Property Investment Analysis Lecture Notes PDF

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Lecture 1What are Investments? Commitment of capital to an item/endeavour in expectation of obtaining an additional income or profit. o Eg. Business, property, shares, fixed depositsWhy Invest? 2 Main Objectives: o Growth: Long Term Horizon o Income: Perpetual Cash Flow  We look at perpetual cash...

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Property Investment Analysis Lecture Notes Lecture 1 What are Investments? 

Commitment of capital to an item/endeavour in expectation of obtaining an additional income or profit. o Eg. Business, property, shares, fixed deposits

Why Invest? 

2 Main Objectives: o Growth: Long Term Horizon o Income: Perpetual Cash Flow  We look at perpetual cash flow because there is a high chance the real estate outlives you

Fundamentals of Investment Process 1. 2. 3. 4.

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Define your basic investment objectives Choose suitable investments Implement and monitor Possibly: disposal of investment &/or repeat step 1.  Before you make an investment, thing about every single possible outcome based on how the market is going go  Example: buying a 400k investment property o What is your plan?  Do you want to hold it and keep it for your kids?  Hold it got 5 years, 10 years etc 2 Major Key Issues o Risk  How much is risk is associated with your objective  You want a good cash flow  What is the risk to get that god cash flow though? o Objectives

Fundamentals of Risk  

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Risk is deceptive in real life. o It should “look this way” but in reality, its no where close Risk is directly related to potential return o Higher the level of risk an investor is prepared to assume the higher the potential reward offered & vice versa. Risk is an indicator of the potential gain/loss associated with investing over time. All investments carry with them varying degrees of risk: o Shares = Volatile = High return = High Risk o Fixed Deposit = Stable = Low Return = Low Risk  This does not always hold true for shares and fixed deposits

Risk Return Trade Of  

This states that the more risk you have the larger the return With changing markets this can be wrong

Property Investment Analysis Lecture Notes

Risk of Income Producing Properties   

Market risks - oversupply, declining demand for the space or the investments Financial risks - the volatility and threats created by borrowing Property risks - those specific to individual properties – arising from their location, buildings or tenants o Because the market is so depressed tenants force the landlord to decrease rental prices o Sensitivity (“what-if”) analysis indicates the severity of these risks

Fundamentals – Objectives 

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The 2 main objectives are: o Financial o Non-Financial Investment decisions are made based on tolerance of 5 things (they are very important): o Liquidity  Do you have the cash and wealth to purchase when the market has started to prosper?  If your liquidity is not ready you have wasted your time o Time  If you are coming to a down turning market (such as in the east) why would you not sell your property and incur losses o Income  What is your income, is it dual income?  How about when you have a kid, it becomes one income o Risk  What risk are you looking at such as; your health, family etc.  Do you need to sell the house so you can fund something else in your time o Growth  What type of the growth are you expecting?  Where should you be investing? o In regards to the investors preference, strategies and plans  Don’t forget, it has to fall align with your life  If you are doing it for a client, make sure it aligns with their life

Financial Objectives  

Inflation hedging/protection of purchasing power Security of regular cash flow return

Property Investment Analysis Lecture Notes            

Capital gain or appreciation potential Portfolio building/estate planning Financial leverage Rapid recovery of equity Liquidity Low risk of return loss Retirement income Required return Risk tolerance Capital Constraints Tax shelter Etc.

Non – financial factors            

Desirability of the property in terms of marketing Familiarity with property type/specific market Green/environmentally friendly Property and building size Pride of ownership Public acceptance Personal attitudes/beliefs Quality of location Structurally sound building Favourable lease provisions Acceptable management burden Aesthetically pleasing design

Lecture 2: Time Value of Money (TVM)

Property Investment Analysis Lecture Notes Investment Value 

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Definition: the perception of a specific investor (or group of investors) as to the capital sum that they would be prepared to pay (or accept) for the stream of benefits expected to flow from an investment into the future. Investment Value ≠ Market Value We are here to Analyse Investment Values in Income Producing Properties.

How much would you pay today to get your profit tomorrow?

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When you buy property at first it is negative from the initial down payment and then your cash flows start increasing and then disposition

Compounding & Discounting (TVM) PV, FV, PVA & FVA 

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Time Value of Money o Is the difference of value in money over time. o It is the compensation of forgoing $ now, that you could have used to invest or save. o What is $1 worth in 12 months time? Interest – Many different types of Interest o The cost of borrowing o The price of lending o The cost of holding money o The required rate of return & etc…

Compounding & Discounting (TVM)     

How much will $1000 be worth at the end of 5years with 5% compound interest? Will now be known to you as: How much will $1000(PV) be worth at the end of (FV?) 5years (N) with 5%p.a. (i) compound interest (M) ? Formula for FV Lump Sum = PV(1+i)n = 1000(1+0.05)5 =$1276.28156

