investment & financial analysis for international real estate

Investment & Financial Analysis for International Real Estate

Instructor Manual

Certified International Property Specialist Network

National Association of REALTORS® 1.800.874.6500 x8412 US/Canada International Operations Division +1.312.329.8412 Internationally430 North Michigan Avenue Fax: 1.312.329.8358Chicago, IL 60611-8047 USA [email protected] www.realtor.org/international

CIPS Investment & Financial Analysis

Copyright 2008 National Association of REALTORS®

Table of Contents

Introduction ............................................................................ 1

Chapter 1: Preparing for an International Transaction .......... 1-1

Chapter 2: Legal Issues .......................................................... 2-1

Chapter 3: HP-10BII Functions ............................................. 3-1

Chapter 4: Case Study: Mr. Chen - Inbound Residential Transaction .............................................................................. 4-1

Chapter 5: Finance and Capital Markets ................................ 5-1

Chapter 6: Case Study: Dr. Garcia - Inbound Commercial Transaction .............................................................................. 6-1

Chapter 7: The Impact of Taxes on Investments ................... 7-1

Chapter 8: Case Study: Eurovest - An Outbound Commercial Transaction .............................................................................. 8-1

Appendix ................................................................................. 8-21

Glossary .................................................................................. 8-23


Copyright 2008 National Association of REALTORS® Introduction 1

Introduction International Real Estate Investment Any international real estate transaction, whether it involves the purchase of a home, a user-occupied business facility or an income-producing property is considered an investment. The purchaser or lessee typically commits a substantial amount of cash in their own currency to carry out a transaction in a foreign currency.

If the international investor has money on deposit in the currency of the country where the investment is being made, there will eventually be some kind of exchange transaction. There is always the possibility that money will be made or lost based on the currency exchange dynamics alone. For that reason, it is important to be familiar with the mathematical and financial skills presented in this course.

Domestic residential brokers and salespeople are accustomed to presenting homes as investments in terms of appreciation and tax sheltering. Many real estate professionals are not familiar with how to determine, discuss and present an investment analysis of a property. This course examines how customary real estate practices need to be modified when working with international clients or properties.

In some ways, a real estate transaction involving international clients or properties is similar to a domestic transaction.

Similarities The buyer, the seller and the real estate professional are usually concerned about:

prices

costs

returns, income and cash flows

tax liabilities

suitability of property

market

procedures

government regulations concerning ownership, environment, etc.

Time: 30 minutes Welcome students to the course and the NAR International Section. Your welcome sets the tone for the class. The objective is to set a friendly and relaxed environment where learning can take place. Introduce yourself and give a brief summary of your experience. Outline the schedule for the day including lunch and break times. Indicate the location of the bathrooms and telephones. Conduct the opening exercise. Introductions and Expectations: Ask students to introduce themselves, state what motivated them to take this course and what they expect to learn. Capture expectations on a flip chart. You will refer to this list when concluding the class. At that time, be prepared to offer suggestions (or solicit suggestions from the class) if certain expectations are not met by the course. Present Introduction Section.


Introduction 2 Copyright 2008, National Association of REALTORS®

Differences An international transaction is also different from a domestic one because:

The principals may be subject to the tax laws of more than one nation.

Prices, costs, returns, income and cash flows are all affected by foreign exchange transactions and by currency fluctuations.

Different countries use different time increments and/or standards of property measurement.

Real estate laws and procedures vary from country to country.

Cultural differences may influence the transaction.



Course Overview The International Real Estate for Local Markets course introduced the international real estate market, including conditions and practices around the world. This course builds upon that knowledge by providing:

• basic preparation requirements for the international client.

• financial concepts such as capitalization rate and cash-on-cash return.

• legal and tax issues.

• the importance of incorporating a team of professionals .

Case studies are used to present the course material. There are three cases which follow a progression of increasing complexity. They are:

Case 1: Mr. Chen A foreign national is coming to work in the USA and would like to purchase a personal residence. To complete this transaction, the real estate professional must:

organize client profile data.

complete area conversions to determine size requirements.

complete currency conversions to determine price requirements.

examine the types of ownership entity which could apply.

calculate the net proceeds from the sale.

examine the effects of a change in the currency exchange rate.

Case 2: Dr. Garcia A foreign national decides to make a commercial property investment in the USA. In addition to addressing the same concerns as in the preceding case, the real estate professional must now:

provide a higher level of investment analysis, taking into account income, expenses, net income, property value, and yield.

consider the basics of commercial financing.

assess the impact of currency conversions.

utilize demographic data and complete a market analysis to evaluate the prospective investment.



Case 3: EuroVest A Brazilian pension fund, EuroVest, is looking for an international real estate investment. This case study involves a warehouse-distribution facility in Europe that will be leased to a USA firm. To successfully complete this transaction, a real estate professional must:

calculate foreign currency units and units of measure.

project gross and net income.

analyze pro forma cash flows.

evaluate the effect of taxes on investment return.

advise on the effects of appreciation, rent escalation and currency fluctuation on the return and timing of the transaction.

Together, the cases provide participants with a working knowledge of the financial and investment analysis techniques needed for successful practice in international real estate.

Calculator: HP-10BII • A portion of the class is devoted to applying financial concepts to the

case studies using a Hewlett Packard HP-10BII financial calculator.

• Participants will review currency, area and time conversions.

• The course features step-by-step systems to calculate mortgage payments, cash flows, and returns on investments.

• Chapter 3 covers the key strokes used in this course.

• This is not a calculator course but it is important for the rising professional to be well-versed in the use of a financial calculator.

• Your job will be easier and your level of professionalism will increase as you grow in your proficient use of the HP-10BII.

Exam • At the end of Day 2, participants will be given a multiple-choice, open-

book exam to test and reinforce achievement of the course's learning objectives.

• Following successful completion of the course, each student will receive a CIPS course certificate.

Resources The appendix of this manual contains many resources for expanding on the material presented in this course. These resources are as up-to-date as possible. It is the real estate professional’s responsibility to remain current

Explain that the course uses the HP-10BII calculator. Students are encouraged to find and use other resources for financial calculations. Point out that software programs and sites on the Internet may be used. Explain exam structure: open book and multiple choice questions.



on trends and issues in the ever-changing real estate market. The following websites are extremely useful resources for the CIPS courses.

• CIPS Network: www.realtor.org/international

• National Association of REALTORS®: www.realtor.org

• WorldProperties.com: www.WorldProperties.com

• CIA World Factbook: www.CIAworldfactbook.com

• Denver University Global Real Estate Project: burns.dcb.du.edu


Copyright 2008 National Association of REALTORS® Chapter 1-1

1. Module heading– denotes section page as 1.1, 1.2, etc.

Chapter 1:

Preparing for an International Transaction

Overview • A review of fundamental terminology and concepts.

Objectives • Recall fundamental terminology

• Discuss strengthening and weakening currencies

• Review globalization, capital flow and currency conversions

• Identify six steps in preparing for an international transaction

Application • To analyze the potential of an international real estate investment, a

real estate professional must have a solid understanding of the terminology, concepts and strategies used when conducting business in world real estate markets.

Time: 30 minutes Read through overview, objectives and application with students. Ask for questions.


Chapter 1-2 Copyright 2008, National Association of REALTORS®

Terminology Review

1. The movement by countries, companies, organizations and people toward a single market environment is called ____________________.

2. Supply, demand and investment return are underlying forces of _________________________________.

3. When one currency strengthens against another, its exchange rate ______________.

4. A stronger currency is worth _________________.

5. If a currency unit ___________________, its exchange rate increases.

6. The most important component of a successful international business is building personal _________________________.

7. Identify banks and financial institutions with experience in _____________________________ markets.

8. An international real estate practitioner must be proficient at market ____________________________.

Answers: Present and discuss terminology and concepts. 1. Globalization 2. Capital Flow 3. Falls 4. More 5. Weakens 6. Relationships 7. International 8. Assessment

Note:

The next 5 pages contain information to support the discussion of terms in the review quiz. It should not

be necessary to go in depth on any of these

topics since they will have been discussed at length

in previous courses.

New material begins on 1-8.



Globalization Globalization is the movement by countries, companies, organizations

and people toward a single market environment.

A shrinking economic world means:

• Single network of supply and demand for

o Products

o Services

o Capital

o Resources

• Impact of globalization on real estate

o Global investors now enter and leave local markets to

Create business opportunities

Seek investments

• International investors expect real estate professionals to have knowledge of:

o Markets

o Economies

o International business transactions

Real Estate

• Expanding markets require foreign capital{ XE "capital flow" } • International professionals know where and why investments are

being made

o Know patterns of capital flow

o Examine underlying forces

Supply and demand

Investment return

o Identify potential investors

o Knowledgeable about international transaction mechanics

Investors examine and invest in markets that best match the risk and return objectives of their portfolios.

Exam Question #1:

Why is it important to know basic financial

analysis techniques with international clients?

All of the Above.

Most are educated, Relate with other professionals on

investor’s team, Your responsibility to advise clients in knowledgeable

manner.

Exam Question #2:

Which explains why investors acquire real

estate outside their own country.

Better opportunities to match risk and return

objectives



Capital Flow

Capital flow is a complex interplay of foreign exchange instruments that move currency, assets, credits and debt around the world almost

instantaneously.

Currency

Investors will buy real estate because of the favorable trend of the investor’s currency against a foreign currency.

• A successful international real estate professional must understand the impact of exchange rates on international investment alternatives.

• Currency exchange rates provide insight into a country’s economic and financial performance

• When Currency A gains against Currency B, its exchange rate falls

o Currency A is worth MORE

o It takes fewer units of Currency A to purchase the same product in Country B.

Example:

• Canadian dollar STRENGTHENS against the Mexican peso

• Canadian dollar will now buy MORE Mexican goods with the same amount of money

Weaker Currency Takes MORE to buy

Exchange Rate

Rises Stronger Currency Takes LESS to buy Exchange Rate

Falls



Country Assessment Model • Economic, capital and currency conditions

• Geography

• Cultural

• Political influences

• Local real estate practices

• Favorable and unfavorable climates

• Government stability

• Population equilibrium

• Free market philosophy

• Social harmony

• Democratic institutions

• Adequate infrastructure

• Underlying economic strength

This course reviews general trends. Focusing on a foreign market requires specific details, which must be up to date. While the business press can provide general information, more in-depth information can be obtained through colleagues (via CIPS membership), the Internet, market visits, specialized newsletters and professional meetings.

Cultural Influences • Build relationships

• Do not make assumptions about investment objectives

• Historical influences

• Decision-making processes

o Vary from country to country

Group decision-making in Japan

Consult elders in China

o Short-term vs. long term perspective

• Negotiating behavior

o Win-win not common to all cultures

o Silence

o Time to make an offer response

Exam Question #3: Which of the following factors are important to an international buyer

when looking at a market?

All of the Above (Demography, Infrastructure,

Geography)

Exam Question #4: Which of the following

explains why international buyers

invest in U.S. commercial-investment

property?

Political Stability



• Language

o Pronunciation, grammar and syntax will vary

o Paraphrase concept to facilitate understanding

Different terms may convey same concept

o Provide examples

• Religion

o Centuries-old disagreements may terminate a sale

• Legal issues

o Lawyers, title searches or title insurance may be new concepts

o Different fee expectations for services

May affect buyer’s opinion of investment return

o Notaries

o Land ownership

In most former British protectorates (i.e. Hong Kong, Nigeria) land cannot be owned, only leased.

Some investors may believe ownership rights are absolute.

• No eminent domain understanding

• No environmental controls

• Class structure

• Customs

o Feng-Shui

• Values

• Prejudices and stereotypes

• Real estate professional expectations

o Exclusive devotion to client interest regardless of agency position

o Buyer may expect agent to carry out every aspect of transaction from analysis to property management

• Anonymity

o Conceal assets

o Avoid export limitations on capital

o Avoid public attention



• Degree of control and involvement

o Individual ownership allows maximum property control

o Indirect ownership reduces involvement

• Acceptable levels of financial risk and personal liability

o Corporate ownership reduces personal liability and risk

o Direct ownership creates greatest exposure on both

o Could offer tax advantages.

Conducting Business • Include banks and financial institutions with international

market experience as part of your team of professionals

• International transaction tasks similar to domestic practice

• Differences are:

o Greater distances

o Longer transactions

o Complex business channels

o Cultural differences may affect interactions

• Rewards:

o Intensely loyal clients

o Referrals

o Opportunities to learn and see the world



Preparing for an International Transaction

There are six basic steps when preparing for an international transaction. This strategy is utilized in the course case studies.

Step #1: Develop a Client Profile Organization of information is crucial to any successful transaction. A Client Profile is the starting point for basic personal and contact data. Add categories as needed.

Name:

Nationality:

Occupation:

Employer:

Home phone number:

Cell phone number:

Fax number:

Email address:

Mailing address:

Residency Status:

Family information:

Stated Requirements:

Price range:

Client’s experience and knowledge of market:

Location and type of funds:

Will financing be needed?

How much cash is client willing to apply to this transaction?

