PRE COURSE WORKBOOK DOESTPENCIL.NET. DOES IT PENCIL / PRE COURSE WORKBOOK 2017 Still Training, LLC 1

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1 PRE COURSE WORKBOOK DOESTPENCIL.NET 2017 Still Training, LLC 1

2 HOW TO USE THIS WORKBOOK This workbook and the pre course videos integral to the DOES IT PENCIL training. The training is designed for you to read this workbook and watch the videos BEFORE you attend the live training. The HP 10BII Financial Calculator Integral to the training is the use of the HP10BII. You MUST get either the physical calculator or the smart phone app as a part of this course. Please get your 10BII as soon as you can. You will need it to go through this workbook and watch the videos. What s in this Workbook & Videos This workbook and the videos will focus on the technical steps and keypresses of using the HP 10BII in the training. At the live training will review each of the skills in this workbook, but the live training is focused on applying these skills to real estate analysis, not teaching you the keypresses. There are 4 videos and 4 sections in the pre course training: Calculator Set Ups Time Value of Money Mortgage Constant, APOD and Advanced Cap Rate T Accounts, Cash Flows & Internal Rate of Return Using the Workbook and the Videos It s best to have this workbook as you watch the videos that go with it. If you can t, just make sure you get your calculator and at a minimum watch these videos before you attend the live training. The videos are downloadable for later viewing. The videos will also be available after the live training to serve as a resource for you to come back and practice. What to do Next Get your HP 10BII calculator or smart phone app Watch the videos Do the problems See you at the live training. Joe Still CREA, CPN, CCIM Course Developer and Lead Instructor Still Training, LLC 2017 Still Training, LLC 2

3 VIDEO 1 CALCULATOR SETUPS Time value of money keys. N, I/YR, PV, PMT and FV. BEG/END key. Changes beginning or end of year. IRR/YR: Internal rate of Return. NPV: Net Present Value Gold Key Clear or Clear All. DISP. Used to change the significant places displayed Still Training, LLC 3

4 1.1 Default Settings There are 3 defaults you need to use on the calculator: set the beginning of year (BOY) or end of year (EOY) modes clear the registers set the number of digits displayed for calculation (significant places) 1.2 BOY and EOY Settings The HP 10BII has the ability to make calculations contemplating receiving and making payments at the beginning of the period or at the end of the period. In DOES IT PENCIL training we will assume that the investor receives the benefits of all cash flows for the entire period. This is called the end of year setting (EOY). If you see the word BEGIN in your display, it needs to be turned off, or set to end of year. If you do not see the word BEGIN in the display, the calculator is set on end of year (EOY). keystrokes END description press the GOLD key, then the BEG/END Key 1.3 Clearing the Registers The HP 10BII allows you to save information in some registers while it is cleared in others. making corrections before a number is entered clearing the last entry clearing all registers 1.4 Making Corrections Before a Number is Entered keystrokes description clears the last digit in the display otherwise it cancels the current calculation 1.5 Clearing the Last Entry keystrokes description C clears the last entry 1.6 Clearing all Registers keystrokes description C ALL clears all memory functions 1.7 Set the Significant Places On the HP 10BII calculator, changing the number of digits shown to the right of the decimal point will not affect the internal iteration of the calculator. The calculator will always performs tasks and store digits up to 12 places. EXCEPTION: when performing mortgage loan calculations (discussed later), the calculator will round to the number of places you have pre-set in the calculator. keystrokes DISP # description press the GOLD key, then the = key, then the number of digits desired to be displayed to the right of the decimal point. For example, to display 4 significant places, press DISP 4. You will see Still Training, LLC 4

5 VIDEO 2 TIME VALUE OF MONEY 2.1 The 5 Time Value of Money Keys (The Top Row) There are 5 fundamental time value of money keys on the top row of the HP10BII calculator. They are: N The number of time periods. Note: this is not always the number of years, rather the number of periods (i.e 12 periods in a year, 4 periods in a quarter). I/YR The "rate", "interest rate", or "yield". PV Present Value is the "worth" today of money received or paid. FV Future Value is the worth in the future of money received or paid. PMT The payment. Investors receive (or pay) a series of payments throughout the holding cycle of an investment. Payments can be positive or negative. The notation used to make a number negative is referred to as sign convention. NOTE: In this workbook, a negative sign convention will be denoted by < > or The Relationship of I/YR and N When performing time value of money calculations, you will need to preset the calculator for the correct number or payments per year to make the conversions required for I/YR and N. 2.3 Setting the Number of Periods Per Year keystrokes description enter number of periods (i.e. 12) P/YR press the GOLD key, then press the P/YR (PMT) key, NOT the xp/yr (N). NOTE: to check the number or periods currently set, press and hold down the C ALL key. 2.4 Example: Adjusting N and I/YR Assume you want to borrow $100,000. You will be paying an interest rate of 9% per year The loan will be amortized over 30 years Payments will be made monthly. The keystrokes would be as follows: keystrokes register description 12 P/YR sets payments per year to 12 C ALL 12 P_Yr clears registers, verifies 12 payments per year PV 100, enters 100,000 as the PV 30 N multiplies the 30 X the number of periods preset per year (12) 9 I/YR 9.00 internally divides the 9% annual interest rate by the number of periods per year PMT solve for monthly payment 2017 Still Training, LLC 5