Compounding & Discounting (TVM)      

TVM Table PV = -1000 N = (M x N) = 5 i=5 FV = ??? = $1276.28 Excel entries is

Property Investment Analysis Lecture Notes “=FV(5%,5,,-1000,)” “=FV(Rate,Nper,PMT,[PV],[Type])” Note that this is 5%!  5% = 0.05 and 100% = 1.0 Your answer should read: $1000 at the end of 5 years at 5% compound interest would be worth $1276.28 o o o

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How do we apply what we have learnt? o By using TVM functions (PV, FV & etc…)! You are considering purchasing a block of land for $50,000(PV). You expect land values to  at a rate of 10% p.a. (i & m) How much will the land be worth at the end of 3 years (n & FV?)? o Break it down to sections to understand the Question! o FV = 50,000(1+0.10)3 = $66,550 Your answer should read: The $50,000 block of land would be worth $66,550 at the end of 3 years if land values increase at 10%p.a. TVM Table: PV = -$50,000 *i = 10 n = 3 years FV = ??? = $66,550 Excel entries is “=FV(10%,3,,-50000,)” o “=FV(Rate,Nper,PMT,[PV],[Type])” So how much was a property worth 3 years ago with an increase of 10%p.a. if it is now worth $66,550? o Yes, quite simple = $50,000. o It is just the reverse.

Formula for PV Lump Sum PV = FV / (1+i)n You want to buy land & expect to sell it for $66,550 at the end of 3 years. Your required rate of return is 10% p.a. How much would you be willing to pay for the land today?

Property Investment Analysis Lecture Notes   

What do we know? What don't we know? PV = 66550 / (1+.10)3 = $50,000 Calc entries FV = 66550, i = 10, N = 3 & PV =???

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Excel entries “=PV(10%,3,,66550,)” o “=PV(Rate,Nper,PMT,[FV],[Type]) Your answer should read: The land would be worth $50,000 today if I expect to sell it for $66,550 at the end of 3 years with a return of 10%p.a. Tip: When answering a question, find out what is given and what is being asked of you. List it down clearly and create a time line and see what is being asked of you. Try it to see if it makes sense. Then double check if you made a mistake.

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PV Lump Sum with a “Twist” o You’re selling your home & a buyer offers you $35,000 today plus $35,000 in 2 years time. What is the PV of this offer, given that you require a return of 12%? o We know that $35,000 will be received immediately, so it’s already a PV. However, an additional $35,000 will be received in 2 years. This second $35,000 is a FV. o If we discount the FV back to the present, we can add the two PVs to get the total PV of the offer.

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PV = 35,000/(1.12)2 = -$27,902 TVM Table: FV = 35,000, i = 12, N = 2 & PV = ??? -$27,902 PV of total offer = 35,000 + 27,902 = $62,902 Excel entry “=PV(12%,2,,35000,)” o “=PV(Rate,Nper,PMT,[FV],[Type])”

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PV Lump Sum with a “Twist 2” PV = FV/(1+i/m)^mn How much is the PV(?) of a 5year (N) future investment that is worth $1645.31(FV) that was compounded monthly (M) at 10%p.a. (i)? = 1645.31 / (1+0.1/12)12*5 = $1000.00065 TVM Table: FV=1645.31, M=12P/Yr, N=5, i=10 & PV=???= -1000.0006474 Excel entries: “=PV(10%/12,5*12,,1645.31,)” “=PV(Rate/M,Nper*M,PMT,[FV],[Type])”

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FV Lump Sum with a “Twist” How much is $1000 (PV) worth at the end (FV?) of 5years (N) with monthly compounding (M) at 10%pa (i)? FV = PV(1 + i/m)mn = $1,000(1 + 0.10/12)(12 x 5) = $1,000(1.00833…)60 = $1,645.31 TVM Table: M=12P/YR, PV=-1000, N=5, i= 10 & FV=??? = $1,645.3089 Excel entries: “=FV(10%/12,5*12,,-1000,)” PS: You will require a lot of practice to do well!

Present Value of an Annuity (PVA)  

Annuity = a series of equal amounts received each period for a specified number of periods. Timeline shows an example of a 3 year, $100 annuity.

Property Investment Analysis Lecture Notes      

Time

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2 3  Cash Flows $100 $100 $100 If paid at the end of each period = Ordinary (or deferred) annuity. If paid at the beginning / start of each period = Annuity Due. PVA = the single (lump sum) payment today that would be equivalent to the annuity payments spread over the annuity period. PVs are additive i.e. PV of a stream of CFs = sum of the PVs of each individual CF. Because CFs are all equal amounts, we can use a shortcut equation.

