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Making an investment decision
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Value
Investment value: The value determined in view of investment objectives, goals and constraints.
Market value: The price that participants in the market place are willing to pay for the investment, in order to make the investment decision. Market value also represent the anticipated future benefit.
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Objectives of real estate investment
Means of building an estatePride of ownershipHedge against inflationDesired rate of return on equity investedDiversification of investor objectivesWealth Maximization
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Risk & Return
Risk: is the variation in the expected future benefits.
Return: is the amount inflow generated by an investment each year.– NOI– NOI net of debt payments– After-tax Cash Flows
Rate of return: is measured as percentage per year as relationships between cash flows and amount invested
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Real Estate Investment Process
Identify investor’s objectives, Goals, and constraints
Analyze Investment Climate and Market Conditions
Develop Financial AnalysisApply Decision-making CriteriaInvestment Decision
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Identifying investor objectives
Each participants have different objectives in real estate investment.
The Equity investor: amount of cash flows from the investment and must be certain of having the legal rights to the cash flows
The Mortgage lender: recovery of the amount lent, as well as in earning a rate of return on the loan.
The Tenant: LeaseThe Government: The relationship among
participants and restrictions on real estate market
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Environment for Decision Making
Market Environment: Supply & Demand, Real Estate Sub-market, Population, employment, income, etc.
Legal Environment: Forms of ownership, Land-use control, Limitations on property rights. Community.
Financing Environment: Debt & Equity Financing
Tax environment
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Cash Flows Forecasting
Cash outflows from initial investmentCash flows from rent collectionCash flows from assets disposition
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Cash Flows Forecasting (cont’)
Potential Gross Income: (PGI)Vacancy and bad debt allowanceEffective Gross Income (EGI)Operating expensesNet Operation Income (NOI)Debt ServiceBefore Tax Cash Flows (BTCF)TaxAfter Tax Cash Flows (ATCF)
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Cash Flows From sales of investment
Expected Selling PriceSelling expensesNet sales ProceedsUnpaid Mortgage balanceBefore-tax equity reversionTaxes due on salesAfter-tax equity reversion
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Criteria for Decision Making
Rules-of Thumb Techniques: Gross Income Multiplier (GIM), Overall Capitalization (net income multiplier), Equity Dividend
Traditional Appraisal Method: Direct Sales Comparison Approach, Cost Approach, Traditional Income Approach
Discounted Cash Flow (DCF): NPV, IRR