Cultural considerations (language, expectations, decision-making):



Step #2: Make Necessary Conversions Convert to client measurement and currency for their

understanding

Convert to USA measurement and currency for agent understanding

Step #3: Determine Investment Objectives • May or may not be revealed

• Reasons for investing will influence expectations of transaction

Step #4: Determine Purchasing Motivations Quantitative Motivations [Tied to profit and investment gains. Client should understand investment analysis]

• Unable to find investment opportunities in their domestic economy.

o Investor’s home economy may:

lack viable real estate investment market

have excess capital

be overbuilt

have restrictions on investment and ownership

have oppressive regulation

• Desire to protect capital against inflation and other domestic threats.

o Inflation is always a threat to capital

o Other threats include:

Devaluation of domestic currency

Pending changes in government regulations

Nationalization of private real estate holdings and key industries

Fear of such threats causing capital flight.

• Minimize investment risk through diversification. o Spread risk across various types and grades of investments



• Cash flow and profits. o Many people invest to make or preserve money

o Timing of cash flows, the size of profits, and the pursuit of growth versus income may differ significantly for various international investors.

Non-Quantitative Motivations [Relates to nature of investor and their culture]

• Investor wants to establish a basis for obtaining a visa and/or citizenship in another country.

o Often coincides with the capital flight motivation

o Occurs when:

a country’s internal situation appears to threaten the livelihood or interests of investors

there is a lack of investment alternatives

• Expand a business into a foreign market.

o As businesses establish overseas offices, branches, subsidiaries or joint ventures, real estate acquisition may be involved

• Protect family interests o Investors seek a base to expand their family’s investment and

employment opportunities

• Prestige o Holding overseas investments may represent wealth,

sophistication and shrewdness



Reasons for Investing in a Property Type The following chart matches reasons for investing with the types of property chosen.

Reason Property Type Income Retail, office, industrial, land, resorts,

apartment buildingsDevelopment profit Land for development, buildings for rehab

or redevelopmentSheltering capital Land or net leased properties with credit

tenants Business Retail, office, industrial, distribution, farms,

mines or woodlotsVacation or retirement or homes

Houses, condos or timeshares

Step #5: Assemble a Team • The complexities of international transactions require the assistance

of various professional specialists.

• Legal, tax and financial experts extremely important.

• Identifying and selecting team members o Evaluate:

level of expertise

specialization in commercial or residential transactions

experience in international transactions

referrals

compatibility with you and your client

knowledge of tax laws

knowledge of the property

knowledge of zoning requirements and other relevant local legislation

fee structure (per transaction fee vs. hourly billing)



Step #6: What Does Your Market have to Offer? Study your market from an international perspective to understand what it has to offer the buyer. The market elements an international real estate buyer should consider include:

government and regulations

financial and economic conditions

demographics

available technology

infrastructure

geography

natural resources

society and culture

real estate opportunities

Key Point Review

• Knowledge of currency and measurement is a basic skill needed by all international real estate practitioners.

• There are six steps needed in preparation for an international transaction.

o Develop a client profile

o Make necessary conversions

o Determine investment objectives

o Determine purchasing motivations

o Assemble a team of professionals

o What does your market have to sell?

Note:

These steps are for use as a preparation

template only. Additional research,

calculations and problem-solving will be

necessary as the transaction progresses.



2. Module heading–do not delete.

Chapter 2:

Legal Issues

Overview • International real estate transactions encompass new legal areas

which increase risk and require a team of specialized professionals.

Objectives • Discuss differences between types of residency status.

• Discuss ownership options

• Review basic income tax liability laws for non-resident aliens

Application • When assessing investment risk and financial return an international

agent must have knowledge of non-resident alien residency status, type of property ownership and applicable tax liability laws.

Time: 60 minutes Read through overview, objectives and application with students. Ask for any questions.



Domestic vs. Foreign Investor Status{ XE "domestic vs. foreign investor status" }

• Taxing authorities apply various standards to determine whether an ownership entity is domestic or foreign

• Taxes are imposed accordingly

• Determination is based on the entity’s residency status, and on which country provides the source of income

• The term alien is a specific technical term used by the USA Internal Revenue Service (IRS) and State Department; it is not generally used outside of this context.

Residency Status • Residency status, or intended residency status, is fundamental in

determining how the individual may be taxed, and which will eventually impact an investor’s return.

• In the USA, resident aliens receive the same tax treatment as domestic investors.

• As a resident alien, a foreign individual is taxed on income and gains on worldwide income.

USA Citizen Taxed on worldwide income; credits allowed for foreign taxes paid

Resident Alien Taxed on worldwide income; credits allowed for foreign taxes paid

Non-Resident Alien Taxed only on USA-sourced income It is not always obvious whether a foreign individual or corporation is a resident or a non-resident. The advice of tax counsel should be obtained. When qualifying an investor in the USA, the following conditions define residency:

Green Card Holder: The investor has been a lawfully admitted resident at any time during the calendar year.

Physical Presence Test: The investor has been present in the USA for at least 183 days during the calendar year.

Substantial Presence Test: The investor has been present in the USA for a weighted average of 183 days over a three-year testing period comprised of the current and last two preceding years. Exceptions apply to certain parties and circumstances.

Exam Question #5:

Which of the following is a condition that will result in an individual being considered a

resident?

All of the Above. Holds a green card. Present in the USA more than 183 days

during the year. Meets requirements

of substantial presence test.



USA transfer tax rules, gifts and bequests, do not define residency in the same way as federal income tax laws. Due to the complexity of these rules, legal advice should always be obtained.

Government Reporting Regulations in a Client’s Country{ XE "government reporting regulations in a client’s country" } Consult a professional expert concerning government regulations. Certain countries may require reporting of foreign investments held in some ownership structures but not in others. Other governments treat the expatriation of income and gains differently for corporations, partnerships, individuals or other entities.

Call Your Attorney



Ownership and Taxation Considerations

Determining the Type of Ownership Entity Title to a property defines how tax will be applied. Factors to consider include the type of entity used to hold title to the property, and whether the owning entity is considered domestic or foreign.

These decisions should be made by the client after consultation with a legal professional.

• Three USA foreign-ownership choices

o Direct individual ownership

o Indirect ownership through a USA entity

o Indirect ownership through a foreign entity

Direct Individual Ownership • Direct individual ownership is the simplest form of ownership

o It involves USA transfer taxes.

o In the absence of a tax treaty with an investor’s country, federal estate taxes apply to any USA property held in an individual’s name.

o Possibility of double taxation

o A tax may be applied to the investor’s worldwide holdings

Consult the IRS for copies of tax treaties

o Exposure to personal liability

o Limited tax planning alternatives

o The major advantage is the high degree of direct control over the property.

o Principal residence tax exclusion

Encourage investors to seek professional tax and investment counsel to determine the best ownership strategy.

Exam Question #6

Which of the following is an advantage of direct ownership of property?

High degree of

property control.



Indirect Ownership through a USA Entity • Property held through a corporation or trust is not subject to

USA estate taxes unless the foreign investor is domiciled in the USA.

• Partnership: income is taxed only once at the individual investor level.

• General partnership disadvantage: individual is personally liable for the actions and debts of the partnership

• For tax purposes, the income from an investment may be effectively connected with a USA trade or business through actions of other partners.

• Limited partnership, an “S” corporation or a limited liability company (LLC) eliminates the above possibility.

• “C” corporations income is taxed twice, first as corporate tax, then at the individual level as tax on dividends received.

Indirect Ownership through a Foreign Entity • Tax treaties may offer some relief from tax liabilities

• If there is a tax treaty with the USA, an investor may find it advantageous to own the property through a business entity in their own country.

• USA tax laws have been changed in recent years to diminish the advantages of owning through a foreign entity.

Location of Income Source • For tax purposes, it is important to discover whether the foreign

investor intends to use a property in such a way that income or gains is construed by the IRS as effectively connected with a USA-based business or trade.

• Income is effectively connected if it is derived from assets used in an activity classified as a USA trade or business, and if the business activities of the USA trade or business are directly related to achieving that income.

• Size of the investment, nature of the property, and the extent and frequency of the investor’s involvement with the property may also be considered.

• Competent tax counsel is needed to determine how the latest tax laws will treat the investor.



Tax Liabilities{ XE "tax liabilities" } • For the investor coming to the USA, the primary liabilities are:

o income

o gains

o ownership transfers.

Income Tax Liability • Only USA-sourced income received by nonresident aliens is

subject to USA tax.

• A nonresident alien engaged in a USA trade or business is treated in the same way as a USA individual or corporation.

• Possible exceptions.

o If the alien’s rental income is determined to be, or if the alien elects it to be effectively connected to a USA trade or business, it is taxed as if it were received by a USA individual or corporation.

o Treatment of depreciation and net operating losses differs according to how the income is classified.

o Tax treaties may modify tax treatment. The alien party may elect to be taxed on a net basis with respect to all USA income (if not in a USA trade or business).

Gains Tax Liability-FIRPTA, DEFRA, TAMRA • The provisions of the Foreign Investment and Real Property Tax

Act of 1980 (FIRPTA), the Deficit Reduction Act of 1984 (DEFRA) and the Technical & Miscellaneous Revenue Act of 1988 (TAMRA) all apply to nonresident alien individuals and corporations that buy or sell USA real estate.

• The purpose of these laws is to equalize the treatment of domestic and foreign investors.

Exam Question #7:

When passive income such as rent is subject to withholding, the amount

withheld is:

30% Passive income: Rents, dividends, interest

Subject to 30% withholding tax Based on gross income No deductions allowed!

DEFRA requires withholding, reporting and transmitting 10% of amount realized to IRS within 10 days of the transfer.

Exceptions may apply.



• According to DEFRA, the buyer, or their agent, must withhold, report and transmit 10% of the amount realized on the disposition of real estate to the IRS within 10 days of the transfer

• The seller may document that they are not a foreign person(s) or has made other arrangements with the IRS.

• DEFRA applies to all forms of interest in real estate, including participation loans.

• The withholding agent, often a real estate professional, is liable to civil penalties for failure to comply.

• Agents of the buyer or seller can also be held liable for failure to disclose knowledge of false certifications or claims of exemption from withholding. If the failure is willful, criminal penalties may also apply.

Transfer Tax Liability • USA imposes transfer taxes on the value of gifts and bequests

passing from one individual’s estate into the hands of another.

• TAMRA makes the maximum tax rate imposed on estates belonging to foreigners with an USA domicile equal to the tax imposed on USA citizens and residents.

• The estate and gift taxes apply to the worldwide estate of an USA citizen or resident, they apply only to USA-located assets of the USA-domiciled, but nonresident, aliens.

• Holding USA property through a domestic or foreign company prior to making any gifts or bequests may avoid USA transfer taxes.

• Income and gains taxes may increase if the property is held through a company to minimize transfer taxes, instead of being held directly by the individual.

• Holding property through a foreign entity, or through an irrevocable non-grantor trust, may enable the investor to avoid USA estate tax.

Exam Question #8:

If a Venezuelan with legitimate non-resident status sells his U.S.A.

home for $280,000 to an elderly German couple who plan to retire and live there, how much

must be withheld by the withholding agent?

$0 - None of the Above

Residential, non-business property, with a value up to $300,000 is exempt from DEFRA if

the property has been used as a primary residence by the seller and will be used as a

primary residence by the buyer.



• Securing the property with a non-recourse loan where the mortgagor has no personal liability may decrease tax liability. The mortgaged amount is not included in the gross estate.

• Joint ownership of a property may lower estate tax liability.

Any action concerning the holding of USA real estate by an international owner should be taken ONLY with the advice of USA tax

specialists and specialists in the investor’s home country.

Key Point Review • Residency status is basic to determining how an individual will

be taxed.

• Three conditions define residency:

o Green Card Holder

o Physical Presence Test

o Substantial Presence Test

• Calling an attorney to clarify residence issues for a client is a risk reduction tool.

• Three ownership entities

o Direct Individual ownership

o Indirect ownership through a USA entity

o Indirect ownership through a foreign entity

• Passive income subject to 30% withholding

• DEFRA requires withholding, reporting and transmitting 10% of amount realized to IRS within 10 days of transfer.

• Residential, non-business property under $300,000 exempt from DEFRA if the property has been used as a primary residence by the seller and will be used as a primary residence by the buyer.



3. Module heading– do not delete.

Chapter 3

HP-10BII Functions

Objectives

• Identify components of HP-10BII to be used in case studies.

• Discuss calculator default settings.

• Set necessary function modes to successfully complete course case

studies.

Time: 90 minutes

Read through objectives with students.

Ask for any questions.



Row 1

Row 2

Row 3

Row 4

Row 5

Row 6

Row 7

Row 8

1 2 3 4 5

HP

10BII



HP 10BII Keys used in this course All keys on the HP-10BII perform at least two functions. WHITE key functions are on the left and GOLD Key function are on the right

White Key Only

Functions

Dual Functions

Gold Key [Shift] Function

Key Location

Activated Symbol

Function Shift + Activated Symbol

Function

1-1 N Time Gold Key, xP/YR (N register)

Total Periods/Yr.

