Private Real Estate Investment: Data Analysis and Decision Making_5

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Private Real Estate Investment: Data Analysis and Decision Making_5 81 Fundamental Real Estate Analysis 1 2 3 4 5 6 7 8 BEGINNING OF YEAR ---> 0 1 2 3 4 5 6 7 END OF YEAR ---> VALUE 1250000 1287500 1326125 1365909 1406886 1449093 1492565 1537342 LOANS 875000 871061 866667 861764 856294 850191 843381 835784 EQUITY 375000 416439 459458 504145 550592 598902 649184 701559 ACCRUED DEPRECIATION 31818 63636 95455 127273 159091 190909 222727 SALE COST PERCENT: 7.50% 96562 99459 102443 105516 108682 111942 115301 B-TAX SALES PROCEEDS 319876 359999 401701 445076 490220 537242 586258 BASIS CALCULATION: GROSS SALE PRICE 1287500 1326125 1365909 1406886 1449093 1492565 1537342 ORIGINAL COST 1250000 1250000 1250000 1250000 1250000 1250000 1250000 −31818 −63636 −95455 −127273 −159091 −190909 −222727 LESS DEPRECIATION PLUS COST OF SALE 96562 99459 102443 105516 108682 111942 115301 OTHER BASIS ADJUST ACB AT SALE 1314744 1285823 1256989 1228244 1199591 1171033 1142573 −27244 CAPITAL GAIN 40302 108920 178642 249502 321532 394769 −59063 −23334 REAL GAIN 13466 51370 90411 130623 172042 TAX RATE 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% RECOVERY RATE 25.00% 25.00% 25.00% 25.00% 25.00% 25.00% 25.00% 25.00% −905 TAX 12409 25883 39524 53334 67321 81488 REVERSION CALCULATION: B-TAX SALES PROCEEDS 319876 359999 401701 445076 490220 537242 586258 −12409 −25883 −39524 −53334 −67321 −81488 TAX 905 AFTER TAX EQ REVERSION 320781 347590 375818 405552 436886 469921 504770 FIGURE 4-7 Sale computations for sample project. THE NET PRESENT VALUE In order to determine net present value, we need a function, Equation (4-1), that iterates each annual cash flow, cfn, takes the present value of each at the investor’s required rate of return, r, sums these present values adds the total to the present value of the after-tax equity reversion, ert, and subtracts the initial investment (dp). X t cfn ert npv ¼ À dp ð4-1Þ þ ð1 þ rÞn ð1 þ rÞt n¼1 Figure 4-8 displays the results of Equation (4-1) for the sample project. We certainly went to a lot of trouble only to learn that the property has a negative net present value. For our sample project this means its return does not support its cost of capital. Note that all ‘‘Yields’’ in Figure 4-8 are less than the investor’s required rate of return, r. Therefore, the potential buyer/ investor will reject the project. Simply stated, a negative net present value means this project is a bad deal from the buyer’s perspective. 82 Private Real Estate Investment 1 2 3 4 5 6 6 BEGINNING OF YEAR ---> YIELDS NPV END OF YEAR ---> 0 1 2 3 4 5 6 GPI EGI −1250000 117000 NOI 120510 124125 127849 131685 1516258 11.3087% −375000 17006 BTCF 20516 24131 27855 31691 572883 11.9799% −375000 20812 −47353 ATCF 22934 25106 27328 29599 501841 10.1146% FIGURE 4-8 Net present value and IRR computations for sample project. INSIGHT INTO THE ANALYSIS It is time to engage in some decomposition, looking behind the equations and the spreadsheet icons into the inner workings of the process. Previously, we referred to the variables as ‘‘deterministic’’ because we can determine the outcome—the net present value—by choosing values for particular variables.1 The outcome changes every time the values of the variables change. With any change in the nominal value of a variable, we explicitly cause a change in return, as measured by the net present value. But there is usually also a corresponding implicit change in the risk. Understanding the inner workings o ...