Idea: The exact discount rate such that NPV = 0 Invest if IRR is > “Next” Best Opportunity Use Basic TVM to Solve for r: N = 5, PV = 1m, PMT = $50k, FV = $1.2m, r = 8.38% If Alt Risk Adjusted Return < 8.38%, Then Invest Use Uneven Cash Flow Function: CF0: 1m; C1 = 50,000, F1=4; C2 = 1.25m, F2 = 1 Hit [IRR], then [CPT] IRR = 8.38% Dr. Eriksen Lesson 10: RE Investment 7 Initial Cost Cash Flow From Operations Cash Flow at Sale 8 9 3 Real Estate Fundamentals Texas Tech University Net Present Value (NPV) Basic Idea: Discount Future Cash Flows Received by Return (r) on Alternative Investment of Similar Risk Subtract Costs from Discounted Benefits If > 0, the Investment Increases Net Worth Use TVM Calcs to Solve: r = 12% $50k per year for 5 years: $180,238.81 $1.2 m in 5 years: $680,912.23 NPV = 861,151 $1,000,000 = 138,849 What Does this Mean? Another RE Investment Example You are looking to invest in some raw land to eventually build an office building. The land costs $800k to purchase today and you will have to pay $20,000 per year in property taxes. At the beginning of the 9 year you anticipate you will construct the building for $2million, which you will sell at the end of that year for $4.6 million Should you invest given you have a risk adjusted discount rate of 11%? Using Uneven Cash Flows Hit [CF], then… CF0 = $800,000 C1 = $20,000, F1 = 7 C2 = $2,020,000, F2 = 1 C3 = $4,580,000 ($4.6m – 20,000 in taxes) Net Present Value = $19,660 (Invest) Hit [NPV], Set I = 11%, Down Arrow, [CPT] IRR = 11.25%...
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