1-2 I/YR Interest/Income Per Year

1-3 PV Present Value 1-4 PMT Payment Gold Key, P/YR Payment/Yr 1-5 FV Future Value Gold Key, AMORT Amortization

Schedule 2-3 2-5

Gold Key, IRR/YR Internal Rate of Return

Gold Key, BEG/END Beg./End of Year/Month

3-1 K Constant 3-2 % Percent Gold Key, %CHG Percentage

change 3-3 CFj Cash Flows 3-5 Backspace 4-1 +/- Sign Convention 5-2 7 5-3 8 5-4 9 5-5 ÷ Division

6-1 Gold Key Shift Key 6-2 4 6-3 5 6-4 6 6-5 X Multiplication 7-1 C Clear Gold Key, C All Clear All 7-2 1 7-3 2 7-4 3 7-5 - Subtraction

Note:

Instructor may add keys they like to use to the information in this

chapter.



8-1 ON Turn on Gold Key, OFF Turn off 8-2 0 8-3 . Decimal Pt. Gold Key, / , European

Mode 8-4 = Equals Gold Key, DISP Display

Additional Symbol Information

• The Row 1 keys are the primary keys used in this course.

• Data is entered from left to right for continuity.

• While the HP 10BII is capable of a wide range of calculations, only those relevant to this course will be discussed.

Dual Key Functions • All keys on the HP-10BII perform at least two functions.

• A typewriter has a shift key to activate upper case letters.

• This calculator has a GOLD key to activate the second function of each key.

• The HP-10BII has an additional purple key which will not be used in this course.

• The primary function of a key is printed on top of the key in WHITE.

• The secondary function of a key in printed in GOLD at the bottom of the key.

Power Turn ON—Press ON key on bottom left corner of calculator

Turn OFF—Press Gold Key and OFF at the bottom left corner of

calculator. Same key, different function.



Displaying Decimal Places

• The display format default is set for two decimal places.

o True when working with money

• The numerals to the right of the decimal point can be changed.

o Can go as high as 9 places to the right

o Changing the digits alters only the screen display.

o The internal calculations continue using up to 12 digits.

• Change the places to the right of the decimal by:

o Press Gold Key DISP then the desired number of places.

For example: 8 ÷ 13 =

Key Strokes Display Description Gold Key, DISP, 1 0.6 one decimal place is rounded (up)

Gold Key, DISP, 2 0.62 returns display to two decimal places

Gold Key, DISP, 3 0.615 three decimal places are displayed

Gold Key, DISP, 4 0.6154 four decimals places are displayed

Gold Key, DISP, 5 0.61538 Five decimal places are displayed

Gold Key, DISP, 6 0.615385 Six decimal places are displayed

Gold Key, DISP, 7 0.6153846 Seven decimal places are displayed

Gold Key, DISP, 8 0.61538462 Eight decimal places are displayed

Gold Key, DISP, 9 0.615384615 Nine decimal places are displayed

Basic Arithmetic • HP-10BII calculators have a = key because it uses the algebraic

logic system.

• The format for entering data is the way you think:

DATA and FUNCTION key = ANSWER

• The steps for simple calculations are:

1) Enter the number 15

2) Press the appropriate arithmetic operator +

3) Enter the number 20

4) Press = for the answer

5) Display will read 35.



Clearing Data from the Registers • The HP-10BII has several functions to clear the calculator.

• Four of these functions are explained here:

o This arrow clears the last digit in the display.

If the cursor is not displayed on the calculator, the function resets the display to 0.00 and cancels the operation

o C clears the entire number while it is being entered. When the calculation is complete, the function

clears the display, cancels the operation and returns display to 0.00.

o Gold Key C ALL clears all memory Does not reset fixed modes [i.e., number of

payments per year, begin and end, or decimal place settings].

o ON N FV Pressing and holding these three keys at the same time will clear all memory and reset the calculator.

Calculator returns to default positions

• 12 months per year

• Two place decimal display

• End of period

Sign Convention • The calculator distinguishes between income (cash receipts/

positive values) and expenses (cash disbursements or losses/ negative values) when solving financial problems.

• Sign convention must be consistent throughout a calculation.

• To change signs, press the +/- key

o Enter all losses and payments (cash outflows) as negative numbers.

A mortgage payment is calculated as a negative number for the borrower who will make the payment.

o Enter all revenue and income (cash inflow) as positive numbers.

For the lender who receives the payment, it is a positive number.



=

• All values that are calculated for PV, PMT and FV should adhere to this sign convention

• It is considered the industry standard.

Begin and End (BEG/END) Functions • This function calculates loans and amortizations from either the

beginning of the month/year or the end of the month/year.

Rent payments are made at the beginning of the month.

Mortgage interest is paid at the end of the month.

• To change the BEG/END mode press BEG/END

• In this course we deal with mortgages so set your calculator to End Mode.

European Mode Function

• Decimals are not displayed in many countries outside the USA.

• In Europe, the comma and decimal point are used opposite of USA.

o £ 1.000.000,00 (one million pounds sterling)

o $ 1,000,000.00 (one million USA dollars)

• To change the decimal point from a comma to a period, press

• Gold Key ./,

Constant Key • When there are calculations using the same number.

• Saves entering the same numbers over and over again.

• Example:

o An apartment rents for $800 and will increase 3% every

year.

o Enter 800 + Year 2

Year 3

Year 4

Year 5

Store Data

• Gold Key STO Used to store data in memory registers.

3 % K =

=

=




Chapter 4:

Case Study: Mr. Chen Inbound Residential Transaction

Overview • This chapter follows the agent and his international client, Mr. Chen,

through the preparation, property review and potential question resolutions leading to an accepted offer.

Objectives

• Review 6-Step International Transaction Preparation Process

• Apply 6-Step process to Mr. Chen

• Complete calculations necessary to answer Mr. Chen’s questions

Application • Knowledge of information organization and sequence of

calculations to answer specific questions are essential skills for the international practitioner.

Time: 90 minutes Read through overview, objectives, and application with students. Ask for any questions.



Mr. Chen’s Worksheet

1. Sales price 3 years ago

2. Sales price today

3. Rate of appreciation

4. Projected sales price

5. Costs of sale

6. Original loan amount

7. Mortgage balance

8. Net Sales Proceeds After Taxes

Activity

Instruct students to remove this page from

their notebook and fill in the blanks for Mr. Chen

as you move through the material. They will need some of these answers to complete future calculations.



Case 1: Inbound Residential Transaction{ XE "inbound residential transaction" } Your office phone rings. An international operator informs you that Mr. Chen is calling from Taiwan.

Mr. Chen: Hello. My name is Mr. Chen.

Salesperson: Hello Mr. Chen. My name is Susan Johnson. How may I help you?

Mr. Chen: I am a trader with Tiger Securities Company in Taipei. Tiger Securities is sending me to the USA to staff a new regional branch operation.

Salesperson: Congratulations Mr. Chen. Will you be bringing your family with you?

Mr. Chen: Yes I will. I am married and have three children ages 6, 9, 15. Their schooling is of great importance to us, particularly in English programs.

Salesperson: We have some excellent schools here and they always welcome new families’ questions and requests for visitation. Could you share some information with me regarding your housing needs?

Mr. Chen: Of course. We want a four-bedroom house with a den and a study. It must all be on one floor and it must pass additional requirements we will discuss at a later time.

Salesperson: Our market offers many homes of the size you require. They are of course, in varying price ranges. Have you determined how much you want to invest in this purchase?

Mr. Chen: Yes. The most we want to pay is 20 million Taiwanese dollars. For that amount we expect at least 90-95 pings of living space.

Salesperson: Do you want to make an all cash purchase?

Mr. Chen: No. We will make a 20% down payment and do not want to pay more than 7.5% interest on a loan.

Salesperson: That sounds reasonable in our market Mr. Chen.

Mr. Chen: Just a few additional items. My new branch will be located in the financial district. I do not want to travel more than 30 minutes from my residence to the office. I will be visiting your office in a week to see what you have available. Since I will be traveling until then, I will provide any additional information you need at our meeting.

Salesperson: That sounds good. I look forward to meeting you Mr. Chen.

Mr. Chen: Thank you. See you next week.

Introductory Exercise

1. Before class begins, ask two individuals privately if they will participate in this short skit. 2. If they agree, give them a copy of the skit so they can become familiar with it before getting in front of the class. 3. Ask them to put some feeling into it. Have them use their cell phones as props. Make it as real as possible. 4. When they have presented to the class, give each a small prize. 5. Facilitate the skit as a lead-in to the rest of this chapter.

Follow-up Question

Is this a typical first contact with a foreign

investor?

Why or why not?



Step 1: Develop a Client Profile

Name:

Nationality:

Occupation:

Employer:

Home phone number:

Cell phone number:

Fax number:

Email Address:

Mailing address

Residency Status:

Family information

Stated Requirements

Price range:

Client’s experience and knowledge of market:

Location and type of funds:

Financing:

Client cash involvement:

Objectives and Motivations:

Cultural considerations (language, expectations, decision-making):

.

Activity Have everyone complete the Client Profile for Mr.

Chen with the information they have at

this time.

Facilitate discussion

Discussion Questions

How do you approach the issue of available

funds?

When is the best time to discuss location and

type of funds?

Is it good business to ask what the client’s

objective and motivations are for the

purchase?

When and how do you introduce the concept of

agency?



Step #2: Make Necessary Conversions

Convert Area • Mr. Chen would like a house between 90-95 pings

• Convert this measurement into square feet

Summary Conversion Table: If you are converting: Then (conversion factor):

Pings to square feet 1 ping = 36 square feet

Square feet to pings 1 square foot = 0.02778 (or 1÷36)

Exam Question #9:

A ping is equal to:

36 square feet.

Answers

90 pings x 36 = 3240 SF

95 pings x 36 = 3420 SF

Answers

3240 X 0.02778 = 90 pings 3420 X 0.02778 = 95 pings

Converting Square Feet to Pings Conversion Factor: 1 sq. ft. = 0.02778 pings (1÷36)

Formula: Multiply Square Feet to be converted (X) conversion factor (0.02778)

3240 (square feet) x 0.02778 = ________ pings

3420 (square feet) x 0.02778 = ________ pings

Converting Pings to Square Feet Conversion Factor: 1 ping = 36 square feet

Formula: Multiply pings to be converted (X) conversion factor (36)

90 pings x 36 = ____________ square feet

Convert upper end of Mr. Chen’s range

95 pings x 36 = ____________ square feet

Mr. Chen’s size range is ________ to ________ square feet.



Convert Currency • Mr. Chen expects to pay 20 million New Taiwanese dollars.

• To convert the price, use the exchange rate of New Taiwanese dollars for USA dollars.

• Check the financial section of newspapers or go to XE.com

• You find a property that costs $750,000

• Use the same exchange rate of one USA dollar to New Taiwanese dollars as above:

US$1 = NT$25 (exchange rate ÷ conversion factor).

If you are converting: Then (conversion factor):

USA dollars to New Taiwanese dollars US$1 = NT$25

New Taiwanese dollars to USA dollars NT$1 = US$0.040 (or 1/25)(4¢)

Converting US Currency to Foreign Currency

Formula: US Dollars to be converted (X) New Currency Conversion Factor

US$750,000 x 25 (conversion factor) (=) NT$_____________

Is this property is within Mr. Chen’s requirements?

Converting Foreign Currency to US Dollars

Formula: Foreign currency to be converted (X) US Dollar Conversion Factor

1. Today the exchange rate is NT$25 = US$1.

2. Adjust the exchange rate to a per unit basis in New Taiwanese dollars. (One NT$ = how much in US money?)

3. NT$1 = 1÷US$25 or US$0.040 (exchange rate ÷ conversion factor) (One NT$ equals 4 cents US)

4. Multiply the number of New Taiwanese dollars by the exchange rate:

NT$20,000,000 (X) 0.040 (exchange rate) = US$____________

We now know Mr. Chen will spend approximately US$____________

Answers

US$800,000 US$800,000

Answer

NT$18,750,000

Exam Question #10:

How many US$ in NT$4,200,000

assuming exchange rate is NT$30=US$1?

US$140,000



Step # 3 Client Objectives • Before selecting potential properties learn the client’s objectives for

purchasing.

• This information may not be revealed.

• If the objectives are purely financial the client may be very knowledgeable regarding investment analysis.

• Do your homework

• Be sure the client doesn’t know more about your market than you do!

• What are Mr. Chen’s objectives?

Step #4: Client Motivations • Motivations for international purchases vary greatly.

• All of the client’s reasons may not be apparent at first, and some reasons may never be revealed.

• Cultural aspects always play a large role in international transactions.

• Mr. Chen mentioned he wanted a one-story house that would meet certain requirements.

• To understand and anticipate Mr. Chen’s needs, an agent should become familiar with certain aspects of the Taiwanese culture.

o Are there cultural considerations such as living in an area where they share a common language with their neighbors

o Will the property be evaluated by a feng-shui expert?

Is the client motivated by the expectation of having someone lead them through the process?