6 2.5 TVM Practice Problem 1 How much will $10,000 invested today in an investment that pays 10% monthly be worth in 20 years? Problem Set Up Key Value Description P/YR = 12 preset for 12 payments per year (monthly payments) PV = -10,000 the lump sum paid at the beginning (note: it s negative) N = 20 the number of years in the problem I/YR = 10 the interest rate FV solve for what you will have in the future Keypress on the HP 10BII Keystrokes Display Description 12 P/YR sets payments per year to 12 C ALL 12 P_Yr clears registers, verifies 12 payments per year /- PV -10, enters -10,000 as the PV 20 N multiplies the 20 X the number of periods preset per year (12) 10 I/YR enters the 10% annual interest rate FV 73, solves for the future value NOTES: 2.6 TVM Practice Problem 2 You buy a piece of vacant land for $275,000 today and he believes it can be sold in 10 years for $500,000. If this happens, what is your annual rate of return on appreciation? Problem Set Up Key Value Description P/YR = 1 preset for 1 payment per year (annual payments) PV = -275,000 the lump sum paid at the beginning (note: it s negative) N = 10 the number of years in the problem FV = 500,000 the future sales price (note: it s positive) I/YR solve for the annual rate of return Keystrokes Display Description 1 P/YR 1.00 sets payments per year to 1 (annual) C ALL 1 P_Yr clears registers, verifies 1 payment per year /- PV -275, enters -275,000 as the PV (paid) 10 N multiplies the 10 X the number of periods preset per year (1) FV 500, enters 500,000 as the FV (received) I/YR 6.16 solves for the rate of return (annual percent) NOTES: 2017 Still Training, LLC 6

7 2.7 TVM Practice Problem 3 The market is going up at 5% per year. You believe this will hold going forward. You buy a rental for $300,000 all cash. If your assumption about market appreciation is true, what will the rental be worth in 4 years? Problem Set Up Key Value Description P/YR = 1 preset for 1 payment per year (annual payments) PV = -300,000 the lump sum paid at the beginning (note: it s negative) N = 4 the number of years in the problem I/YR = 5 the rate of appreciation FV solve for the future price Keypress on the HP 10BII Keystrokes Display Description 1 P/YR 1.00 sets payments per year to 1 C ALL 1 P_Yr clears registers, verifies 12 payments per year /- PV -300, enters -300,000 as the PV (paid) 4 N 4.00 multiplies the 20 X the number of periods preset per year (1) 5 I/YR 5.00 enters the 5% annual rate of appreciation FV 364, solves for the future value NOTES: 2.8 TVM Practice Problem 4 A buyer has been qualified for a monthly payment of $2,000. A new loan will be amortized over 30 years with an interest rate of 5%. How much can the buyer borrow? Problem Set Up Key Value Description P/YR = 12 preset for 12 payments per year (monthly payments) PMT = -2,000 the money payment (note: it s negative) N = 30 the number of years of amortization I/YR = 5 the interest rate on the note PV solve for present value of the loan amount Keypress on the HP 10BII Keystrokes Display Description 12 P/YR sets payments per year to 12 C ALL 12 P_Yr clears registers, verifies 12 payments per year /- PMT -2, enters -2,000 as the monthly payment 30 N multiplies the 30 X the number of periods preset per year (12) 5 I/YR 5.00 enters the 5% annual interest rate PV 372, solves for the present value of the loan amount NOTES: 2017 Still Training, LLC 7

