1. Apply What You've Learned - Real Estate and High-Risk Investments Scenario: You are considering investing in real estate-both for the short-term cash flows and the potential long-term capital gains-and are evaluating both a commercial lease property (such as a strp shopping center or an office building) and a residential rental property (such as several rental hours or a small apartment complex). It is likely that you will invest in only one of these properties at the time. The general data regarding these investments is as follows: Property type Strip shopping center Small apartment complex Price $900,000 $600,000 Mortgage 5504,000 $270,000 Expected Rental income Depreciation expense (per year) (per year) $95,872 58,654 $76,877 $7,636 Estimated resale value $972,000 5621,600 The first potential investment consists of a seven-store shopping center, which has a current market price of $900,000. of this amount, $225,000 represents the cost of the land, and the balance, 5675,000, is attributable to buildings on the property. The second possible investment, which costs $600,000, consists of a small four unit apartment complex. $180,000 of the investment's total price is reflects the cost of land, and the remaining $420,000 is associated with structures on the land. For both properties, you believe you can increase the rents 2% per year for each of the next four years, and expect to sell either property at the end that time. You desire a return of 7% on your investments, One of the more important considerations associated with your investment is a property's potential for generating a positive cash flow. One indicator of a property's likelihood of generating a positive cash flow is the property's rental yield. The best formula for computing a property's rental yield is: Check all that apply Rental yield (%) - (Annual ret/(Purchase price / 2)] 100 Rental yield (6) - [((Monthly rent12)/2) / Purchase price X 100 In the equations above, the reason that the values are divided by two is that it is assumed that spent on expenses other than debt repayment. half of the rental income is The rental yield expected on the commercial property is Based on their respective rental yields, the , while the expected yield on the residential property is is the better investment. is Another indicator of their relative attractiveness as an investment is each property's price-to-rent ratio. The shopping center has a price to rent ratio of while the corresponding ratio for the apartment complex is Based on this data, the the better investment. From an investor's perspective, a negative condusion associated with an overty tarpe ratie is that it suppests that property prices are very Similarly, a discouraging explanation for an overly ratio is that rents and market prices are so close in value that a financially astute investor would rather a given property The loan-to-value (LTV) for the shopping center in .but is for the apartment complex Assume that your expected annual operating costs-exduding your annual depreciation expense--for the commercial property will be 35% of your annual rental income. For the residential property, the annual operating costs (excluding depreciation expense) will be 20% of your annual rental income. The interest rates of the mortgages for the commercial and residential lease properties are expected to be and respectively Given your other assumptions, complete the following two tables and then use your computations to answer several Questions, Round all amounts to the nearest whole dollar. (Hint: Don't round intermediate calculations. Also, don't forget that capital gains are taxed at 15% properties are sold for more than their original purchase price Year 1 Year 2 Year 3 Year 4 Strip shopping center Annual rental income Estimated resale value 0 0 Given your other assumptions, complete the following two tables and then use your computations to answer several questions. Round all amounts to the nearest whole dollar. (Hint: Dont round intermediate calculations. Also, dont forget that capital gains are taxed at 15% if properties are sold for more than their original purchase price.) Year 1 Year 2 Year 3 Year 4 $ 0 0 0 30,240 28,728 27,216 25,704 Strip shopping center Annual rental income Estimated resale value Less: Annual operating expenses Less: Annual depreciation expense Less: Annual interest payments (6%) Lesst Taxes (28%) Less: Capital gains tax (15%) Net profit Interest factor (7%) PV of Cash flow Total PV of Cash flows 0 0 0 $ s 5 0.9346 0.8734 0.8163 0.7629 S 5 5 5 S The net discounted return expected from an investment in the shopping center-after deducting the cost of the investment is Now perform a comparable analysis for the residential foase property Year 2 Year 4 Year 1 $76,877 Year 3 379,983 Small apartment complex Annual rental income Estimated resale value $78,415 581,582 621,600 0 15.683 15,997 16,316 Year 2 $70,415 0 Now perform a comparable analysis for the residential forse property: Small apartment complex Year 1 Annual rental income $76,877 Estimated resale value 0 Less: Annual operating expenses 15,375 Less: Annual depreciation expense 7,636 Less: Annual interest payments (4%) 10,800 Less: Taxes (28%) 12,058 Less: Capital gains tax (15%) 0 Net