Will the client make the buying decision on their own or will other individuals or groups be consulted?

Motivations vary and all affect the buying decisions.

Mr. Chen’s Motivations

He needs a place to live

while working in the USA. He desires a base for

future, more significant real estate purchases. He wants a base for

relatives who will arrive later.

He wants to learn about

the USA real estate market and practices before

making any significant real estate investments.

Mr. Chen’s Objectives

90-95 pings living space

Pay no more than 20 million Taiwanese dollars

Interest 7.5 or less

Finance 80%

30 min. or less travel time

to work

1 floor, 4 bdrm with den and study



The more you can learn about the motivations for purchasing, the more complete service you can provide.

What are Mr. Chen’s motivations for buying?

Step #5: Assemble Your Team • What professionals will be needed for Mr. Chen? Why?

• Additional team members are part of your risk management program.

Step #6: What Does Your Market Have To Offer? • Prepare information about your marketplace

• Include local newspapers

• If there is a newspaper or magazine in your marketplace written in the client’s language, include them.

• Businesses, churches, schools, colleges, universities, hospitals, libraries, recreational opportunities, parks, theatres, restaurants, maps and anything else that might be of interest to an individual or family.

• Articles on what is happening in your area. Save good ones and ask your local paper for permission to copy them for newcomer packets.

• Contact Chamber of Commerce

• Are businesses coming into your area?

• Is property appreciating? What supports your claims?

• Sell them on your area as well as the property within.

Group Question

Do these preparations sound familiar?



Profile Update

Mr. Chen Arrives Today • Your personal preparation includes:

o Client profile with available information to date

o A list of questions for Mr. Chen

o Community information

o Three homes to show him

• Because you understand the importance of relationship-building, you let Mr. Chen approach the business portion of your meeting when he is ready.

• Mr. Chen brings his feng-shui consultant on the tour of homes.

• Mr. Chen selects one of the homes that meet the requirements he stated in his original telephone call.

• The home he selected is:

Description: one-story brick ranch, 3,350 square feet, 4 bedrooms, 3 baths, den/ study

Location: Moonshine Valley, North Carolina

Price: $750,000

Financing: 80% conventional loan at 7.5% interest, 2 points cost of mortgage, 30 year mortgage

Reasons selected: proximity to employment and schools, potential for rental income, appreciation potential

Before making an offer, Mr. Chen would like an estimate of his proceeds if he sells the house in three years.

• You agree to meet the next day to provide him with answers.



Projecting Net Proceeds from a Sale • The research of comparable sales for the neighborhood establishes that

the house is reasonably priced at $750,000. • The MLS shows comparable sales three years ago to be $634,300. • Assuming straight line inflation/appreciation it is possible to calculate

the value of the property at any time in the future.

Projecting Future Net Proceeds

What You Know • The value 3 years ago was $634,300. • The value today is $750,000. • Find the value three years from now.

How many years out does client want to project? (N)________________ Sales price 3 years ago (money going out) (PV when purchased)________________ Sales price today (FV three years ago)_______________ Solve for: Rate of appreciation per year? (I/YR) ________________

Exam Question #11:

If the loan-to-value ration is 75%, one’s

equity in the property exceeds the mortgage

loan.

False

Answers

Projected years: 3

Sales price: 3 yrs. ago $634,300

Sales price today:

$750,000

Rate of appreciation per year:

5.74



Calculating Projected Property Rate of Appreciation • Use the calculator's PV (present value) and FV (future value) keys • Use the initial investment of $634,300 as occurring in the present day.

Calculations

1. Clear the calculator registers. (GOLD KEY, C ALL) 2. Set the calculator for 1 payment per year. (1, GOLD KEY, P/YR)

3. Since we are looking 3 years into the future, press 3 and (N)

4. Enter 634,300 into the calculator.

5. Press (+/-) money going out from purchaser

6. Press (PV) Present Value

7. Enter 750,000 into the calculator. Since this is the price for which the property

was sold, this number remains positive.

8. Press (FV) Future Value of property sold 3 years later

9. Press the ( I/YR) key.

10. The answer of _______ is the annual rate of appreciation during the 3 years of

ownership.

Three-year Projected Price Options Leave the numbers in the calculator and re-enter the new PV value.

Use the appreciation rate and do a new projection. The answer is slightly different because of rounding.

Answer

5.74%



Calculating Projected Sales Price

• The calculation begins with the Present Value (PV).

• Three (3) years from now is the Future Value (FV).

Calculations 1. Press (GOLD KEY) and (C ALL) to clear the registers.

2. Enter 3

3. Press (N) (The length of the holding period.)

4. Enter 5.74 as the appreciation rate from the calculation above and press (I/YR)

5. Enter 750,000 (price paid today)

6. Press the (+/-) key. This is the amount paid out now so it is negative.

7. Press (PV), the present value.

8. Solve for Future Value by pressing (FV).

9. The display reads ________________

10. Round this off to _____________ as the projected sales price 3 years from now.

Caveats:

This model portrays appreciation in a straight line. If a line chart were drawn on monthly numbers it would look like a mountain range. The results could be very different based on the starting and ending points. This method makes no allowance for extaordinary events tha have happened or could happen, thus skewing the results.

Answers

886,705.049

886,700.00



Calculation Steps for Net Sales Proceeds after Taxes The money Mr. Chen receives from the sale of the property is referred to as

Net Sales Proceeds After Taxes.

Calculating Future Net Sales Proceeds after Taxes

1. Sales price ________________

2. (-) costs of sale ________________

3. (-) loan balance ________________

4. (-) tax liability _________________

5. (=) Net sales proceeds after taxes _________________

Steps for Mr. Chen are: Step 1: Enter the projected sale price ($886,700) for Mr. Chen’s home into chart.

Step 2: Calculate and subtract Costs of Sale expenses (7.5% estimate)

cost of initial repairs/remodeling

commissions

any marketing expenses incurred by the seller

any legal or closing expenses incurred by the seller

time on the market if an income-producing house is left vacant

Calculating Costs of Sale

Estimate settlement expenses and commissions at 7.5% of sale price. Costs of sale are rounded:

$886,700 (sales price) (X) 7.5% (estimated costs) = ________________ Enter into the Future Net Sales Proceeds After Taxes Chart, line 2.

Answers

Sales price $886,700

Costs of Sale

66,502

Mtg. Balance 582,085

Tax Liability

0

NSPAT 238,113

Answer

886,700 X 7.5% = 66,502



Step 3: Before calculating the remaining loan balance you must determine the original loan amount.

Step 4: There are two ways to calculate a remaining loan balance

• Interest Reduction Method: If loan balance only is needed

• Traditional Method: If a loan amortization or the interest paid during any particular period is needed

• Since the only the loan balance is needed here, we use the Interest Reduction Method.

• Enter the remaining loan balance on line 3 of the Net Sales Proceeds after Taxes chart.

• Remaining loan balance is subtracted from Mr. Chen’s sale price in deriving net sales proceeds.

• The initial point and origination fee charged are deductible as interest in the year of purchase, so they do not impact net sales proceeds.

Calculating Original Loan Amount

Sales Price (X) Allowable loan to value percentage= loan amount Mr. Chen wants an 80% LTV mortgage. What is his loan amount?

$750,000 (original purchase price) X 80% (LTV)=_________________

Calculating Remaining Loan Balance Interest Reduction Method

1. Calculate remaining loan balance at end of 3 years (balloon payment)

2. Clear calculator (GOLD KEY), (C ALL)

3. Set payments at 12/year (1, 2, (GOLD KEY), (P/YR)

4. Enter term of loan: (30)

5. Press (GOLD KEY), (xP/YR)

6. Enter annual interest rate: (7.5)

7. Press (I/YR)

8. Enter loan amount $600,000

9. Press (PV) (Present Value)

10. Enter (0) (Full Amortization)

11. Press (FV) (Future Value)

12. Press (PMT) (Monthly Payment)

13. Press (3) to reset loan term to 3 years instead of 30

14. Press (GOLD KEY), (xP/YR)

15. Press (FV) to find remaining loan balance after 3 years

16. Remaining loan balance after 3 years is ____________________

Answer

$750,000 X 80% = 600,000

Answer

$582,085.49

Monthly Payment

$4195.28



Step 5: Determine Tax Liability

• The Budget Act of 1997 allows Mr. Chen and his wife to avoid gains tax on this home if it has been their legal residence for two of the previous five years.

• Mr. Chen tells you he will be living in this home for at least two years. With this information, Mr. Chen will have no tax liability.

• Enter this information on line 4 of the Net Sales Proceeds after Taxes chart.

Step 6: Complete the calculations for Mr. Chen’s projected net sale proceeds:

Meeting with Mr. Chen • The report to Mr. Chen that his Net Proceeds After Tax on the sale of

this home would be estimated at __________________ is met favorably.

• This information is satisfactory and he makes an offer on the home.

• Negotiations result in a contract with a 30-day closing.

Additional Concerns • Mr. Chen is concerned about the possibility of a change in the exchange

rate and the effect it would have on his future proceeds.

• Calculate his proceeds if the exchange rate remains the same as today, decreases [strengthens] or increases [weakens].

Answer

$238,113



• Suggestions for Mr. Chen:

o Consult tax and legal experts concerning the advantages of maintaining non-resident alien status

o Owning the property through a trust (instead of individually)

o Avoid being treated as a USA business.

• Mr. Chen’s return on investment will depend on his decisions before the acquisition

o Type of entity used to acquire the property.

o Mr. Chen’s residency status

o Income level of person or entity

Key Point Review Assembling a team of experts in the areas of finance, banking, law and

accounting is critical for successfully completing an international transaction.

Preparing and presenting information to clients in terms relevant to them are significant features in every step of the transaction.

Effect of Changes in Exchange Rates

Formula: Net Proceeds after Sale (X) exchange rate 1. Exchange rate the same as when the transaction began (US$1=NT$25) US$238,113 (Sales Proceeds) (X) 25 (exchange rate) (=) ______________

2. Exchange rate decreases (US$1 = NT$15) (NT$ strengthens) US$238,113 (Sales Proceeds) (X) 15 (new exchange rate) (=)___________ 3. Exchange rate increases (US$1 = NT$40) (NT$ weakens) US$238,113 (Sales Proceeds) (X) 40 (new exchange rate)(=) ___________

Answers

NT$5,952,825

NT$3,571,695

NT$9,524,520

Exam Question #12:

Fluctuations in a currency’s exchange rate have little or no

effect on the investment return of

an international transaction.

False


Copyright 2008, National Association of REALTORS® Chapter 5-1


Chapter 5:

Finance and Capital Markets

Overview

• This chapter discusses:

o Four elements of an investment

o Measures of return on investment [yield]

• The student will:

o Apply the IRV Formula

Calculating Capitalization Rate

Calculating Cash-on-Cash Return

Objectives • Calculate the financial problems associated with investing

• Apply financial concepts to the case study

• Identify the effects of exchange rate fluctuations on a transaction

• Obtain the skills needed for basic financial analysis

Application Knowing how to use basic financial tools, such as the T-bar and a

financial calculator, will enhance understanding of the financial concepts.




Four Investment Elements{ XE "elements of an investment" }

1. Yield

• Yield is the dollar amount earned on each dollar invested over the life of the investment

• Known as rate-of-return

• Desired yield or return depends on an investor’s objective

o An investor whose main objective is to protect as much capital as possible may be willing to pay a higher price (resulting in a lower yield) than one who is mostly interested in achieving maximum cash flow and income.

o One who invests for appreciation rather than income will be willing to accept a lower initial return.

o Risk-averse investors may pay more for proven properties and knowingly accept lower returns.

2. Safety

• Yield should be balanced with the safety of the investment

• Three basic risks faced by real estate investors

o Loss of capital

o Loss of return on capital

o Capital lost because the investor was unable to invest it

• International investors may incur a fourth risk called country risk.

o Currency losses

o Nationalization of property

o Unfavorable regulatory changes

3. Leverage

• Using borrowed money to build wealth.

• Positive leverage is using borrowed funds to finance an investment where the yield exceeds the cost of the borrowed funds. The investor makes a profit on the loan itself.

• Negative leverage is when the cost of borrowed funds exceeds the yield of the investment.

o Negative leverage is beneficial if an investor gains control of a rapidly appreciating asset or uses currency trends to an advantage.

Exam Question #13:

Which are elements of

an investment?

All of the Above. Yield, safety, control.



4. Control Passive investors invest their money and allow others to operate the

investment.

Active investors want to be involved and manage many or all aspects of the investment themselves.

International investors will be looking at the commitment involved in managing, repairing and visiting the property.

Control issues vary from property to property and are not specifically dependent upon the market.

The first three investment elements relate directly to conditions of the market where the property is located. The investor cannot hope to obtain desired yield, safety or leverage without paying attention to market trends such as inflation, supply, absorption, interest rates and price fluctuations.

Time Value of Money{ XE "time value of money" } Time Value of Money (TVM) states that the value of money

received today is greater than the value of money to be received in the future. This principle incorporates the following ideas:

o Risk: There is virtually no risk if you have the money in hand rather than anticipating the receipt of money from an investment.

o Purchasing power: Due to the effects of inflation, money in hand today will purchase more goods or services than money in the future.

o Opportunity costs: Money invested today to earn interest that will result in a larger sum at some point in the future.

