George Mason University Center for Real Estate Entrepreneurship Real Estate Finance & Investment Analysis September 24, 2009

Transcription

1 George Mason University Center for Real Estate Entrepreneurship Real Estate Finance & Investment Analysis September 24, 2009 Coleman Rector Weber Ghadban & Associates Realty, Inc. How do you value a piece of income producing real estate? Appraisal Sales comparison approach Cost to construct approach Income approach It is the income approach that we are going to focus on today 2 1

2 The value in real estate is derived from the income it produces, or the income that it has the ability to produce. Real estate evaluation has gotten much more sophisticated in the past 20 years, for several reasons: RE was somewhat ignored by Wall Street as a real investment They had a hard time analyzing it because information was not readily available RE was more of a local man s game and income and expense numbers were not shared They could not put a real value on RE with great confidence, like they could a stock or a bond. Moody s and S&P are not rating the debt or credit worthiness of individual property owners. So, how do you value a piece of income producing RE? We ll start with the Single Period Analysis This is taking a snapshot of the income & expenses of the RE at a particular period in time. 2

3 Value = Net Operating Income CAP Rate V = NOI/r (cap rate) Probably the most used equation in Real Estate MEMORIZE IT If you walk out of here today with one thing; this is it So, let s break it down Simple math tells us that given any two of the three variables we can determine the third. V= NOI/r (cap rate) NOI = Vxr R = NOI/V 3

4 V= Value Most often we are trying to determine what a property is worth; what is its value If you are trying to solve for one of the other two variables you must know what the value is. Sale Price Assessed Value (public records) Appraised Value What you think Market Value is NOI = Net Operating Income is: PGI = Potential Gross Income (Rents, Additional Income, CAM Pass Thru s s, Other) Less Vacancy & Bad Debt (for example 10%) = EGI (Effective Gross Income) Less Operating Expenses (do not include debt service) = NOI (Net Operating Income) If one doesn t know what the expenses are, rules of themb can be used: Ex.) Office $8-$12/sf, depending on building and location Ex.) Apartments: New 25%-30% of PGI; Old 40%-50% of PGI 4

5 r = CAP Rate A Cap Rate is a rate of return a property generates, as defined by r = NOI/V CAP Rates are market driven, how much return does an investor require on his/her investment. The greater return required (the higher the CAP Rate) the lessor the value The lower return required (the lower the CAP Rate) the higher the value CAP Rates are commonly determined by comparable sales of similar properties Investors generally know the CAP Rates and their range r = CAP Rate Let s come at it from another angle. A CAP Rate is a return on ones investment How does one determine a return that he/she will be satisfied with? Returns change with levels of risk, right? The more risk an investor takes the more return they should get. Where can you put your money and be guaranteed that you will get it back with a return? U.S. Treasuries, is as riskless as you have in this world. This is called your Zero Risk return. This gives you a Base Return to work from. Typically the 10 year treasury retun is used. 5

6 How much more return do I need over and above my zero risk return to make this investment? Risk Premium Examples: Risk Premium Variables Credit worthiness of the Tenant Location Lease Term Adaptive re-use of the building Saleability Illiquidity of the investment Investors personal situation Coutless others This is another way of determining ones rate of return (CAP Rate) on a deal. Keep in mind that if an Investors risk premium differs greatly from that of the market, he/she will have a problem getting a deal done. First Level of Financial Analysis Back of the Envelope (BOE) Pro-Forma Example: You receive a package on a property for sale, an apartment building. You have the following information: 20 units, 2BR/2BA units $1200/mth Fully Occupied, 0% vacancy Expenses $72,000/yr Buildings are 38 years old Price: $4,320,000 6

7 First Level of Financial Analysis Back of the Envelope (BOE) Pro-Forma Given: V = 4,320,000 (asking value) Can Determine: PGI (20 units x $1200/mth x 12 mths) $288,000 - $ 0 (0% vacancy) $288,000 (Effective Gross Income) -$ 72,000 (Operating Expenses) $216,000 = NOI V= NOI/r : Have V & NOI, solve for r (cap rate) r = NOI/V = $216,000/$4,320,000 r = 0.05 = 5.0% CAP Rate First Level of Financial Analysis Back of the Envelope (BOE) Pro-Forma That was a good starting point for the BOE. Now ask yourself some questions: Do you believe their numbers? $1200/mth income 0% vacancy $72,000/yr expenses (25% of PGI) Asking price works out to a 5.0% CAP Rate Is this enough risk premium for you? 7

8 First Level of Financial Analysis Back of the Envelope (BOE) Pro-Forma Make some adjustments $1200/mth OK Change vacany to 10% Adjust expenses to 45% of PGI Change CAP Rate to 8.0% to better reflect your risk premium Now recalculate NOI $288,000 (PGI) - $ 28,800 (10% vacancy) $259,200 (Effective Gross Income) - $129,000 45% of PGI) $158,400 = NOI Solve for V V= NOI/r = 158,400/0.08 = $1,980,000 $1,980,000 is more in line of what this property is worth First Level of Financial Analysis Back of the Envelope (BOE) Pro-Forma THE SET UP POTENTIAL GROSS INCOME (PGI) Base Rental Income Rent Escalations -VACANCIES & BAD DEBT Effective Gross Income (EGI) -OPERATING EXPENSES Expense Reimbursements Other Income RE Taxes Insurance Repairs Utilities Maintenance Char Services Administrative Replacement Reserves Other Expenses =NET OPERATING INCOME (NOI) 8

