Real Estate Development: Principles and

Process, 5th Ed
Miles, M.E, et al
CHAPTER 11
REAL ESTATE FINANCE : THE BASIC TOOLS

KELOMPOK 2:

Achmad Saifuddin (9116202301)

Jeffry Dwi (9116202303)
Ade Rochmanu (9116202316)
Novrizal Putra (9116202318)

PROGRAM MAGISTER MANAJEMEN TEKNOLOGI

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PROGRAM PASCASARJANA
INSTITUT TEKNOLOGI SEPULUH NOPEMBER
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2017
 The feasibility of a real estate investment, investors and lenders use the same measurement
tools, but their objectives differ materially, an investors primary objectives is to maximize the value
of the investment, while a lenders primary objective is to avoid losing money by ensuring that the
underlying collateral value remains intact and property cash flow are sufficient to cover debt service
payment, for both, the estimation of value starts with an estimation of property cash flow. Property
cash flow come in two forms: the periodic payment of rents (net of operating expenses and other cash
outflow) and the eventual sale of the property.

Real estate asset is associated with a unique location, every building is unique. Furthermore,
information about real estate assets is more dispersed, and there is no entity like the securities and
excange commission the requires regular, stndardized financial reports.

Real estate usually has higher transaction costs than do stock and bond investments. Individual
common stocks, for example, can be sold almost instsntneously for a very small commission. In
contrast, a commercial property sale may take many months from the start of marketing to final close.

Lather chapter deal with the more nuanced aspects of getting the numbers to accurattely reflect
what is likely to happen. In this chapter, the basic tools for assembling that information are covered.
Specifically, this chapter discusesses three things:

1. Calculation of net operating income (NOI) and property cash flow.

2. Direct capitalization and discounted cash flow (DCF) valuation method and
3. Capital structure debt and equity financing and related tax considerations.

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THE COMPONENTS OF NET OPERATING INCOME
One of the most frequently used terms in real estate financial analysis is net operating income.
NOI measures a propertys productivity and is the source of the returns to lenders and equity investors.
NOI is the income from the operation of a property.

Potential Gross Income

In its simplest form, potential gross income is the rent a property could generate if it were fully
occupied, with no discounts. Many office, industrial, and retail leases require tenants to reimburse
landlords for certain property expenses or increases in property expenses. These reimbursements are
usually recorder as a part of the income to the property owner. Clearly such reimbursments can be
quite significant and therefore are negotiated strenously.

There are three general types of expense reimbursement clauses (note that each real estate market may
use slightly differnt names):

Gross-the landlord pays for property operating expenses and expense increases. Apartment
lease agreements are gross leases in terms of property taxes and maintenance, but the tenant
usually pay for utilities.
Modified gross or full service-the landlord pays all expenses up to a lease-defined expense
stop, and all expense over the expense stop are passed through to (or paid for by) tenants.
Net-a net lease is assentially a modified gross lease with an expense stop of zero. In a single
net lease, the tenant is responsible for property taxes, and the landlord or leassor is responsible
for building insurances and property maintenance. While the landlord is responsible for
property maintenance.

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Vacancy, Collection Loss, and rent Concessions
Similar to income statement for large corporations, income statement for real estate contain
negative income items, or items, or items the decrease the amount of incomed received.

Investors also consider collection loss, which is the loss of income from tenants that occupy
space but do not pay the contractually agreed-upon rent. Althought no tent or landlord expects this
situation when a lease is signed, a savvy investor includes a modest credit loss in certain projects.

Lanlords may give rent concessions to tenants in the form of free rent when the market for
tenant space is overbuilt; these concessions should be included in the pro forma. Even when the market
is not overbuilt, landlords, often offer new tenants free rent while the space is being fitted out with
tenant improvement.

Micellaneous Income
Micellaneous income, additional income obtained from real estate that is ancillary to contract
rents, can be a significant addition to gross potential income. Miscellaneous income can be verified
through parking receipts, rent payments, and contracts with vendors. During the due diligance process,
the purchaser of a real estate investment attempts to verify all property income streams.