Money to be received in the future cannot earn interest until it is received.

This lost opportunity to earn interest is called the “opportunity cost.”

Exam Question #14:

A simple definition of the time value of money

states that the value of money received today is

less than the value of money to be received in

the future.

False.



The interest rate applied to calculate future value (FV) or present value (PV) also incorporates the ideas of risk, purchasing power and opportunity costs.

Key Components in Calculating Time Value of Money (TVM) Compounding: Determining the future value of an investment made today. May be a single payment or series of payments. Interest earned is reinvested to earn additional interest. Discounting: Determining the present value of money received in the future. May be a single payment or series of payments. The more time until maturity of the mortgage or note, the greater the discounting.



Measuring Investment Performance Yield and rate of return are interchangeable terms used to measure investment performance, the percentage return on each dollar invested.

Two types of return or yield:

return of capital [return of the initial amount invested]

return on capital [profit generated from the investment]

The IRV Formula{ XE " measuring yield:IRV formula" } Almost all measures of yield use the IRV formula.

IRV stands for Income, Rate and Value

Rate equals Income divided by Value

Example: You deposit $10,000 (V) in the bank.

You are receiving $400.00 (I) interest annually.

What is your (R) rate of return?

$400.00 (Income) divided by $10,000 (Value of investment) = 4% (Rate)

Value equals Income divided by Rate

Example: A property with a $4000 NOI (Net Operating Income) (I)

Purchased at a cap rate (R) of 11%

What would the value (V) be to the purchaser?

$4000 (Income) divided by 11% (Rate) = $36,363.64 (Value)

(I)ncome

(R)ate (V)alue

If you have 2 numbers you can solve for the 3rd.

Divide the bottom numbers into the

top. Multiply 2 bottom numbers



Income equals Rate multiplied by Value

Example: You paid $450,000 (V) for a piece of property.

The capitalization rate (R) was 8%.

What is the annual Net Operating Income (I)?

$450,000 (Value) multiplied by .08 (Cap Rate) = $36,000 (Income) NOI

Capitalization Rate{ XE " measuring yield:capitalization rate" }

Cash-on-Cash{ XE " measuring yield:cash-on-cash" }

Cash-on-Cash (ConC)

Measures cash received against original cash invested Calculated before and after tax Use IRV formula (I)ncome divided by (V)alue of investment (=) Rate of Return (R)

Cash Received (I)

Invested Cash (V)

Rate of Return

(R)

Capitalization Rate (Cap Rate)

Measures net operating income (NOI) against total cost of the investment.

Cap Rate is expressed as a decimal or percent. NOI (I) divided by (V) Value of investment = Cap Rate (R)

NOI

Total Value of Investment Capitalization Rate ?

Exam Question #15:

Capitalization, or the cap rate, is determined by:

Dividing NOI by value.

Exam Question #16:

A property with an NOI of $50,000 per year sold at

a 9% cap rate. What was its price?

$555,555.56



Key Point Review

• The four elements of an investment income property are:

• Yield

• Safety

• Leverage

• Control

• The key components in calculating the Time Value of Money are

compounding

discounting

• The IRV Formula is used to calculate:

Capitalization rate

Cash-on-cash return




Chapter 6 Case Study: Dr. Garcia Inbound Commercial Transaction

Overview

• A new client, Dr. Garcia, is interested in purchasing commercial property. His requirements necessitate a higher level of knowledge and skill by the real estate practitioner. This case study takes the student through the necessary calculations to answer Dr. Garcia’s questions.

Objectives

• Apply six step preparation process to Dr. Garcia’s case • Calculate steps to achieve the 5-year projection of rents • Calculate the capitalization rate for each of the 5 years • Measure yield using the IRR

Application

• The calculations demonstrated in this case study apply to any commercial transaction whether the client is international or domestic.




Dr. Garcia Worksheet 1. Desired NOI

2. Monthly loan payment

3. Annual Debt Service

4. Cash Flow Before Taxes

5. Cost of Points

6. Before Tax Cash on Cash Return

7. Total Initial Investment

8. Projected Sales Price

9. Remaining loan balance EOY 5

10. Costs of sale

11. Net Sales Proceeds Before Taxes

12. IRR

13. Depreciable Basis

14. Cost Recovery

15. Mid-month Convention Year 1

16. Total Cost of Points

17. Cost of Points per Year

18. Adjusted Basis

19. Capital Gain

20. Tax Liability

21. Sales Proceeds After Taxes

22. After Tax IRR

Activity

Instruct students to remove this page from

their notebook and fill in the blanks for Dr.

Garcia as you move through the material.

They will need some of these answers to complete future

calculations.



Dr. Garcia Referral Ramon Gonzalez, whom you met at the NAR International Networking Center in San Francisco, calls to make a referral of Dr. Garcia from Cabo San Lucas. Dr. Garcia has been researching your part of the country on the internet and in international business publications. He is interested in acquiring a real estate investment in your area.

After finalizing the terms of the referral, Lic. Gonzalez faxes you the following information.

Step #1:

Client Profile Name: Dr. Garcia

Nationality: Mexican national

Occupation: investor/businessman

Residency status: non-resident alien

Family information: unknown, except that various family members manage some of his businesses.

Stated requirements: safe real estate in the southeastern USA

Price range: US$6-8 million

Step #2: Conversions Dr. Garcia does not require any area or currency conversions at this time.

Step #3: Client Objectives

• Invest $6-8 million in USA real estate.

• Achieve 12% before-tax cash-on-cash yield on 100% equity investment.

• Obtain 12% before-tax cash-on-cash yield with financing.

• Realize 10% after-tax yield if sold after five years

Introduce the new

case.

This is a commercial transaction. The

purpose of the case is to expand financial analytical skills.



• Take title through a single-asset domestic corporation.

• Finance 50% of the purchase price.

Step #4: Client Motivations

Spread risk of family portfolio by diversifying.

Find safe harbor for part of family capital.

Minimize risk.

Minimize management requirements.

Step #5: Assembling a Team

What team members might be needed for Dr. Garcia?

Step #6: Local Market Investment Opportunities

• A group of four steak houses

o Net leased to a national chain with good credit standing.

o All four properties are offered for $7.8 million

o 9% cap rate calculated on contract rent.

o Leases contain percentage rents projected to increase the yield to 12% over the next four years.

o Two properties have eight years remaining on the leases with 10-year renewal options.

o Two properties have nine years remaining and 10-year renewal options.

o None of the properties are producing percentage rents at this time

Group Activity

Ask class as a whole what team members might be needed and

why.



• A new build-to-suit office building leased to a start-up software firm o 140% increase in price of stock since going public six months ago.

o Excellent business plan

o Some of the brightest young minds in the software industry

o Offered sales price is $6.2 million

o Cap rate of 14%

• A new warehouse and distribution center

o Leased for 20 years to a NYSE-listed pharmaceuticals company

o Company holds multiple patents for prescription and non-prescription medications

o Active research department working on several new treatments for AIDS, cancer and Alzheimer’s disease

o Property is listed for $7.9 million

o Cap rate of 9%

o Lease contains annual increases of 3%

Dr. Garcia’s Decision Dr. Garcia decides to investigate the pharmaceuticals warehouse for the following reasons:

• Steakhouses

o Did not like the food

o Options for renewal gave landlord minimum say in new rent levels

o All leases have renewal dates within months of one another

• Software company

o Too risky

o Product focus too volatile/unstable

• Pharmaceutical warehouse

o Likes medical industry

o Believes needs of aging population will stimulate growth

o Likes warehouse construction



o 9% cap rate lower than he wanted to achieve

Annual rent increases helped offset cap rate issue

o Conversion of income to pesos should significantly increase annual yields

Dr. Garcia’s Questions

Question #1: Dr. Garcia asks for a five-year projection of rents and the cap rate for each year.

What you know:

The first-year rent is $59,250 per month.

The property has a net lease meaning the tenant pays taxes, insurance and maintenance

Where to begin:

• Organize operating data to calculate Net Operating Income (NOI)

• With no allowance for vacancy and credit losses and no additional income, the NOI and rent are the same.

Steps for Calculating Net Operating Income (NOI)

Gross potential rental income ____________________

(-) vacancy and credit losses ____________________

(=) Effective gross income ____________________

(+) other income ____________________

(=) Gross operating income ____________________

(-) operating expenses ____________________

(=) Net operating income (NOI) _________________

Calculating Desired Net Operating Income (NOI)

NOI (Income) (=) Purchase Price (Value) multiplied by the cap rate (R)

$7,900,000 (purchase price) x .09 (cap rate) = $711,000 per year rent (income)

Note

The warehouse must generate $711,000/yr.

rent to meet Dr. Garcia’s 9% cap rate requirement

on this $7,900,000 investment.

Answers

59,250 0 59,250 0 59,250 0 NOI = 59,250

Exam Question #17:

Which of the following has no effect on NOI?

Cost recovery

Exam Question #18:

Which of the following is not a tenant expense

for a lease?

Mortgage payments



Dr. Garcia’s Response Dr. Garcia finds this investment’s projected income and cap rates fall short of meeting his requirement of 12%.

Question #2:

Dr. Garcia asks if he can finance 50% of the purchase price, what his payments will be and what an analysis of his yield will be with the

financing.

Year

Annual Rental Income

Original Price of Property

Capitalization Rate (Cap Rate)

1 $711,000 $7,900,000 9.0%

2 $732,330 $7,900,000

3 $754,300 $7,900,000

4 $776,929 $7,900,000

5 $800,237 $7,900,000

6 $824,244 $7,900,000

Calculating Annual Rent Increases

Formula: Rent for year 1 (+) % increase (=) Rent for year 2

Enter Annual Rental Income $711,000.00 1. Press (+), (3), (%), (K), (=)

Press (=) key $732,330.00 (Rent for year 2) Press (=) key __________ (Rent for year 3) Press (=) key __________ (Rent for year 4) Press (=) key __________ (Rent for year 5) Press (=) key __________ (Rent for year 6)

Calculate New Annual Cap Rate [Valid for the first year]

Formula: Cap Rate (=) Annual Rental Income (÷) Original Price of Property

Answers

Rent Income

732,330.00 754,299.90 776,928.90 800,236.76 824,243.87

Answers

Yr. 1 9.0% Yr. 2 9.27% Yr. 3 9.54% Yr. 4 9.83% Yr. 5 10.13% Yr. 6 10.43%



• You find a mortgage broker who can provide:

o 50% mortgage

o 7.5% interest

o 1.5 points

o 15-year, fixed-rate loan

o Loan amount will be $3,950,000

Cash Flow Before Taxes{ XE "cash flow before taxes" } and Cash-on-Cash Yield (CFBT – ADS)

Calculating Monthly Loan Payments

1. Clear all memory and reset calculator (GOLD Key) (C ALL)

a. Payments at 12/year (1, 2, GK, P/YR)

2. Enter term of the loan (15)

3. Press (GOLD Key), (xP/YR) (total periods/year)

4. Enter interest rate (7.5)

5. Press I/YR

6. Enter loan amount (3,950,000)

7. Press (PV)

8. Enter (0) (value at end of paid off loan)

9. Enter (FV) future value when paid off

10. Press (PMT) for monthly payment

11. Answer: _________________ Answer

$36,617.

Annual Debt Service (ADS)

Formula: Monthly payment (X) 12 (months in a year) = Annual Debt Service

$36,617 (monthly payment) (X) 12 (months) (=) $____________

Answer

$439,404



{ XE "cash-on-cash yield" }

The CFBT and cash-on-cash yield can now be derived for each year:

Calculating Pre-Tax (CFBT), Cash-on-Cash (ConC) Yield [Valid for the first year]

Formula: CFBT (÷) Original amount invested (including points) (=)

ConC (cash-on-cash) Yield

Calculating Dollar Cost of Points

Formula: Loan Amount (X) Cost of Points (=) Dollar cost of points

$3,950,000 (loan amount) (X) .015 (cost of points) (=) ______________

Calculating Original Amount Invested

Formula: Initial investment (+) Cost of points (=) Total initial investment

$3,950,000 (initial investment) (+) $59,250 (cost of points) (=) _______________ (Total initial investment)

Cost of Points

$59,250

Total initial investment

$4,009,250.

(I)ncome Before Taxes

(CFBT)

V (V)alue of Investment

I

R (R)ate of Return

Cash-on-Cash Yield

Exam Question #19:

A borrower obtains a 75% LTV mortgage on a $280,000 property with 1 discount point.

What is the cost of that point?

$2,100



NOI (-) ADS (=) CFBT (÷) DP with points (=) ConC $711,000 439,404 271,596 4,009,250 ____% $732,330 439,404 292,926 4,009,250 ____% $754,300 439,404 314,896 4,009,250 ____% $776,929 439,404 337,525 4,009,250 ____% $800,237 439,404 360,833 4,009,250 ____%

Dr. Garcia’s Response

• If his offer is accepted, Dr. Garcia accepts the payment figure, on a 50%, 7.5% interest, 15-year, fixed rate loan.

