Flashcards in Chapter 4 Deck (18)
Describe three areas where value can be derived from an investment in commercial real estate property.
1) The properties ability to to create income
2) The expected sales price
3) For private, entrepreneurial investors, tax benefits may constitute a third source of value
Explanation the relationship between GPI (Gross Potential Income), EGI (Effective Gross Income), and NOI (Net Operating Income).
GPI-income from property if rented at market rates
EGI=GPI-cost for vacancy or credit loss
Discuss the difference between the cash basis accounting and accrual basis accounting.
cash-only recognizes income and expenses received and paid out
accrual-income and expenses posted when earned or incurred
Describe how time affects the book value and equity appreciation (or depreciation) of a property.
As more time passes the book value become less representative therefore equity appreciation is commonly calculated on a quarterly basis.
Discuss the process and assumptions used for determining DCF (discounted cash flow).
DF is determined by calculating NOI for a period of time (typically ten years) and then capitalizing to NOI at a determined rate in a stabilized year.
Define IRR (Internal Rate of Return) and describe its relationship to investment analysis software.
The IRR is the actual rate of return on a series of cash flows generated by an investment. It is commonly used as a benchmark to evaluate the financial attributes of various investments.
Investment analysis software is used to calculate the IRR automatically, given stated parameters or assumptions. It is important to understand that the IRR can be misleading under certain circumstances such as with highly leveraged investments.
How are real estate values typically categorized?
What is the equation for calculating value from net operating income and desired rate of return?
Value-NOI/rate of return (also called capitalization rate or yield)
What are the five key components of Net Operating Income (NOI)?
*GPI-Gross Potential Income
*Credit Loss-tenant charges to be written off as uncollectable
*EGI (Effective Gross Income)-GPI-vacancy-credit loss
Describe the benefits of accrual basis accounting.
It helps to avoid anomalies that may be present with cash basis accounting.
Describe two common factors used to calculate yield.
cash-on-cash return=cash return/cash invested
market-to-market basis-a factor that indicates that a property is adjusted to the current market value
Explain GAAP (Generally Accepted Accounting Principles) formula for determining book value.
Book value is the value of property on a financial statement.
BV=original cost+cost of improvements-capital disposals-depreciation+income earned-cash received
How does discount rate affect property value and risk?
discount rate-the rate of return in a DCF (discounted cash flow) analysis.
high discount rate results in lower property value and high risk.
also called yield rate
Describe the advantages and disadvantages of using IRR (internal rate of return) to evaluate the financial attributes of various investments.
*most widely used
* simple to compute
*can be misleading for highly leveraged properties
*assumes all cash flows are invested at the same rate
Describe the relationship between the FMMR (Financial Management Rate of Return) and the IRR (Internal Rate of Return).
FMMR is a safe rate, compared to IRR, for which future cash flows are invested during a particular period
For FMMR, cash flow is invested at treasury bond rates rather than the IRR
Describe how asset managers use investment analysis software.
It helps the asset manager balance trade offs of a transaction to maintain or enhance the value of a property.
Identify typical data points needed to generate reports using asset management software.
building areas (net rentable, usable, etc.)
tenant improvements and leasing commissions
vacancy allowance/credit loss
downtime and rent abatement
revenues and expenses