PVA 

You are a mortgage lender. A borrower promises to pay you $11,746 p.a. for the next 20 years. You want to earn a return of 10% p.a. How much would you be willing to give up now in exchange for an annuity of $11,746 p.a. for 20 years?

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We could discount each payment using the PV of a lump sum formula, then sum the PVs to determine PVA.

To solve PVA  

The Formula. Don’t try it. Ann can also be regarded as Pmt

Property Investment Analysis Lecture Notes     

TVM Table: Pmt=11746, N=20, i=10% & PV=?= -100,000.32 Excel entries: “=PV(10%,20,11746,,)” o “=PV(Rate,Nper,PMT,[FV],[Type])” Your answer should read: I would be willing to lend $100,000 if someone is willing to pay me $11,746p.a. for 20years if my expected return is 10%p.a.

Future Value of an Annuity (FVA)  

FVA = total amount you’d have at the end of ‘n’ periods if each pmt were invested at ‘i’ & held to the end of ‘n’ periods. Accumulated Value of a Series of Deposits (monthly savings)

FVA Example 

You will receive $1,000 p.a. for 3 yrs. If you deposit each pmt in an account paying 10% p.a., how much will you have at the end of 3 yrs?

To solve FVA     

The Formula. Don’t try it. Ann can also be regarded as Pmt TVM Table: Pmt=-1000, N=3, i=10% & FV=?= 3310 Excel entries: “=FV(10%,3,-1000,,)”  “=FV(Rate,Nper,PMT,[PV],[Type])”

Property Investment Analysis Lecture Notes  

Your answer should read: I will have $3310 at the end of 3 years if I deposit $1000 at every end of the year and receive an interest of 10%p.a.

Lecture 3 - TVM’s, FVAD, PVAD, Perpetuities, PMT, NPER & RATE. The Difference?!?! 

What is the difference between an ordinary annuity and an annuity due?

Property Investment Analysis Lecture Notes

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Annuity Due = Amounts that are received at the “BEGINNING”, “START” or “IN ADVANCE” of each period  each payment is compounded for 1 additional period  FVAD = FVA compounded for 1 additional period.

One more time! 

Payments made at the “Start”, “Beginning” or “In Advance”, have one additional compounding.

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Excel Function “Type = 1” Type “BEG/END”

Compare the Pair 

Accumulated Value of an Ordinary Annuity

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Accumulated Value of an Annuity Due

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Property Investment Analysis Lecture Notes FVAD Example  

You make deposits of $1,000 p.a. at the beginning of each year for a 3 year period into an account paying 10% p.a. Solution: The Formula. Don’t try it! o Ann can also be regarded as Pmt

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We simply multiply the FVA formula by (1+i) to represent the additional compounding over 1 more period.

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In the example, you will receive $1,000 p.a. for 3 yrs at the beginning of the year, so the FVAD is calculated as:

FVAD Example 

TVM Table: o Type = 1 (0 is End and 1 is Beg) o PV = N/A o PMT = 1000 o N=3 o i = 10 o M = N/A (1 PYR)

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FV = ??? = -$3641 Excel entry “=FV(10%,3,1000,,1)” “=FV(Rate,Nper,PMT,[PV],[Type])”

FVAD Sample Problem 

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You would like to purchase a $500,000 home at the end of 3 years. You can afford to save $2000 at the start of every month into an account paying 10%pa. Approximately what will be the loan amount required to purchase your home in 3 years? TVM Table:

Property Investment Analysis Lecture Notes

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PV = N/A, FV = ???,

o i = 10, o PMT = -2000, o N = 3, o M = 12 (12 P/YR) & Type = 1 (Begin) Excel entries: “=FV(10%/12,3*12,-2000,,1)” I would have saved $84,260.01 based on the given scenario. Therefore, I would need to loan approximately $500,000 - $84,260 = $415,740

PVAD  

PVAD = single pmt/receipt today that would be equivalent to the annuity pmts spread over time ‘n’, given beginning of period pmts/receipts. i.e. PV of a 3-year, 5% annuity due payment of $100 is:

PVAD

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The Formula. Don’t try it o Ann can also be regarded as Pmt o

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So looking at the original PVA formula you can see we simply subtract 1 from ‘n’ & add the amount of the annuity

Property Investment Analysis Lecture Notes 

Try this: You are selling your home & the buyer will pay $35,000 now, plus $7,000 at the beginning of each year for the next 5 yrs. Your required rate of return is 12% p.a. What is the PV of this offer?