• One of his objectives was to obtain 12% before-tax cash-on-cash yield with financing.

• This investment falls short of that objective.

• Are there any off-setting points you can present?

Question #3: Dr. Garcia requests a five-year projection of the rents and a projected sale price, assuming he sells the property after the fifth

year.

• What you know

o Dr. Garcia tells you to use the sixth year income figures

o Determine the sale price at a 9% cap rate.

o A single asset corporation will own this property.

o The first $50,000 of income will be taxed at 15%.

o The balance will be taxed at 25%.

o The property will be depreciated over 39 years.

o The land is worth 20% of the total purchase price.

Calculating Cash-on-Cash (ConC) Yield [Valid for the first year]

ConC

6.77% 7.31% 7.85% 8.42% 9.0%

Off-setting Point

The loan is for 15 years allowing his equity to build at a more rapid pace.

Can you think of

others?



• Calculations so far:

o NOI

o Annual Rental Increases

o Annual Property Value at 9% Cap Rate

o Monthly Loan Payment

o Annual Debt Service

o Cash Flow Before Taxes

o Dollar cost of points

o Before Tax Cash-on-Cash Return

Net Sales Proceeds before Tax{ XE "net sales proceeds before tax" }

• Calculate the results of selling the property after five years.

• How will that affect the yield?

• Begin by calculating the net sales proceeds.

• The net sales proceeds are added to cash flows to derive after-sale proceeds.

Calculating Net Sales Proceeds before Tax

Sales price ______________ Based on Year 6 NOI $824,244.00 Divided by (÷) 9% cap rate (=) projected sales price (-) Mortgage balance EOY5 ______________ (-) Costs of sale ____________

(=) Net sales proceeds before taxes ______________

Answers

Price: $9,158,267

Mortgage Balance:

$3,084,789

Costs of Sale: $641,079

NSPBT:

$5,432,400

Cash Flow Before Tax

Net Sales Proceeds

Before Tax

Before Tax After Sale Proceeds



• Use the Traditional Method to calculate Dr. Garcia’s remaining loan balance after five years.

Calculating Remaining Loan Balance

Traditional Method

Calculate Remaining Loan Balance at the end of 5 years. 1) Clear the calculator (Gold key) (C All)

2) Set payments at 12/year. (1, 2, Gold Key, P/YR)

3) Enter the term of the loan:

Press 1, 5, (GOLD KEY), (xP/YR)

4) Enter the interest per year:

Press 7.5 (I/YR)

5) Enter the loan amount:

Press 3,950,000, (PV)

6) Enter zero in future value for full amortization:

Press 0, (FV)

7) Find the monthly payment:

Press (PMT) (Answer will be 36,617.)

8) To see the interest, principal and balance amounts:

Press (GOLD KEY) (Amort)

Display the first 12 month period (Per 1-12)

9) Press = to display the principal amount: Prin 148,178

10) Press = to display the interest amount: Int 291,225

11) Press = to display the balance: Bal 3,801,821

12) Enter interest, principal and loan balance in the chart below 13) Press (GOLD KEY) (Amort) for Per 13-24

14) Press = key 3 times for interest, principal and loan balance for Year 2

15) Enter in chart below.

16) Continue steps 13-15 until you have figures through Year 6

17) Enter all calculations in chart below

18) The loan balance at the end of (Per 49-60) or year 5 is ______________

Exam Question #20:

What is the regular monthly payment on a

9% fixed-rate mortgage of $200,000 with a 30-

year term?

$1609.24

Exam Question #21:

What is the balance at the end of the 4th year of

payments on the mortgage from Question 19? Calculate one year

at a time using the “amort key” on the

calculator.

$193,716.14

Answer

$3,084,789



Steps for Calculating Net Sales Proceeds before Tax

Sales price ______________ [Based on Year 6 NOI (÷) 9% cap rate (=) projected sales price] (-) Mortgage balance EOY5 ______________ (-) Costs of sale ______________ (=) Net sales proceeds BEFORE taxes ______________

Dr. Garcia will have ______________ left BEFORE he pays taxes.

Dr. Garcia’s Principal, Interest and Remaining Loan Balance

EOY Principal Interest Remaining

Loan Balance

1

2

3

4

5

6

Answers

$9,158,267

$3,084,789

$ 641,079

$5,432,399

Calculating Costs of Sale

Formula: Sales Price (X) Cost of Sale Estimate (%) (=) Cost of Sale

If Dr. Garcias’s sales price is $9,158,267 and selling costs total 7%, what is his cost of sale?

$9,158,267 (sales price) (X) 7% (selling cost estimate) (=) __________ (costs of

sale)

Answer

$641,079

Answers

148,178.75 Principle 291,225.11 Interest 3,801,821.25 Balance

159,682.25 Principle 279,721.60 Interest 3,642,139.00 Balance

172,078.80 Principle 267,325.06 Interest 3,470,060.20 Balance 185,437.72 Principle 253,966.14 Interest 3,284,622.49 Balance 199,833.73 Principle 239,570.13 Interest 3,084,788.75 Balance 215,347.35 Principle 224,056.51 Interest 2,869,441.41 Balance



Measuring Annual Yield Using the IRR • What is an IRR?

o Measures inflow and outflow of capital over time

o Considers uneven cash flows

o Reduces a variety of investments to a common return rate

o Conventional investments considered attractive if the IRR is greater than the cost of the capital [positive leverage]

• The T-bar is used to calculate the IRR

• Components of the T-bar model include:

o Initial investment

o Investment holding period

o Cash flows from operations

o Sales proceeds

Dr. Garcia’s Annual IRR for Pre-Tax Cash Flow{ XE "IRR of pre-tax cash flow" } Within the T-bar model, n indicates the time period, and $ indicates the cash flow. The T-Bar for cash flows of Dr. Garcia’s investment is as follows:

n $

0 (4,009,250) Down payment + points

1 271,596 Cash flow EOY1

2 292,926 EOY 2

3 314,896 EOY 3

4 337,525 EOY 4

5 360,833 EOY 5 + 5,432,399 (reversion)*

*reversion means the sales proceeds



The IRR for this property exceeds Dr. Garcia’s initial request.

Cash Flow After Taxes Income will have an effect on the returns Dr. Garcia actually receives. These are examined in Chapter 7.

Calculating Annual IRR

Set calculator for 1 period per year (1), (GOLD KEY), (P/YR)

1. Press (GOLD KEY), (C ALL) to clear all registers

2. Enter 4,009,250 (initial cash flow)

3. Press (+/-) (money going out is negative)

4. Press (CFj)

5. Enter 271,596 (EOY 1 cash flow)

6. Press (CFj)


8. Press (CFj)


10. Press (CFj)


12. Press (CFj)


14. Press (+)

15. Enter 5,432,399 (reversion/net proceeds before taxes)

16. Press (=)

17. Press (CFj)

18. Press (GOLD KEY), (IRR/YR)

19. The IRR for Dr. Garcia’s property is __________________

Exam Question #22:

A property had the

following cash flows. What was its IRR?

Yr 0 (4,000,000) Yr 1 200,000 Yr 2 225,000 Yr 3 240,000 Yr 4 250,000

Yr 5 265,000 + 5,000,000

9.93

Answer

13.19 IRR



Key Point Review • The 6-Step Preparation Process helps organize data regarding client.

• Purchasing decisions are based on a variety of financial calculations.

• The international real estate agent must be prepared to:

o apply the necessary calculations

o satisfactorily explain the meaning of each

• The IRR is a useful tool in measuring the investor’s annual yield

over a period of time.




Chapter 7:

The Impact of Taxes on Investments

Overview This chapter revisits Dr. Garcia’s transaction and examines the effect of

taxes on the rate of return.

Objectives • Calculate the potential effect taxes have on a real estate

investor’s return

• Recognize the need to develop a team of legal and tax experts

Application Every investor’s tax situation is unique. Agents must understand and

communicate the potential effects of taxes on the investor’s property. It is

necessary to consult tax experts to ensure the best possible return for your

client and reduce your level of risk.




Effect of Taxes{ XE "effects of taxes" }

• Taxes have a profound effect on the return of an investment.

• Calculating the tax that will be paid depends on several variables.

o ownership entity

o residency status

o laws of descent

o bankruptcy

o profits

• Tax laws change frequently and are often complex

• Unwise to assume generalities

• Every investment has unique attributes that affect tax liability

• It is always best to consult tax and legal experts

• Many countries have tax treaties with other nations that affect

o tax rates

o withholding rates

o applicability of branch profits tax

• Tax treaties change frequently

• Information is available on the Internal Revenue Service web site at www.irs.ustreas.gov

The Garcia Case (Tax During the Holding Period) In Chapter 6, some pre-tax financial projections were calculated for Dr.

Garcia’s purchase and eventual sale of a pharmaceutical warehouse.

• What we know:

o If he sold the property after five years, Dr. Garcia is estimated a pre-tax profit of $5,432,399

o The pre-tax annual IRR on cash flow would be 13.19%



• Additional calculations

o Depreciable basis

Land is not depreciable

Only improvements are depreciable

Deduct land from purchase price

Land assumed to be 20% of total property value

o Straight-line depreciation (cost recovery)

Assume a 39-year straight-line depreciation

• Depreciation will be the same every year

• First and last years are the exceptions

Answer

$162,044.80 Depreciation (cost

recovery) per full year

Calculating Depreciable Basis

$7,900,000 (purchase price) (X) 20% (=) $1,580,000 (land value)

$7,900,000 (purchase price) (X) 80% (=) $6,320,000 (improvements)

Only improvements are depreciable.

Dr. Garcia’s depreciable basis is ____________________

Straight-line Depreciation (Cost Recovery)

Formula: Divide 100 by number of depreciable years

Dr. Garcia’s property is assuming a 39-year straight-line depreciation

100 (÷) 39 (=) 2.564% (depreciation per year)

Dr. Garcia’s annual depreciation (cost recovery):

$6,320,000 (depreciable basis) (X) .02564 (depreciation factor)

(=) ____________________ (depreciation per year)

Answer

$6,320,000 Dr. Garcia’s depreciable

basis



o Mid-month Convention

Mid-month convention states all closings occur on the 15th of the month for tax purposes

Because you are only projecting the sales price, assume the closing will occur after the 60th month.

o Deduction of Mortgage Points

Pro-rata annual portion is deductible

Answer

$155,282.40 Depreciation (cost recovery) 1st year

Answer

2.457% Partial year depreciation

(cost recovery) factor

Total Cost of Points

$59,250

Cost of Points/Year

$3,950

Mid-Month Convention

Formula: Divide months of the partial year by full year.

Multiply answer by 2.564 depreciation factor

11.5 (partial yr.) (÷) 12 (full yr) (X) 2.564 (full yr. depreciation factor) (=) ____________ (partial year depreciation factor)

$6,320,000 (depreciable basis) (X) 0.02457 (partial year depreciation factor) (=)

______________(Dr. Garcia’s 1st year depreciation)

Deduction of Mortgage Points

Dr. Garcia can deduct the pro-rated annual portion of the points paid. Points are amortized over the life of the loan. Unamortized points for remaining life of the loan will be expensed at time

of sale. Dr. Garcia’s points deduction.

Formula:

Loan amount (X) % cost of points (=) Total cost of points

$3,950,000 (loan amount) (X) .015 (% cost of points) (=) __________ $59,250 (Total cost of points) (÷) 15 (term of loan) (=) _________/yr



o Taxable income

NOI – Cost Recovery – Interest – Points = Taxable income

On a net-leased property, the only significant deductions from NOI are cost recovery (depreciation) and interest.

Calculating Taxable Income Yr.

NOI (-)

Cost Recovery (-)

Interest (-)

Points (=)

Taxable Income

1 $711,000 155,282 291,225 2 $732,330 162,045 279,722 3 $754,300 162,045 267,325 4 $776,929 162,045 253,966 5 $800,237 162,045 239,570

o Total tax

The first $50,000 of income will be taxed at 15%.

The balance will be taxed at 25%.

Calculating Total Tax • Calculate Dr. Garcia’s taxes

• Assume Dr. Garcia will pay:

o 15% on the first $50,000

o 25% on the balance.

Year

Taxable Income

1st 50K taxed @

15%

Taxable Balance

Taxed at

25%

Total Tax 1 $260,543 $7,500 $210,543 $52,636 $60,136 2 $286,614 $236,613 3 $320,980 $270,980 4 $356,968 $306,968 5 $394,672 $344,672

Calculate the remaining taxes and complete the chart.

Taxable Income

Year 1: 260,543 Year 2: 286,613 Year 3: 320,980 Year 4: 356,968 Year 5: 394,672

Answers

50K taxed at 15% $7,500/year 1-5

Answers

Taxed at 25% Year 1: $52,636 Year 2: $59,154 Year 3: $67,745 Year 4: $76,742 Year 5: $86,168

Exam Question #23

Cost recovery is an expense deduction when figuring the

taxable income of a property.

