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TUTORIAL Post Housing Bubble, Property Still Pays, The Wall Street Journal Online Real estate investors seek the same thing from their real estate investments as security investors - a great return on investment - they just talk about it a little differently. Investors will look at dollars per square foot, cap rates, gross rent multipliers, and IRR's in determining purchase and sales prices. As with most investments, you want to buy low and sell high. Keeping in touch with the market will help you determine whether your price is high or low at any given time. Please see our "News" and "Links" in keeping up with current market conditions. Keep in mind that timing has a great deal to do with the success of an investment. In Southern California, 1988 was a great time time to sell, and 1995 was a great time to buy. Generally, if you were buying in 1988 and getting a good price, the investment still probably didn't turn out well for you, considering the time value of money. Conversely, if you were buying in 1995, and didn't get a great price, you probably still made money if you were selling in 2003. TERMINOLOGY Equity: the capital invested by the investor, or the amount derived by considering the estimated value of a project less the amount of debt against the property. Leverage: The use of debt to increase the size of an investment that can be acquired with a given amount of equity. Risk: The potential for loss on an investment. Gross Potential Income: all potential income generated by a property. Adjusted Gross Income or Gross Effective Income: the total income generated by a property, adjusted for vacancy and collection losses. Operating Expenses: the costs of maintaining and managing income-generating real property incurred by the investor, or landlord. These expenses may include maintenance, utilities, property management fees, property taxes (but not income taxes), insurance, repairs, and janitorial services, if provided. Operating expenses do not include depreciation. In some cases, Landlord’s share of Operating Expenses will vary based upon whether these costs are passed on to the tenants through a reduction of the lease rate. Landlord's share of operating expenses will be higher under "full service" leases, common in office buildings, as compared to "triple net" (NNN) leases, where the operating expenses are passed on to the tenant. Triple net leases are more common in shopping centers and industrial buildings. Net Operating Income (NOI): the income remaining after meeting operating expenses. NOI is the equivalent of earnings before interest, taxes, depreciation, and amortization ("EBITA"). Capitalization Rate: otherwise known as "Cap Rate", the NOI as a percentage of the acquisition cost or value of an investment. A property's capitalization rate is derived by dividing the net operating income by the acquisition cost of the property. The higher the Cap Rate, the lower the price, and vice versa, the lower the cap rate the higher the price given a fixed NOI. Yield: The annual rate of return of an investment paid in dividends, or interest, expressed as a percentage of the investment. Gross Rent Multiplier: A factor used to derive a value of an income-generating residential property based upon the annual gross potential income of the property. The lower the Gross Rent Multiplier, the lower the value of the property, given a fixed gross potential income. Discount Rate: A target or hurdle rate of return that an investor will apply to future income to determine a present value or purchase price of an investment. Valuation of Real Estate Generally, there are three traditional approaches to valuing real estate:: Cost Approach: The cost approach adds all costs needed to produce the project to estimate its value. Market Approach: The market approach considers recent sales comparables, adjusted to account for dissimilarities in properties. Income Approach: Used on properties generating income typically through rents or leases. Commercial Properties: Commercial properties generating income to the owners through leases are appraised based on the property's Net Operating Income and an assumed Capitalization Rate. The Capitalization Rate, expressed as a percentage, is divided into the stabilized Net Operating Income to derive a value. Residential Properties: Income-generating, residential rental properties are valued either based on the property's Net Operating Income and Capitalization Rate, as typically used on commercial properties, or through use of the Gross Rent Multiplier. The Gross Rent Multiplier is the factor by which the gross potential income is multiplied to estimate the value of residential, income-generating properties. Debt Coverage Ratio: the ratio of the income pledged to service the debt to the debt payments. The higher the Debt Coverage Ratio, the lower the income allocated to service the debt, and the safer the loan. MEASURES OF RETURN ON INVESTMENT Present Value: the adjusted or discounted value of an investment in "today's" dollars.
Net Present Value (NPV): the value of a future stream of revenues in "today's" dollars, adjusted by a Discount Rate.
Internal Rate of Return (IRR): the rate of return of an investment and a future stream of revenues in today's dollars. The IRR compares the rate at which the present value of the amounts invested to the present value of the amounts received in income.
Cash on Cash Return: another method of computing rates of return. The Cash on Cash Return is calculated by dividing the income available to investors after debt service by the equity of the investors. Low Income Housing Tax Credit: A tax credit an investor can use to off-set his income tax liability due to his/her investment in an approved low income housing project. Tax Credit Allocation Committee: An organization formed under the State Treasurer’s office to set up procedures, review projects, and authorize the award of both State and Federal Tax Credits to low income housing projects. REDEVELOPMENT AFFORDABLE HOUSING TERMINOLOGY Persons or Families of Low or Moderate Income: Persons or families whose income does not exceed 120% of area median income, adjusted for family size. These include: Extremely Low income households: Persons or families whose income does not exceed 30% of area median income, Very Low income households: Persons or families whose income does not exceed 50% of area median income, Lower Income households: Persons or families whose income does not exceed 80% of area median income, Persons and families of moderate income or middle-income families: Persons and families of low or moderate income whose income exceeds the income limit for lower income households. |
