Real Estate Development: Borrower-Lender Goals, Negotiable Items, and Finance Appraisals, Slides of Managerial Economics

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Real Estate Development – Principals and Process Chapters 7-9 Finance

Goal’s of the Borrower

• Minimize cash investment
• Maximize “after tax” income
• Get a timely commitment
• Afford the payments
• Hedge against inflation

Goal’s of the Lender

• Minimize Risk
• Maximize Yield
• Minimize cost of handling and servicing
• Comply with regulations
• Hedge against inflation

APPRAISALS

Cost Approach – What is the cost of the property? What would cost to replace?

Market Approach – What is the current price being paid for similar properties sold in the area?

Income Approach-What is the current value of the future income stream to be generated by the property?

LOAN CONSTANT

Constant – The annual debt service of a mortgage as percent of the loan.

$100,000 @ 10% for 20 Years = constant. $100,000 x .1158026 = $ 11,580.26 per year or $ 965.02 per month

$100,000 @ 11.5% for 43 Years = constant. $100,000 x .1158443 = $11,584.43 per year or $965.37 Per Month

INCOME APPROACH

TO VALUE

Value = Net Income Before Debt Service

Capitalization Rate

OTHER FORMULAS

TO KNOW

Coverage Ratio = Net Income Before Debt Service Loan Payment

Loan Payment = Net Income Before Debt Service Coverage Ratio

Note: The above are derived at Lenders request.

Loan Amount = Net Income Before Debt Service Coverage Ratio Loan Constant

Total Development Cost

• Loan Amount = Equity

Return on Equity = Cash Flow Equity

Cash Flow = Equity x Return on Equity

Learning Objectives

Identify available methods for measuring

investment performance

Define, calculate and interpret measures

of investment performance for selected

sample investments

Explain how the Cash Flow Model and its T-

bar are used in the measurement of

investment performance

Page 6.

Learning Objectives

Define, calculate, and interpret net present value (NPV) as a measure of investment performance for selected sample investments

Define discount rate and explain its various uses

Define, calculate, and interpret internal rate of return (IRR) as a measure if investment performance for selected sample investments

Page 6.

Sales Comparison Approach

The sales comparison approach may

be used to determine what a buyer

will pay for a property given the price

per square foot or per unit.

Price/square foot

Total square feet of building

Investment Value

×

Page 6.

Sales Comparison Approach

Sales Comparison Approach to Compare Similar

Properties in the Market

 Compare per unit costs of the subject property

to comparable properties in the market

Purchase Price /Development

Cost

otal Square feet of building

= Price per square foot

Page 6.

Gross Rent Multipliers (GRM)

Calculates the investment value of a

property by using the “gross rents”

anticipates the property will produce

The GRM used is derived from

comparable properties in the

marketplace and may be adjusted by

the investor to reflect specific

requirements

Page 6.

Gross Rent Multiplier × Forecast 1 st^ Year PRI = Value

Determining Investment Value Using

the Gross Rent Multiplier

Property is forecast to have $100,000 first year PRI

Potential buyer GRM Requirement is 7

Investment value is calculated as:

7 × $100,000 = $700,

Page 6.

Sample Problem

Measuring Investment Performance Using the

Gross Rent Multiplier

Investment Value

Forecast 1st^ Year PRI

Property is forecast to have $100,000 first year PRI

Potential buyer GRM Requirement is 7

Investment value is calculated as:

= Gross Rent Multiplier

$700,

$100,

= 7

Pros & Cons of Gross Rent

Pros Multiplier

• A principal advantage of using a gross rent multiplier

is its simplicity

Cons

• That quality also limits reliability, since a gross rent

multiplier does not take into account:

Any vacancy and credit losses

Any operating expenses

Financing

Any tax impact