9 Single Period Analysis NET OPERATING INCOME (NOI) -FINANCIAL PAYMENTS Mortgage Interest Mortgage Amortization (Principal) Land Lease Payments -CAPITAL EXPENDITURES Major Repairs or Replacements Capital Improvements -Tenant Roll Over Cost =CASH FLOW BEFORE TAXES (CFBT) -INCOME TAXES DUE =CASH FLOW AFTER TAXES (CFAT) Multi Period Analysis Taking a snapshot of the RE in the single period analysis is very informative, however it does not give us all of the information we need. Given a choice between a dollar today and a dollar a year from now, most people would choose the dollar today. Why: Because a dollar received in the future can be less valuable for 3 reasons: Opportunity Cost: Earnings, the returns that could have been earned had the money been available for immediate investment, are forgone Inflation: The purchasing power of a sum to be received in the future may be diminished by intervening increase in the price of goods & services Certainty of Payment (Risk): There is uncertainty about receiving payment in the future. 10 yr T-Bills are considered risk free, a lottery ticket bears a great degree of risk. Most real estate investments fall somewhere between these extremes. 9

10 Multi Period Analysis In most cases RE changes every year: Rental income increases (you hope) Expenses increase Markets Change Tenants Change How long are you going to hold the investment? What return do you need to have over the entire investment period? Typically a 10 year study of the property is done and discounted d back to today s value Reversion price...(1/2% higher than "going in" cap rate used) Discounted Cash Flow Multi Period Analysis Discounted Cash Flow Statement Waterfall Returns Go To Pro-Forma 10

11 Discounted Cash Flow All lenders have a different set of lending criteria A lenders lendinglending criteria will change w/ : Market conditions Interest rates Weight & distribution of their loan portfolio Strength, experience & integrity of the borrower Discounted Cash Flow Loan The Lenders triangle - Your typical vanilla bank loan for a building will have 3 main criteria: Loan to Cost (LTC): 80%-90% Loan to Value (LTV): 70%-80% Debt Coverage Ratio (DCR): LTC DCR LTV 11

12 Discounted Cash Flow Loan Your loan amount will have to fit inside of this triangle. 1 of the 3 parameters will be the defining parameter. You do sensitivity analysis to your spread sheet, with small adjustments to different variables: Loan Amount Interest Rate Amortization Period Rental Rate Expenses DO NOT MAKE ADJUSTMENTS THAT ARE UNREALISTIC!!! With this exercise complete, you know how much money you can borrow and most importantly you know how much equity you have to come up with. Lenders & Facilitators Commercial Banks Mortgage Bankers Institutional Lenders GE Capital GMAC Pension Funds Endowments (Yale, many other major universities) Unions CMBS Conduits (Commercial Mortgage Backed Securities) Mortgage Brokers Investment Banks Credit Companies Investment Advisors Private Lenders 12

13 Where can you find a lender: Local Banks Real Estate Publications Subscription Services (Crittenden) Investment Advisors Word of mouth talk to other developers active in the area Debt Structures Construction Loan Permanent Loan Construction / Perm Loan Mezzanine Loan Bullet Loan Land Development Loan Participating Loan Debt / Equity Joint Venture Sale Leaseback Synthetic Lease Many Other types 13

14 Loan Payment Structures Fixed Rate Variable Rate Interest Only Fully Amortizing Partially Amortizing Reverse Mortgage Many More Rewards of Leverage Increased returns to equity Appreciation in property p value accrues to equity position Increase in NOI goes to investor Interest is tax deductible helps after tax cash flow Gives the investor the ability to purchase more with less Allows an investor to purchase several properties with his equity in lieu of paying cash for one property. This increases the investors liquidity all of her eggs are not in one basket. Possible mortgage out for tax-free cash Equity buildup via amortization and appreciation Risks The return on your investment is amplified, good or bad Risk of default increases greatly Real Estate is an illiquid asset 14

15 Request for Package General Fact Sheet 2-3 pages, Owner, Developer, Principles, building type & size, tenants, pre-leasing, pertinent facts & assets, site benefits, schedule & other relevant information Proposed Term Sheet The loan structure that you are requesting; loan amount, LTC, LTV, DCR, equity, collateral, term, rate, recourse & other conditions Location Maps Site plan / Building plan (floor plans) Rendering or Photo if existing Proforma, 10 yr discounted cash flow Market study / market information Phase I environmental study Developer information Tenant information General Contractor information, if applicable Financial statements Submit your package to several lenders best suited to lend in the arena for which you are playing, and/or lenders you are most comfortable with. The Lenders will underwrite the loan: Review loan information Property analysis Market analysis Borrower analysis Integrity Profitability Liquidity Decision Fees to discourage cancellation 15

16 You will receive a Proposed Term Sheet from the lenders if they decide that they want the loan. The terms of the term sheet should be negotiated with the proposed lender(s). Very Important Most bank lenders have a list of approved appraisers that they use. If you have paid for an appraisal that is not on your lenders list, you will be buying another appraisal. The new appraiser may be more conservative than your appraiser. Interview the appraisers before picking which appraiser you want to use from the banks list. Formal Loan Documents Close the Loan 16

17 Real Estate Finance & Investment Analysis Any Questions? George Mason University Center For Real Estate Entrepreneurship Real Estate Finance & Investment Analysis September 24, 2009 Coleman Rector Weber Ghadban & Associates Realty, Inc. 17