Operating Expenses
To the determain NOI, operating expenses are subtracted from total revenue. Management fees
are often statedas a percentage of rvenue and are paid to the parties that manage the day to day needs
of buildings and tenants. Depending on the buildings and tenants. Depending on the building, they
ussualy run from 2 to 5 percent of revenue. A single-tenant warehouse buiding may have a
management fee lowerthan 2 percent, but a bussy shopping mall with high turnover, many inline
retailers, a constant flow of cutomers, and large common areas my require a management fee greater
than 5 percent.

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Calculating Net Operating Income
NOI is total revenue less operating expenses. NOI does not include mortgage debt service, capital
expenditures associated with significant building improvements and re-leasing of tenant space, or
property depreciation (a tax, not a cash flow expense). NOI measures the amount of regular income
expected to be available to debt and equity investors. How that income is devided between them
depends on financing decisions, which are typically viewed separately from decisions about the
propertys operations.

PROPERTY CASH FLOW

Although NOI is the industry standard for assessing property performance. It does not account
for all of the costs to operate the property. Subtracting financing costs (annual principal and interest
payments) from the cash flow from operations yields cash flow after financing:

NOI
Tenant improvement
Leasing commissions
Capital improvent
Cash flow from operation
Financing costs
Cash flow after financing

Because shortbread lofts is an apartment building, there are not outside leasing commissions or tenant
improvements as would be the case with an office building.

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Estimating value using cap rates

A. Direct Capitalization
A method used to convert an estimate of a single years income expectancy into an
indication of value in one direct step, either by dividing the income estimate by an
appropriate rate or by multiplying the income estimate by an appropriate factor. Cap rate is
the relationship between the NOI that an investor expects to receive and the price the
investor is willing to pay for the asset.

B. Discounted Cash Flow & Internal Rate of Return

Discounted Cash Flow (DFC) analysis is an alternative to the direct capitalization method
of valuation. It calculates the present value of expected future project cash flows to estimate
the current value of the project. In DFC analysis near term cash flows are valued more highly
than more distant cash flow.

This method not only values on going cash flow when the property is sold. To calculate the
termination value, investor uses direct capitalization method with the projected NOI from
the final year. After calculate annual cash flow, investor determines discount rate to use
calculate the present value of the cash flow. The project will either a positive or a negative
net present value. The internal rate of return (IRR) calculate the annual return that a stream
of cash flows generates over the life of a project. The savvy investor undertakes is sensitivity
analysis. Even if a project yields a positive NPV or a favorable IRR, the investor wants to
determine how sensitive these metrics are to changes in the underlying assumptions

Capital structure

The real estate project is typically financed by at least two capital sources: dept & equity. The first
major distinction is that dept financing is more contractual, while equity financing is more residual.
Prefered equity providers expect a higher return on investment than both senior and mezzanine debt
providers require.

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 Loan Underwriting Process
The loan underwriting process for a development proposal can be illustrated in six steps :
1. Market and submarket analysis
2. Location analysis of the subject site
3. Assestment of the appropriateness of the proposed improvements for the site
4. Determination of the creditworthiness of the borrower
5. Evaluation of the developers construction team and property management plan
6. Evaluation of the financial viability of the proposed improvements
Lenders calculation
1. DSCR (Debt Service Corporate Ratio)
The DSCR measures the propertys ability to cover debt service payment.
DSCR = NOI + Annual Debt Service
2. LTV (Loan to Value Ratio)
LTV ratio asesses the propertys collateral value.
LTV Rasio = Loan Amount + Property value
Benefits and Costs of Using Debt Financing
A basic benefit of debt is that it can be used to leverage up the equity return.
Adding Income Tax Consideration
Tax benefits to the investor in real estate paralled those to investors in corporate finance as
interest payments are tax deductible

INDUSTRY TOOLS FOR PROJECT UNDER WRITING

Developers use excel because it is straight forward to use for building out development bugdgets,
contruction time lines, and detailed line items

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