PVAD: Answer     

TVM Table: PV = ???, FV = N/A , i = 12, PMT = 7000, N = 5, M = N/A & Type = 1 (Begin) Excel entries: “=PV(12%,5,7000,,1)” = -$28,261.45 Therefore, the cash flow of $7000p.a. in advance over 5 years at 12% discount rate is worth $28,261.45 today. We also have $35,000 the buyer is paying today. So we have $35,000 +$28,261.45= $63,261.45

Perpetuity (Infinite Pmt)   

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An annuity (pmt) that goes on indefinitely is called a perpetuity. I.e. preferred stock & perpetual leases. The PV of a perpetuity is calculated as: o PVp = Payment/Interest rate = PMT/i I.e. if the interest (or discount) rate were 12% p.a., a perpetuity of $1,000 a year would have a PV of: o PVp = PMT/i = $1,000/0.12 = $8,333 Use Formula! Simple maths. You can try using your PV Formula. Use Infinity as N.

Perpetuities: 2 Types 

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Type 1: No Growth o You want to purchase a preferred stock that will pay $10,000 p.a. forever. If your opportunity rate is 8%, what is the most you would pay for the stock today?  PVp = PMT/i = 10,000/0.08 = $125,000 Type 2: Growing o What if the company whose preferred stock you are looking to buy promised that the yearly payments would grow by 3% p.a.?  PVpg = PMT/(i-g) = 10,000/(0.08-0.03) = $200,000

PMT – Many uses     

Don’t try the Formula! Example Sinking Fund = an annuity (or pmt) where a specified FV is needed; accumulated through a series of regular pmts. The sinking fund payment is the amount that must be put aside each period to have a specified FV available at the end of a given time period. To better understand Sinking Funds: You want the Audi R8 which cost $258,000. You know you cant afford one now, but you want to be able to have it in 3 years. How much do you have to save every month to be able to pay for it in cash at 4.5% interest rate?

Property Investment Analysis Lecture Notes Sinking Funds Example 

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For my Audi R8, I would need to save ______ monthly for 3 years at today’s interest rate o TVM Table:  PV = N/A  PMT = ??? = -$6,707.21  N=3  i = 4.50%  M = 12 (12 PYR)  FV = $258,000  Type = N/A ( Excel Entry: “=PMT(4.5%/12,3*12,,258000,)” “=PMT(Rate,Nper,[PV],[FV],[Type])”

Sinking Funds (Retirement)  

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You want to retire with $3 Million cash to spend. How much do you have to save monthly at today’s interest rates over your residual working life to obtain that retirement fund? TVM Table: o PV = N/A o PMT = ??? = -$2,947.70 o N = 35 o i = 4.50% o M = 12 (12 PYR) o FV = $3,000,000 o Type = N/A o Excel Entry: “=PMT(4.5%/12,35*12,,3000000,)” o “=PMT(Rate,Nper,[PV],[FV],[Type])” Do an FV Check! What happens if the Interest% was 8%? Or much lower?

NPER (Time Needed) 

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You want $250,000 to buy your car in the future. You can only afford to save $2000 at the end of each month with an interest rate of 8% compounded monthly. How many months will it take for you to save the $? TVM Table: o PV = N/A o PMT = -2000 o N = ??? = 91.223 months o i = 8.0% o M = 12 (12 PYR) o FV = 250000 o Type = N/A Excel entry “=NPER(8%/1,-2000,,250000,)” “=NPER(Rate/M,PMT,PV,FV,Type)”

RATE (Yield, Rate of return, etc…)

Property Investment Analysis Lecture Notes  

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What is the nominal yield (interest rate) per annum for my investment if I were to pay $100,000 today and receive $500,000 at the end of 20 years at monthly compounding? TVM Table: o PV = -100000 o PMT = N/A o N = 20 o i = ??? = 0.67285% per period (Final Answer 8.07%pa) o M = 12 (12 PYR) o FV = 500000 o Type = N/A Excel entry “=RATE(20*12,,-100000,500000,)” “=RATE(Nper*M,PMT,PV,FV,Type)” then *12

Lecture 4- Introductory Cash Flow Analysis Investment Decisions 

All property investment decisions depend on some assessment of value. o In any investment you need to understand value by itself

Property Investment Analysis Lecture Notes 

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Investment value = the perception of a specific investor (or group of investors) as to the capital sum that they would be prepared to pay (or accept) for the stream of benefits expected to flow from an investment into the future.  central focus lies in assessing this stream of benefits (the cash flows) associated with investment property.

Investment Analysis  

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Value of investment property stems from the stream of future benefits produced  analysis entails forecasting the stream of benefits expected. Develop the property’s operating statement because we know that, “The desirability of a RE investment is strictly a function of 3 factors - the AMOUNT, TIMING and CERTAINTY of aftertax cash flows.” Analysis uses accounting framework - focuses on source & timing of cash flows (CFs). CFs generated by RE comes in 2 parts: o Operating CFs; &  Typically rent o Capital appreciation.  When you sell it, equity Some investors find Cash Flow more important and some Capital Appreciation. o Dep...