True



CFBT

(-) Tax

(=) CFAT

(÷) Down Payment

(=) ConC

$271,596 $60,136 $4,009,250 $292,926 $66,654 $4,009,250 $314,896 $75,245 $4,009,250 $337,525 $84,242 $4,009,250 $360,833 $93,668 $4,009,250

Net Sales Proceeds After Tax{ XE "net sales proceeds after tax" }

• To calculate the cash flow after taxes, you have to know how much the capital gains taxes will be (as opposed to income taxes in the previous section).

• The formula for calculating capital gains tax liability is:

• The sales price and selling costs are known from the CFBT analysis.

• The adjusted basis needs to be identified

Calculating Cash-on-Cash (ConC) Yield After Taxes

Formula: CFBT (-) Total Tax (=) CFAT (÷) Down Payment (=) ConC

Answers Cash Flow After

Taxes

Year 1: $211,460 Year 2: $226,273 Year 3: $239,651 Year 4: $253,283 Year 5: $267,165

Answers

(ConC) Yield

Year 1: 5.27% Year 2: 5.64% Year 3: 5.98% Year 4: 6.32% Year 5: 6.66%

Steps for Calculating Capital Gains Tax Liability

Formula: Sales Price $9,158,267

(-) Selling Costs 641,079

(-) Adjusted basis _______________

(=) Gain _______________

(X) Tax Rate (25%) _______________

(=) Tax Liability _______________

Answers

Adj. Basis 7,096,538

Gain

1,420,651

Tax Liability 355,163

Exam Question #24:

Selling costs may be subtracted from the

Sale price when figuring one’s capital

gain tax liability.

True.



• From the adjusted basis, you can calculate Dr. Garcia’s:

o Capital gains

o Tax liability

o Sales proceeds after taxes

o Yield on CFAT (assuming the sale after the fifth year).

Calculating Adjusted Basis

Formula: Purchase Price (+) Capital Improvements

(-) Cost Recovery Taken (=) Adjusted Basis

Purchase Price $7,900,000

(+) Capital Improvements 0

(-) Cost Recovery _________

(=) Adjusted Basis _________

Cost Recovery: Yr. 1 155,282 Yr. 2 162,045 Yr. 3 162,045 Yr. 4 162,045 Yr. 5 162,045 803,462

Adjusted Basis:

$7,096,538

Calculating Capital Gain and Tax Liability

Projected Sales Price $ 9,158,267

(-) Selling Costs 641,079

(-) Adjusted Basis 7,096,538

(=) Capital Gain __________

(X) Tax Rate (25%)

(=) Tax Liability __________

Answers

Capital Gain: $1,420,651

Tax Liability:

$355,163



a.

Calculating Sales Proceeds after Taxes

Sales Price $ 9,158,267

(-) Mortgage Balance 3,084,789

(-) Costs of Sale 641,079

(=) Net Sales Proceeds BEFORE Taxes $ 5,432,399

(-) Tax Liability 355,163

(=) Net Sales Proceeds AFTER Taxes __________ Answer

$5,077,237

Exam Question #25

The formula for net sale proceeds after taxes is:

Sale price minus selling costs, the

mortgage balance, and taxes



Annual IRR Yield of After-tax Cash Flow n $ 0 (4,009,250) 1 211,460 2 226,273 3 239,651 4 253,283 5 267,165 + $5,077,237

The IRR for the cash flow after tax is 10.25%, compared to an IRR of

Calculating Dr. Garcia’s After Tax IRR (Internal Rate of Return)

1. Set calculator for 1 period per year (1), (GOLD KEY), (P/YR)

2. Press (GOLD KEY), (C ALL) to clear all registers

3. Enter 4,009,250 (initial cash flow)

4. Press (+/-) (money going out is negative) 5. Press (CFj)

6. Enter 211,460 (EOY 1 cash flow) 7. Press (CFj)


9. Press (CFj)


11. Press (CFj)

12. Enter 253,283 (EOY 4 cash flow) 13. Press (CFj)

14. Enter 267,165 (EOY 5 cash flow) 15. Press (+)

16. Enter 5,077,237 (Net proceeds AFTER taxes)

17. Press (=)

18. Press (CFj)

19. Press (GOLD KEY), (IRR/YR)

20. Dr. Garcia’s After Tax Annual IRR is __________________

Answer

After-Tax IRR 10.25% IRR

Compared to 13.19 % IRR Before Tax



Key Point Review • Pre-tax and after-tax investment yield calculations influence the

sophisticated investor’s purchasing decisions • The real estate professional must be aware of the steps involved and

develop a comfort level in setting up and completing the necessary calculations

• Capital gains, tax liability, sales proceeds after taxes and the yield on Cash Flow After Taxes are calculated from the adjusted basis.

• The T-bar is a useful tool for calculating the annual yield, after-tax cash flow.




Chapter 8:

Case Study: Eurovest An Outbound Commercial Transaction

Overview This chapter involves:

• Analysis of an outbound commercial transaction. • Analysis includes matching a client’s investment objectives with a

potential real estate purchase. • Examining the effects of change in the rates of exchange on a buyer’s

return on investment.

Objectives • Analyze potential before-tax, cash-on-cash return.

• Project sales proceeds.

• Estimate the internal rate of return (IRR).

• Evaluate the effects of fluctuations in currency value on the IRR.

• Utilize an annual property operating data (APOD) form and an international cash flow analysis worksheet to organize data for calculations.

Application It is not unusual for international transactions to take several months or years to close. During this time, it is important to monitor exchange rate trends and be able to advise clients of possible opportunities or unfavorable conditions for the transaction.

Time: 90 minutes

Read through overview, objectives, and

application with students.

Ask for any questions.



Case 3: Eurovest: An Outbound Commercial Transaction{ XE "outbound commercial transaction" } EuroVest, a Brazilian pension fund that concentrates on European investments, is willing to invest in a net-leased facility located somewhere in Europe. They want a quality grade investment to protect their income stream.

Client Profile Name: EuroVest

Nationality: Brazilian

Business: Pension fund investing in net-leased European real estate

Objectives: To provide capital and financing expertise in key European markets for strong, creditworthy USA firms

Stated requirements: Investment parameters depend on type and location of project

Price: 30,000,000 BRL (minimum)

Client Objectives • EuroVest’s reasons for choosing an investment are largely based on the

economic feasibility of the individual real estate project.

• Decisions are also based on:

o confidence in the business

o creditworthiness of the tenant

o stability of the target market

o suitability of the target location to the tenant’s business

Matching Objectives with Potential Investments You receive a phone call from Mr. Stephen Bosco, executive VP of OptiGro. You learn OptiGro is a rapidly growing, Chicago-based company that has a newly patented method for analyzing the chemical and microbiological composition of soil and minerals in a given agricultural area. The revolutionary output of the computer-assisted analysis includes a summary of the area’s soil makeup, and recommendations as to what crops should be grown in the area and which combination of fertilizer compounds would optimally enhance the growth of those crops.

BRL = Brazilian real



Mr. Bosco proposes to develop a build-to-suit facility. OptiGro will develop the property to its own specifications, then sell the property and lease it back from the buyer for a term of 20 years. In addition, the buyer will have the option to sell the property to OptiGro at the end of five years.

You call your contact at EuroVest, describe the opportunity and provide him with information on OptiGro. He feels this looks very promising and would like you to pursue it on behalf of EuroVest.

Over a period of several months, you and Mr. Bosco study various countries and regions in Europe. Mr. Bosco finally decides on the Seville area of Spain. After selecting the area, a piece of property is selected, plans are drawn and construction estimates are obtained. The project is now known as Dos Cantos.

Property Profile Name: Dos Cantos

Type: high tech office/warehouse

Location: Carretera de Burgos, 98 Seville, Andalucia Spain

Bldg. Size: 10,000 square meters

Site Size: 2.0 hectare (= 20,000m2)

Tenant Data: Name: OptiGro

Location: Chicago, IL, USA

Requirements: more than 100,000 square feet

Budget: $25 per sq. ft per yr. net

Revised Client Objectives Based on this particular property, EuroVest states that their goals for this investment are:

• first year minimum cash-on-cash yield of 11%

• 11% minimum IRR on five-year hold

• an option to sell at the end of the fifth year



Estimating Return • You are ready to make a proposal to the selection committee at

EuroVest.

• Costs and developed rental rates acceptable to OptiGro have been determined.

• Calculate the final numbers and see if the Dos Cantos project will meet the client’s revised objectives.

As the proposal moves forward you will:

o determine how much EuroVest will pay for Dos Cantos based on a 11% cash-on-cash first year return.

o calculate the yield in each year during the five-year holding period.

o determine the IRR if Dos Cantos is sold after five years.

Year One Operating Data and Cash-on-Cash Return • OptiGro found that the Dos Cantos facility will meet its space

requirements and stated its first year rent goals in dollars per square foot.

• Because this is intended to be a European business, the lease will specify payment in euros and the increases in rent will be based on euros.

Convert Square Meters to Square Feet

Conversion Factor: 1 square meter (=) 10.7639 square feet Formula: # m² (X) conversion factor (10.7639)

10,000 m² (X) 10.7639 (=)_________________ Sq. Ft.

Calculating Rent

Formula: # Sq. Ft. (X) Rent/sq. ft. (=) Total rent

_________ Sq. Ft. (X) $25 (Rent/sq. ft.) (=) _________ Annual Rent

Answers

10,000 m² (=) 107,639 SF

Annual rent: $2,690,975



• Assume 1 Euro (EUR) = 1.25 USA Dollars (USD)

• Convert the rent to euros:

• To continue to determine the cash-on-cash return and IRR, make the following assumptions:

o five-year holding period

o 2% rent escalation

o 11% cap rate at sale

o no vacancy

o initial investment = total acquisition costs

o 0 expenses

Use the data provided to complete the blank International Annual Property Operating Data (APOD) form on the next page. Since EuroVest is a Brazilian company, you may want to calculate the numbers in both euros and reals. Assume the following:

Euro (EUR) = 2.73 real (BRL) 1 BRL = .365 EUR

1 EUR = 1.25 USD 1 USD = .80 EUR

Because a Brazilian Pension Fund is the purchaser/owner and the property is located in Spain, U.S. taxes will not be an issue in these calculations.

Complete the APOD that is on the next page with the class. Explain where the

figures come from.

When the form is completed, calculate the

cash-on-cash return: € 2,152,780 ÷ 19,570,727 =

11%.

Compare C-on-C return with Eurovest’s investment

objectives.

Converting US Dollars into Euros (€)

Formula: USD (÷) Conversion Factor

____________ USD (rent) (÷) € 1.25 (Conversion Factor)

(=) €_____________ (Rent in euros)

Answer

2,690,975 USD (÷) 1.25 (=) € 2,152,780



International Annual Property Operating Data (APOD)

Currency: Property name: Date Location: Price Property type: Loan info: Property size: land: Bldg.:

Operating income: EUR BRL

Potential rental income Less vacancy & credit lossEffective rental income Plus other income Gross operating income

Operating expenses:

Real estate taxes Personal property taxes Property insurance Management fees Repairs & maintenance Services Accounting & legal Leasing commissions Other

Total operating expenses

Gross operating income Minus total operating expenses Net operating income (NOI) Less annual debt service (ADS) Total cash flow before taxes

Note: Now that you have figured the cash flow before taxes, divide it by the investment amount to determine the cash-on-cash return:

cash flow before taxes / investment amount = cash-on-cash return



International Annual Property Operating Data (APOD) Currency: euros and/or reals Property name: Dos Cantos Date Location: Seville, Spain Price: 19,570,727 EUR (rent/cap rate of 11%) Property type: high tech office/warehouse 53,428,085 BRL Loan info: Property size: land: 2 hectare Bldg.: 10,000 m2 Operating income: EUR BRL

Potential rental income 2,152,780 5,877,089Less vacancy & credit loss 0 0Effective rental income 2,152,780 5,877,089Plus other income 0 0Gross operating income 2,152,780 5,877,089

Operating expenses:

Real estate taxes Personal property taxes Property insurance Management fees Repairs & maintenance Services Accounting & legal Leasing commissions Other

Total operating expenses

0 0

Gross operating income 2,152,780 5,877,089minus total operating expenses Net operating income (NOI) 2,152,780 5,877,089Less annual debt service (ADS) 0 0 Total cash flow before taxes

2,152,780 5,877,089

Cash flow before taxes 2,152,780 5,877,089divided by investment amount 19,570,727 53,428,085(NOI / Cap Rate) equals cash-on-cash return 11% 11%


Chapter 8-8 Copyright 2008 National Association of REALTORS®

Five-year Cash-on-Cash Returns • Use the data previously developed to complete this international cash flow analysis

worksheet.

• Develop answers in both euros and reals

• Check them against the solutions provided on the following pages.