8 VIDEO 3 MORTGAGE CONSTANT 3.1 What is an APOD? 2017 Still Training, LLC 8

9 3.2 The APOD and NOI Net Operating Income (NOI) comes to use through the Annual Property Operating Data form (APOD). This is covered extensively in the DOES IT PENCIL live training. For now, use these basic components of the APOD to derive NOI Income - Vacancy + Other Income - Expense Net Operating Income (NOI) 3.3 Example: Solving NOI from the APOD Bill is looking at a 4-plex. Each unit rents for $800 per month. He will estimate vacancy at 5%. He will estimate landlord s expenses at $11,000. He will also collect $100 per month per unit for water/sewer/garbage. The 4-plex NOI is calculated like this: Item Amount Explanation Income 38,400 4 units X $800 per month X 12 months Vacancy -1,920 5% of the gross rental income Other Income 4,800 4 units X $100 per month X 12 months Expenses -11,000 Given NOI 30,280 Net Operating Income (NOI) 3.4 Basic Cap Rate Methodology Basic Cap Rate is used to determine the price of a property that produces income. It s probably the most common method used by brokers and investors in the marketplace. Basic Cap Rate uses 3 pieces of information: Net Operating Income (NOI), Capitalization Rate (CAP RATE) Price (PRICE) There are 2 common uses of the Basic Cap Rate: 1. Using Basic Cap Rate to solve for price PRICE = NOI CAP RATE 2. Using Basic Cap Rate to solve for cap rate CAP RATE = NOI PRICE 2017 Still Training, LLC 9

10 3.5 4 Square (Advanced Cap Rate) The Advanced Cap Rate model is used to build a cap rate. The methodology blends the 4 elements of investment and return together in a simple equation. Percentage of debt from the Loan to Value X The Mortgage Constant = The Weighted Cost of Capital Percentage of equity from the Loan to Value X = The Compensation Investors Desired ROE for Risk Where, = Capitalization Rate % Equity Provided by the lender through the loan to value (LTV) ratio % Debt Provided by the lender through the loan to value (LTV) ratio Desires ROE Mortgage Constant Provided by the investor Solved using Time Value of Money (TVM) 3.6 Steps for Solving the Mortgage Constant 1. Preset Set the calculator for 12 payments per year 2. PV <1>. Always enter negative $1 as the PV (i.e. 1 +/- PV) 2 TERM Enter number of periods of amortization (i.e. 25 years would be 25 N) 3. RATE Enter adjusted rate per period (i.e. 5.5% interest would be 5.5 I/YR) 4. PMT Solve for the payment. (i.e. PMT) 5. DISP Change the display to 4 significant places (i.e = 4) 6. ANN Adjust to annualize (i.e. X 12 =) 2017 Still Training, LLC 10

11 3.6 Example: Solving for Mortgage Constant Solve for the mortgage constant for a loan with 30 year amortization and interest rate of 4.5%. Keystrokes Display Description 12 P/YR sets payments per year to 12 C ALL 12 P_Yr clears registers, verifies 12 payments per year 1 +/- PV enters -1 as the present value or loan amount 30 N multiplies the 30 X the number of periods preset per year (12) 4.5 I/YR 4.50 enters the 4.5% annual interest rate PMT 0.01 solves for the monthly payment = expresses previous step at 4 significant places X 12 = solution What does this mean? It means that the true cost of borrowing with both principal and interest on a 30 year note at 4.5% is really 6.08%. This seems weird. We will discuss the theory more at the DOES IT PENCIL live training. For now, let s just do one more example of how to solve for mortgage constant. 3.7 Example: Solving for Mortgage Constant Solve for the mortgage constant for a loan with 25 year amortization and interest rate of 5.25%. Keystrokes Display Description 12 P/YR sets payments per year to 12 C ALL 12 P_Yr clears registers, verifies 12 payments per year 1 +/- PV enters -1 as the present value or loan amount 25 N multiplies the 25 X the number of periods preset per year (12) 4.5 I/YR 5.25 enters the 5.25% annual interest rate PMT 0.01 solves for the monthly payment = expresses previous step at 4 significant places X 12 = solution What does this mean? It means that the true cost of borrowing with both principal and interest on a 25 year note at 5.25% is really 7.19% Square Problem 1 / Betty s Rental Betty likes a certain rental. The NOI is $15,200 per year. She can get a 75% LTV loan with a 5.75% interest rate amortized over 30 years. Betty would like to earn a 12% return on her money. Question: What should Betty s pay for the rental? Problem Set Up LTV 75% TERM 30 years RATE 5.75% ROE 12% NOI 15, Still Training, LLC 11

12 Problem Solution Step 1. Solve for the Mortgage Constant Keystrokes Display Description 12 P/YR sets payments per year to 12 C ALL 12 P_Yr clears registers, verifies 12 payments per year 1 +/- PV enters -1 as the present value or loan amount 30 N multiplies the 30 X the number of periods preset per year (12) 5.75 I/YR 5.75 enters the 5.75% annual interest rate PMT 0.01 solves for the monthly payment = expresses previous step at 4 significant places X 12 = solution Step 2. Build 4 Square & Solve for Desired Cap Rate Percentage of Debt Mortgage Constant = Weighted Cost of Capital.75 X Percentage of Equity.25 X Investor s Desired ROE = Compensation for Risk = Capitalization Rate.0775 What does this mean? It means that for Betty to achieve her desired 12% rate of return given the structure of the debt (the loan to value) and the true cost of borrowing (the mortgage constant), Betty can must buy at no less than a 7.75% cap rate. The key to this is that she cannot buy at less than a 7.75% cap rate. This will be covered more in the DOES IT PENCIL live training. Step 3. Solve for the Price PRICE = NOI CAP RATE Here s how to solve for Betty s price using the cap rate method: 15,200 = $196, What does this mean? It means that for Betty to achieve her desired 12% rate of return given the structure of the debt (the loan to value) and the true cost of borrowing (the mortgage constant), Betty can must buy at no less than a 7.75% cap rate and give the NOI her price can be no more than $196,129 for this property Still Training, LLC 12