profit Interest factor (7%) 0.9346 PV of Cash flow S Total PV of Cash flows S 15,683 7,636 10,260 12,554 Year 3 $79,983 0 15,997 7,636 9,720 13,056 Year 4 $81,582 621,600 16,316 7,636 9,180 13,566 0 0 0.8734 0.8163 0.7629 The net discounted return expected from an investment in the apartment complex-after deducting the cost of the investment-s Based on the results of your analysis, which of the following statements best reflects your decision regarding the commercial or residential lease opportunities? As the shopping center has a NPV that is greater than that expected from the apartment complex, it is more financially sound to invest in the commercial lease property. Because the apartment complex is expected to generate a negative NPV, you should not consider making this investment Based on the numbers alone, you should prefer an investment in the shopping center since it has a net present value that is greater than that expected from the residential lease property (apartment complex). As the apartment complex has a NPV that is greater than that expected from the shopping center, it is more financially found to inst The net discounted return expected from an investment in the apartment complex after deducting the cost of the investment is Based on the results of your analysis, which of the following statements best reflects your decision regarding the commercial or residential lease opportunities? As the shopping center has a NPV that is greater than that expected from the apartment complex, it is more financially sound to invest in the commercial lose property, Because the apartment complex is expected to generate a negative NPV, you should not consider making this investment. cared on the numbers alone, you should prefer an investment in the shopping center wince it has a net prenent value that is greater than that expected from the residential Inase property (apartment complex) As the apartment complex has a NPV that is greater than that expected from the shopping center, it is more financially sound to invest in the residential lease property. Because the shopping center is expected to generate a negative Nur, you should not consider making this investment Given that the apartment complex has a NPV that is greater than that expected to be generated by the shopping center, you should prefer to invest in the residential lease property Which of the following is not a tax deductible expense for investment property Maintenance and repairs Interest on a mortgage loan Lost rent resulting from vacancies the return on your investment. Tax deductible expenses an investment's taxable income, and 1. Apply What You've Learned - Real Estate and High-Risk Investments Scenario: You are considering investing in real estate-both for the short-term cash flows and the potential long-term capital gains-and are evaluating both a commercial lease property (such as a strp shopping center or an office building) and a residential rental property (such as several rental hours or a small apartment complex). It is likely that you will invest in only one of these properties at the time. The general data regarding these investments is as follows: Property type Strip shopping center Small apartment complex Price $900,000 $600,000 Mortgage 5504,000 $270,000 Expected Rental income Depreciation expense (per year) (per year) $95,872 58,654 $76,877 $7,636 Estimated resale value $972,000 5621,600 The first potential investment consists of a seven-store shopping center, which has a current market price of $900,000. of this amount, $225,000 represents the cost of the land, and the balance, 5675,000, is attributable to buildings on the property. The second possible investment, which costs $600,000, consists of a small four unit apartment complex. $180,000 of the investment's total price is reflects the cost of land, and the remaining $420,000 is associated with structures on the land. For both properties, you believe you can increase the rents 2% per year for each of the next four years, and expect to sell either property at the end that time. You desire a return of 7% on your investments, One of the more important considerations associated with your investment is a property's potential for generating a positive cash flow. One indicator of a property's likelihood of generating a positive cash flow is the property's rental yield. The best formula for computing a property's rental yield is: Check all that apply Rental yield (%) - (Annual ret/(Purchase price / 2)] 100 Rental yield (6) - [((Monthly rent12)/2) / Purchase price X 100 In the equations above, the reason that the values are divided by two is that it is assumed that spent on expenses other than debt repayment. half of the rental income is The rental yield expected on the commercial property is Based on their respective rental yields, the , while the expected yield on the residential property is is the better investment. is Another indicator of their relative attractiveness as an investment is each property's price-to-rent ratio. The shopping center has a price to rent ratio of while the corresponding ratio for the apartment complex is Based on this data, the the better investment. From an investor's perspective, a negative condusion associated with