In Eur YR1 YR2 YR3 YR4 YR5 YR6

Gross rental income

Net operating expenses

Net operating income

Annual debt service

Cash flow before taxes


Interest

Cost recovery

Taxable Income

X tax rate = liability


Minus tax liability

Cash flow after taxes

Divided by investment amount

Cash-on-cash return



In BRL YR1 YR2 YR3 YR4 YR5 YR6

Gross rental income

Net operating expenses


Annual debt service



Interest

Cost recovery

Taxable Income

X tax rate = liability


Minus tax liability



Cash-on-cash return


Chapter 8-10 Copyright 2008 National Association of REALTORS®

In EUR:

YR1 YR2 YR3 YR4 YR5 YR6 Gross rental income 2,152,780 2,195,836 2,239,752 2,284,547 2,330,238 2,376,843

Net operating expenses 0

Net operating income 0

Annual debt service 0

Cash flow before taxes 2,152,780 2,195,836 2,239,752 2,284,547 2,330,238 2,376,843

Net operating income 2,152,780 2,195,836 2,239,752 2,284,547 2,330,238 2,376,843

Interest 0

Cost recovery 0

Taxable income 0

X tax rate = liability 0


minus tax liability 0



19,570,727 19,570,727 19,570,727 19,570,727 19,570,727 19,570,727

Cash-on-cash return 11% 11.22% 11.44% 11.67% 11.91% 12.14%



In BRL:

YR1 YR2 YR3 YR4 YR5 YR6 Gross rental income 5,877,089 5,994,631 6,114,523 6,236,814 6,361,550 6,488,781

Net operating expenses 0

Net operating income 0

Annual debt service 0


Net operating Income 5,877,089 5,994,631 6,114,523 6,236,814 6,361,550 6,488,781

Interest 0

Cost recovery 0

Taxable income 0

X tax rate = liability 0


Minus tax liability 0



53,428,085 53,428,085 53,428,085 53,428,085 53,428,085 53,428,085

Cash-on-cash return 11% 11.22% 11.44% 11.67% 11.91% 12.14%



Pre-Tax Annual IRR after Five Years

• Use the data previously developed to complete the international cash sales proceeds worksheet on the following page.

• This form provides the numbers needed to use the T-Bar for calculating the IRR.



International Cash Sales Proceeds Worksheet{ XE "international cash sales proceeds worksheet" }

Projected sale price (yr. 6 NOI at 11% cap)

Capital Gains and Gains tax

A. Adjusted basis

Beginning basis

- cost recovery taken

= Adjusted basis

B. Calculation of gain & tax

Sale price

- selling costs (7%)

- adjusted basis

= Taxable gain

x rate

%

= Capital gains tax

Calculation of sales proceeds after tax

Sale price

- selling costs

- loan balance

= Sales proceeds before tax

- Capital gains tax

= Net sales proceeds after tax



International Cash Sales Proceeds Worksheet

Projected sale price (yr. 6 NOI at 11% cap) 21,607,664

Capital Gains Tax

A.

Adjusted basis

Beginning basis 19,570,727

- cost recovery taken 0

= Adjusted basis 19,570,727

B.

Calculation of gain & tax

Sale price 21,607,664

- selling costs (7%) 1,512.536

- adjusted basis

19,570,727

= Taxable gain

524,401

x rate

0 %

= Capital gains tax 0

Calculation of sales proceeds after tax

Sale price 21,607,664

- selling costs

1,512,536

- loan balance

0

= Sales proceeds before tax 20,095,128

- Capital gains tax 0

= Net sales proceeds after tax 20,095,128

11%

Yr. 6 NOI 2,376,843

Answer:

21,607,663 (Euros)

Answer

Selling Costs at 7% = €1,512,536

NON-US Transaction: US Tax Items Do Not Apply

?



Annual IRR Calculation – Before Tax

n €

0 ( )

1

2

3

4

5 + =

IRR (=)

Complete T-Bar with

class.

A completed worksheet and T-Bar are provided

in the manual.



Annual IRR Calculation (Set calculator to 1 P/YR)

n € 0 (19,570,727) Initial Investment CFj

1 2,152,780 NOI EOY 1 CFj

2 2,195,835 NOI EOY 2 CFj

3 2,239,752 NOI EOY 3 CFj

4 2,284,547 NOI EOY 4 CFj

5 2,330,238 (+) 20,095,128 NOI EOY 5 (+) Net

Sales Proceeds After Tax (=) CFj

Gold Key IRR (=) ___________

How to calculate sales proceeds before tax: Sale price 21,607,664

- Cost of sale 1,512,536

- Loan balance 0

Sales proceeds before tax 20,095,128

Did this investment meet the client’s objectives?

1. EOY 1 minimum ConC yield of 11%?

2. 11% IRR on 5 year hold?

After completing the worksheet and T-Bar,

compare the results with the investor’s objectives.

Answer

IRR: 11.82%

Answers

Yes Yes



Dealing with Two Currencies • EuroVest is a Brazilian pension fund.

• What happens when you convert the euros to Brazilian reals?

IRR Calculation

1 EUR = 2.73 BRL

n EUR BRL

0 (19,570,727) (53,428,085)

1 2,152,780 5,877,089

2 2,195,836 5,994,631

3 2,239,752 6,114,523

4 2,284,547 6,236,814

5 2,330,238 (+) 20,095,128(=) 6,361,550(+)54,859,699(=)

IRR (=) _______ IRR (=) _______

Answers

EUR = 11.82% BRL = 11.82%



Effects of Exchange Rates on Investments{ XE "effects of exchange rates on investments" } • Consider the effect on the investment if the BRL weakens against the

EUR at the rate of 5% per year.

• EuroVest will receive fewer EUR for each BRL.

• Conversely, EuroVest will receive more BRL for each EUR

EUR BRL Year 0: 1 2.73 Year 1: 1 2.86 Year 2: 1 3.00 Year 3: 1 3.16 Year 4: 1 3.31 Year 5: 1 3.48

IRR Calculation with 5% Decrease in BRL Value

n EUR BRL

0 (19,570,727) (53,428,085)

1 2,152,780 6,156,950

2 2,195,835 6,587,505

3 2,239,752 7,077,616

4 2,284,547 7,561,850

5 2,330,238 (+) 20,095,128 (=) 8,109,228 + 69,931,041 (=)

IRR =_________ IRR = _________

• If the BRL loses 5% against the EUR per year, the IRR, as calculated in BRL, will increase proportionately.

• The higher IRR should not mislead one to think that the return is better or more desirable, because the value of the BRL is decreasing over time.

Remind students of the “strengthens”/

”weakens” concept discussed earlier in the

course.

Review use of K (constant) key

This is a key point in understanding the consequence of

currency rate fluctuations over time (and its relationship to

real property as an asset class.)

(+), (5), (%), (K), (=)

(=)

(=)

(=)

(=)

(=)

Answers

IRR (=) 11.82% EUR

IRR (=) 17.37% BRL



• If the BRL loses 5% against the EUR it takes fewer EUR to buy one BRL

• The increase in IRR, calculated in BRL, is caused by the higher BRL numbers resulting from declining BRL currency and not by increased property operations.

• If the BRL gains 5% against the EUR for five years, the IRR, as calculated in BRL, will decrease proportionally.

• The lower IRR should not mislead one to think that the return is worse or less desirable because the value of the BRL is increasing over time.

• If the BRL gains 5% in value each year against the EUR it takes more EUR to buy one BRL.

• The decrease in IRR, calculated in BRL, is caused by the lower BRL numbers resulting from the increasing BRL currency and not by declining property operations.

Currency Value Effect on IRR Causation

BRL weakens against EURO

IRR in BRL currency will increase

Caused by declining currency value not property operations

BRL strengthens against the EURO

IRR in BRL currency will decrease

Caused by increase in currency value not property operations

EUR BRL Year 0: 1 2.73 Year 1: 1 2.59 Year 2: 1 2.46 Year 3: 1 2.34 Year 4: 1 2.22 Year 5: 1 2.11

(-), (5), (%), (K), (=)

(=)

(=)

(=)

(=)

(=)



IRR Calculation with 5% Increase in BRL Value

n EUR BRL

0 (19,470,727) (53,428,085)

1 2,152,780 5,575,700

2 2,195,835 5,401,754

3 2,239,752 5,241,019

4 2,284,547 5,071,694

5 2,330,238 (+) 20,095,128 (=) 4,916,802 (+) 42,400,720 (=)

IRR =________ IRR = ________

Key Point Review • It is important to monitor exchange rates during a transaction because

they can have a significant effect on a client’s investment objectives.

• Real estate professionals must know how to organize and calculate certain financial projections so that they may provide clients with accurate assessments of potential return.

Answers

IRR (=) 11.82% EUR

IRR (=) 6.20% BRL



Appendix Formulas Equity investment purchase price – loan amount = equity investment

Cash flow before tax net operating income – annual debt service = cash flow before tax

Cash-on-cash return cash flow before tax equity investment = cash-on-cash before tax

cash flow after tax equity investment = cash-on-cash after tax

Debt coverage ratio net operating income annual debt service = debt coverage ratio

Loan-to-value ratio (LTV) loan amount

price = loan-to-value ratio

Maximum financing annual debt service mortgage constant = loan amount

Forms US Federal Tax Forms at www.irs.gov Form 2555 – Foreign Earned Income Form 8840 – Closer Connection Exception Statement for Aliens Form 1040NR – US Nonresident Alien Income Tax Return Form 8288-B – Application for Withholding Certificate for Dispositions by Foreign Person of US Real Property Interests Form 8833 – Treaty-Based Return Position Disclosure Under Section 6114 or 7701



Glossary

A Annual debt service (ADS) The principal and interest paid each year to satisfy the conditions of a loan contract. Adjusted basis A base price from which to evaluate the gains or losses incurred upon the sale of an asset. The basis is determined by adding the value of any capital improvements to the original price of the property, and subtracting any cost recovery deductions.

C Capital flow The movement of money, people, skills and innovations across national boundaries in exchange for other goods or services. Capitalization rate (cap rate) A ratio that represents the future income of an income-producing property. It is determined by dividing the net operating income by the purchase price. Cash flows The net income earned from an investment after depreciation and other noncash charges are taken into account. This can occur through active (sales) or passive (rents) income. Cash flow after taxes (CFAT) The amounts of money received from a real estate investment AFTER taxes have been incurred. These are the returns that an investor actually receives. Cash flow before taxes (CFBT) The amounts of money received from a real estate investment BEFORE taxes have been incurred. Cash-on-cash return A measure of yield in which the cash flow before taxes is divided by the original investment amount.

Currency A medium of exchange that holds value in a particular nation or market and can be exchanged for goods or services.



Compounding A process used in calculating the time value of money to determine the future value (FV) of an investment.

Control The level of involvement an investor maintains in managing an investment.

Cost recovery A deduction from taxable income based on the depreciable life of an asset.

D Debt coverage ratio (DCR) Ratio of net operating income (NOI) to annual debt service. It is determined by dividing NOI by annual debt service (or mortgage payment).

Depreciation The loss of value of a property over time.

Discounting A process used in calculating the time value of money to determine the present value (PV) of money to be received in the future. The PV is reduced to reflect the opportunity cost of waiting to receive the money.

E Exchange rate The value of one currency in terms of another, or the amount that must be paid in one currency in order to obtain an amount in another currency.

Equity investment The amount of money a buyer actually invests in a property. It is determined by subtracting the loan amount from the purchase price of the property.

F Feng-shui An ancient Chinese belief system based on creating harmony between humans and the environment to enhance well-being.



Foreign national A foreign citizen who is present in another country.

G Globalization A trend of movement by countries, companies, organizations and people toward a single market environment.

I Internal rate of return (IRR) The discount rate at which the present value of the future cash flows of an investment equals the cost of the investment itself. An investment is considered acceptable when the IRR yield is greater than the required rate of return.

Internal Revenue Service (IRS) A government entity that regulates and enforces tax laws in the USA.

IRV formula A formula used to calculate value by using a “snapshot” picture of a property at one moment in time. This calculation is used to determine both capitalization rate and cash-on-cash return.

L Leverage The use of borrowed funds to finance an investment.

Loan to value (LTV) The amount of money borrowed as compared to the total value of a property. It is determined by dividing the amount of the loan by the property value.

N NOI Net operating income. The potential income of a property after all operating costs and expenses are accounted for.



Non-resident alien A foreign citizen who is granted entry, but is not a resident of the USA.

Non-quantitative motivations Investor objectives that are tied to the investor’s personal preferences.

O Opportunity cost The rate of return that could be provided by an alternative course of action, but is lost due to the selection of the current course of action.

P Passive income Income from rental activity or other business in which the investor does not actively participate.

Purchasing power The value of money as determined by the amount of goods and services it can buy.

Q Quantitative motivations Investor objectives that are tied to the pursuit of profit and investment gains.

R Resident alien A foreign citizen who is granted temporary residency in the USA.

Risk A measure of the probability of gains or loss in the value of an investment.

S Safety The level of risk involved in an investment. When the risk is low, the safety is high, and vice versa.



T T-Bar A financial tool used to calculate a series of cash flows over a particular period of time.

Time value of money (TVM) An economic principle that states that the value of money received in the present is greater than money received in the future due to earning power.

Y Yield The measure of return on an investment.

investment & financial analysis for international real estate

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