13 VIDEO 4 THE T ACCOUNT, CASH FLOWS & INTERNAL RATE OF RETURN (IRR) 4.1 What is a T-Account? Any investment can be measured in a lifecycle. When measuring this lifecycle, a simple and effective tool is available to the investment professional is the T-Account. There are 3 sections to the T Account Cash Out: Cash Flows: Cash In: The initial cash paid by the investor to control the asset. Typically this is the sum of the down payment plus the other costs of acquisition. Cash flows from operations. Can be both positive and negative. PTCF from the APOD. The sum of cash flows in the year of sale (PTCF) plus the proceeds from the sale (PTSP). 4.2 What is IRR? The internal rate of return is defined as: The interest rate received for an investment consisting of positive and negative cash flows that occur at regular periods. 4.3 The T Account Picture T CF 0 (DP + OCA) 1 PTCF 2 PTCF 3 PTCF + PTSP The Jargon DP Down Payment OCA Other Costs of Acquisition APOD The APOD Form PTCF Pre Tax Cash Flow (from the APOD Form) PTSP Pre Tax Sales Proceeds 4.4 The End: Pre Tax Sales Proceeds (PTSP) 4 simple steps to completing a pre-tax sales analysis: 1. Sales Price 2. (-) Costs of Sale 3. (-) Mortgage Balance 4. (=) Pre Tax Sales Proceeds 2017 Still Training, LLC 13

14 4.5 Populating the T Account PTCF from the APOD Down payment (time period 0): -100,000 Cash Cash flows from operations year 1: 25,000 Asset Cash flows from operations year 2: 14,000 Asset Cash flows from operations year 3: -8,000 Asset Cash flows from the sale in year 3: 130,000 Cash T CF 0 <100,000> Down payment + Other Costs of Acquisition 1 25,000 PTCF from the APOD 2 14,000 PTCF from the APOD 3 <8,0000> + 130,000 = 122,000 PTCF from the APOD + PTSP 4.6 Entering Cash Flows into the HP 10BII Entering the cash flows from 4.5 into the HP 10BII works like this: Keystrokes Register Description 1 P/YR 1.00 Presets for 1 payment per year C ALL 1 P_Yr Verifies 1 payment per year preset /- CFj -100, enters cash flow at time period "0" of -100,000 as time period 0" CFj 25, enters the cash flow at time period 1 as 25, CFj 14, enters the cash flow at time period 2 as 14, ,000 CFj 122, enters the cash flow at time period 3 as 442,000 Now that the cash flows are entered, solving for the IRR works like this: keystrokes register description IRR/YR IRR solution = 20.56% What does this mean? It means that if this investor pays out $100,000 in cash (regardless of the actual price ), and receives 25,000 in year 1, 14,000 in year 2 and a total of 122,000 in year 3, the overall annualized rate of return is 20.56% Still Training, LLC 14

15 4.7 T Account, Cash Flows & IRR Problem 1 / Betty s Rental From problem 3.8, now we will run an IRR analysis for Betty. Assumptions Value Description Price 196,129* from solving for the cap rate PTCF 15,200 Assume Betty pays all cash Term 3 Assume Betty holds for 3 years FV 280,000 Assume Betty can sell the property for $280,000 *For purposes of this example we will assume Betty paid all cash for the property. T Account T CF 0 <196,129> All cash purchase price 1 15,200 PTCF from the APOD 2 15,200 PTCF from the APOD 3 15, ,000 = 295,200 PTCF from the APOD + PTSP Keystrokes Register Description 1 P/YR 1.00 Presets for 1 payment per year C ALL 1 P_Yr Verifies 1 payment per year preset /- CFj -196, enters cash flow at time period "0" of -196,129 as time period 0" CFj 15, enters the cash flow at time period 1 as 15, CFj 15, enters the cash flow at time period 2 as 15, CFj 295, enters the cash flow at time period 3 as 295,200 Now that the cash flows are entered, solving for the IRR works like this: keystrokes register description IRR/YR IRR solution = 19.55% 2017 Still Training, LLC 15