an overty tarpe ratie is that it suppests that property prices are very Similarly, a discouraging explanation for an overly ratio is that rents and market prices are so close in value that a financially astute investor would rather a given property The loan-to-value (LTV) for the shopping center in .but is for the apartment complex Assume that your expected annual operating costs-exduding your annual depreciation expense--for the commercial property will be 35% of your annual rental income. For the residential property, the annual operating costs (excluding depreciation expense) will be 20% of your annual rental income. The interest rates of the mortgages for the commercial and residential lease properties are expected to be and respectively Given your other assumptions, complete the following two tables and then use your computations to answer several Questions, Round all amounts to the nearest whole dollar. (Hint: Don't round intermediate calculations. Also, don't forget that capital gains are taxed at 15% properties are sold for more than their original purchase price Year 1 Year 2 Year 3 Year 4 Strip shopping center Annual rental income Estimated resale value 0 0 Given your other assumptions, complete the following two tables and then use your computations to answer several questions. Round all amounts to the nearest whole dollar. (Hint: Dont round intermediate calculations. Also, dont forget that capital gains are taxed at 15% if properties are sold for more than their original purchase price.) Year 1 Year 2 Year 3 Year 4 $ 0 0 0 30,240 28,728 27,216 25,704 Strip shopping center Annual rental income Estimated resale value Less: Annual operating expenses Less: Annual depreciation expense Less: Annual interest payments (6%) Lesst Taxes (28%) Less: Capital gains tax (15%) Net profit Interest factor (7%) PV of Cash flow Total PV of Cash flows 0 0 0 $ s 5 0.9346 0.8734 0.8163 0.7629 S 5 5 5 S The net discounted return expected from an investment in the shopping center-after deducting the cost of the investment is Now perform a comparable analysis for the residential foase property Year 2 Year 4 Year 1 $76,877 Year 3 379,983 Small apartment complex Annual rental income Estimated resale value $78,415 581,582 621,600 0 15.683 15,997 16,316 Year 2 $70,415 0 Now perform a comparable analysis for the residential forse property: Small apartment complex Year 1 Annual rental income $76,877 Estimated resale value 0 Less: Annual operating expenses 15,375 Less: Annual depreciation expense 7,636 Less: Annual interest payments (4%) 10,800 Less: Taxes (28%) 12,058 Less: Capital gains tax (15%) 0 Net profit Interest factor (7%) 0.9346 PV of Cash flow S Total PV of Cash flows S 15,683 7,636 10,260 12,554 Year 3 $79,983 0 15,997 7,636 9,720 13,056 Year 4 $81,582 621,600 16,316 7,636 9,180 13,566 0 0 0.8734 0.8163 0.7629 The net discounted return expected from an investment in the apartment complex-after deducting the cost of the investment-s Based on the results of your analysis, which of the following statements best reflects your decision regarding the commercial or residential lease opportunities? As the shopping center has a NPV that is greater than that expected from the apartment complex, it is more financially sound to invest in the commercial lease property. Because the apartment complex is expected to generate a negative NPV, you should not consider making this investment Based on the numbers alone, you should prefer an investment in the shopping center since it has a net present value that is greater than that expected from the residential lease property (apartment complex). As the apartment complex has a NPV that is greater than that expected from the shopping center, it is more financially found to inst The net discounted return expected from an investment in the apartment complex after deducting the cost of the investment is Based on the results of your analysis, which of the following statements best reflects your decision regarding the commercial or residential lease opportunities? As the shopping center has a NPV that is greater than that expected from the apartment complex, it is more financially sound to invest in the commercial lose property, Because the apartment complex is expected to generate a negative NPV, you should not consider making this investment. cared on the numbers alone, you should prefer an investment in the shopping center wince it has a net prenent value that is greater than that expected from the residential Inase property (apartment complex) As the apartment complex has a NPV that is greater than that expected from the shopping center, it is more financially sound to invest in the residential lease property. Because the shopping center is expected to generate a negative Nur, you should not consider making this investment Given that the apartment complex has a NPV that is greater than that expected to be generated by the shopping center, you should prefer to invest in the residential lease property Which of the following is not a tax deductible expense for investment property Maintenance and repairs Interest on a mortgage loan Lost rent resulting from vacancies the return on your investment. Tax deductible expenses an investment's taxable income, and