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# RE29RC07: Investment Property Basics

A Description of Investment Property Basics

Formerly known as Investment Property, Advanced

#### I. VALUATION

GOOD LEASE PROTECTS THE VALUE OF A PROPERTY

• Quantity and Quality of the Cash Flow Stream is What an Investor Will Buy or a Financial Institution Will Lend
• The appraisal is on the reliable and quantity of the cash flow.

#### II. MEASURING INVESTMENT PERFORMANCE

Understanding and Calculating the Concepts of Value

A. Capitalization Rates

• Capitalization rate is an investor's subjective overall rate of return demanded from one specific property.
• Examples for Massachusetts Properties

B. Definition and Formula of Band of Investment Approach (use BOI formula)

• Investors impose a capitalization rate to value investment property
• History of BOI
• Relevancy in a Deflationary Economy
• Industry Arguments For and Against Its Importance
• Using BOI for valuation and negotiating tool
• Income Stream vs. "Bricks and Mortar" Purchase
• Return on Equity
• Subjective Rates of Returns
• It's use by Institutional Investors
• Other Factors in Determining Value in addition to BOI
• Debt vs. Equity Financing

BAND OF INVESTMENT APPROACH

INCOME/VALUE RATIO

FORMULA:

1.

 % of Mortgage to Value of Property (Loan to value ratio) X Loan Constant for Mortgage (Mortgage rate) = % Rate of Return to the Loan Portion of the Investment + % of Equity Raised X % Cash on Cash Return Desired By the Investor (Interest) = % Return on Equity OVERALL RATE OF RETURN = % Amount (CAP) 2. Net operating income % Overall Rate of Return (CAP) = Total value of property

Example:

Assume you borrow 75% of the value of a property at 10.5% for 25 years

Your investor requires a 12% return on his equity invested.

If the net operating income of the property is \$180,000 then what could the investor pay for this property?

Mortgage Constant Formula:

Annual Debt Service = Mortgage Constant

Total Loan Amount

C. APOD Sheet

• NOI/Cap Rate = Value

D. Escalators

* Impact to Value

1. Why do we have escalators?

2. Consumer Price Index (CPI)

* Two U.S. indices

* Regional indices (Boston vs. Northeast)

3. Negotiated "Bumps" or Rent Increases

1. VALUATION PROCESS
1. Sources and Investigation of Market Transactions/Valuations in Massachusetts
• Locating Sales Data
• Public Records
• Published News
• Massachusetts MLS
• Listings Offers
• Filing Sales Data
• Commercial Listing Services in Massachusetts
• Improvement Cost Data
• Income & Expense Data
• Capitalization Rates
1. The Three (3) Valuation Approaches
• Sales
• Income
• Cost

#### III. ELEMENTS AND ECONOMIC VARIABLES TO VALUE

A. Definition of Value: Interaction of supply and demand affects value. A function of the purpose for which an estimate of demand is sought.

* The value of real property reflects and is affected by the interplay of basic forces that motivate human activities.

B. Economic Variables To Be Familiar With:

1. Supply and Demand
* If the quantity of a product is high, price will be low
2. Highest and Best Use
3. Economic Variables include Primarily Demand-Side Economic Characteristics:
1. Stock of available vacant and improved properties.
2. New Development.
3. Occupancy Rates.
4. Rent and Price patterns of existing properties.
5. Construction Costs.

C. Elements and Economics Variables Include:

1. Market Value

• Probable price in the open market
• Uses of the Property
• Offering Price
• Collateral for Loan
• Compensation for Condemnation

2. Assessed Value

3. Reproduction Cost

4. Value in Use

5. Investment Value

6. Value as a Function of Property Rights

7. Value in Amenity Properties Compensation to Value in Investment Properties

8. Value in Investment Properties

9. Functional Obsolescence vs. Economic Obsolescence

10. All Types of Value Are Based on Anticipated Future Benefits

D. CASE STUDY: MASSACHUSETTS COMMERCIAL PROPERTY VALUATION