REAL ESTATE INVESTMENTS

& FINANCE
School of Economics
Lee Kong Chian School of Business

Professor Francis Koh

Mapletree Professor of Real Estate

Ku Swee Yong
Adjunct Faculty

1
FNCE231 Lecture
Real Estate Investments and Finance
2
Content
Sathorn Unique Tower

Source: https://en.wikipedia.org/wiki/Sathorn_Unique_Tower
 5
Source: https://groundworkusa.org/wp-content/uploads/2017/06/GroundworkUSA_Development-Process-Map_06.08.17.jpg
 Development Process

• Organization’s • Market test and • Development and • Construction • Operating

goals analysis Operating Pro contracts management and
• Evaluate site • Site analysis Forma • Project maintenance
• Create cost plan • Test cost • Quotes from management • Equity pay-in
• Estimate assumptions suppliers and • Quality and cost • Repay mortgage
development cost • Discuss team contractors control and refinance
roles and project • Negotiation with • Pre-marketing • Report to
details lenders and leasing investors

Source: https://groundworkusa.org/wp-content/uploads/2017/06/GroundworkUSA_Development-Process-Map_06.08.17.jpg
 Development Process
ACTORS PROJECT PHASES
In order to calculate cash
flows, risks and rewards at • Development Concept
different phases, we have Owner/ Investor/
Lender
Formation
to understand the project
development process and
the various actors • Feasibility
involved. • Planning & Financing
Development • Construction
Manager

• Leasing and/or Sales

Asset • Operations
Manager

Source: http://www.ahjamah.com/businesses/development-management
 Project Risks

1. Costs increase with time

2. Risk profile is inversely related to cost profile, i.e. risk
reduces as the project proceeds and uncertainties are
resolved

“Does developer have sufficient funds “Can the project pay a return on
to pay upfront costs?” investment after completion? ”

Source: Chapter 1, The Development Process, Finance for Real Estate Development, Charles Long
 Simple Risk-Cost Profile

Source: Risk-Cost Profile of Development, Chapter 1, The Development Process, Finance for Real Estate Development, Charles Long
 Example of Risk-Cost Profile

> Cost

Source: http://geothermalresourcescouncil.blogspot.com/2016/04/finance-new-report-on-geothermal.html
 Project Risks
Factors affecting the SUCCESS of a project:

Controllable Uncontrollable

•Material supplies and cost •Change of government

management
•Government policy changes
•Construction management
•Market Conditions
• Response to market downturns
• Local dynamics
• Execution of plans e.g. residents around the area
e.g. Marketing, Leasing objecting

Source: Chapter 1, The Development Process, Finance for Real Estate Development, Charles Long
 Sources of Capital

Individuals Organisations & Institutions

An operating partner in a project Include co-mingled funds of high-net
(not silent partner), who recruits worth individuals, organisations,
friends, family, and business pension funds, endowments, banks,
partners on the basis of personal life-insurance companies, developers,
relationships. construction companies, etc.

Source: Chapter 5, Capital Market for Real Estate , Finance for Real Estate Development, Charles Long
 Cost of Capital

• Required return to make Capital Structure Theory

a capital budgeting
project, such as WACC= KdPd + KePe
developing a
WACC: Weighted Average Cost of Capital
condominium, proceed Kd: cost of debt
Pd: proportion of debt
Ke: cost of equity
• Cost of funds used to Pe: proportion of equity
finance a business

SOURCE: https://www.investopedia.com/terms/c/costofcapital.asp
Charles Ward, (1999) "Estimating the cost of capital", Journal of Corporate Real Estate, Vol. 1 Issue: 3, pp.287-293, https://
doi.org/10.1108/14630019910811088
 Cost of Capital
a) Company A was financed in the proportion of 25% debt, 75% equity
with returns of 7% and 15% respectively. Interest rate of debt is 7%,
corporate tax is 30%. Calculate the after-tax WACC.

• After-tax cost of debt:

• 0.07 x (1 - 0.30) = 0.049
• After-tax WACC:
• (0.049 x 0.25) + (0.15 x 0.75) = 0.125 = 12.5%

SOURCE: https://www.investopedia.com/terms/c/costofcapital.asp
Charles Ward, (1999) "Estimating the cost of capital", Journal of Corporate Real Estate, Vol. 1 Issue: 3, pp.287-293,
https:// doi.org/10.1108/14630019910811088
 Financing Structure

Source: Chapter 2, The Basics of Real Estate Finance, Finance for Real Estate Development, Charles Long
Financing Structure

• The increased returns available from creating a good investment

structure outweighs the efforts and costs to create and manage
the complex relationships and contracts between entities.
• A good Structure can make an investment a lot more attractive.
• Why?
• Is it limited to increasing financial returns?
• What other investment parameters might become more attractive
due to a good structure?
• What are some of the downsides and negative factors?
 Financing Structure

• Lenders input funds in the form of • Owners and Investors provide funds in
debt/loans to finance the purchase of the form of capital to finance the land
buildings or the purchase of land and and buildings
construction of property • The real estate will generate returns for
• The real estate will then generate the owners and investors which are
income to pay for the loan received in the form of dividends and
capital gains
Source: Chapter 2, The Basics of Real Estate Finance, Finance for Real Estate Development, Charles Long
 Financing Structure

Public Participation,
Taxes and Fees

Public Sector (Government) grants Developer and Operator project their

permission for the construction of visions and use their skills on the Real
Real Estate and in return, they get Estate and get profits in return
taxes and fees from the real estate

Users occupy, sell, rent the real

estate and in return, they get to use
the premises

Source: Chapter 2, The Basics of Real Estate Finance, Finance for Real Estate Development, Charles Long
 Project Returns
Project returns are expressed in many different ways:

Investment Yield

Ca
Value vs Cost or

f
R) o
sh

(IR ate
• Levered

-o
Return on Cost

rn l R
n-
• Discounted Cash Flow

tu na
Ca

Re ter
• Unlevered
Compared to bonds

In
sh
and bank deposits

Ne lue
co n g

tP
Va
In rati
e
m

Present Value of Cash Flow

re
Total Cash Cost
pe

se
tO

n
Difference between inflows

t
Ne

The “Development” Cap

and outflows

Source: Chapter 2, The Basics of Real Estate Finance, Finance for Real Estate Development, Charles Long
 Net Operating Income (NOI)
• Also “Net Property Income”
• Used extensively to analyze Real Estate investments that generate income
• An indicator for property analysis

Potential Gross Income (PGI)

Less Vacancy & Collection Loss

Effective Gross Income (EGI)

Less Operating Expenses

Net Operating Income (NOI)

Source: Chapter 11, Investment Analysis and Taxation of Income Properties, Brueggeman, William B.
 Net Operating Income (NOI)
Oakwood Apartments
•95 Two-Bedroom Apartments •Laundry Income per unit per year: $120
•Current Monthly Rent per unit: $1,200 • Increases @ 3% per year
• Expected rent after a year: $1,250 •Vacancy (of PGI): 5%
• Expected inflation rate thereafter: •Credit Loss (of PGI): 1%
3% •Real Estate Taxes Increase: 2.5% per year
•Other Expenses Increase: 3% per year

Q. Calculate the NOI for the first 6 years

Source: Chapter 11, Investment Analysis and Taxation of Income Properties, Brueggeman, William B.
 Net Operating Income (NOI)

Source: Chapter 11, Investment Analysis and Taxation of Income Properties, Brueggeman, William B.
 Net Operating Income (NOI)

Source: Chapter 11, Investment Analysis and Taxation of Income Properties, Brueggeman, William B.
 Net Operating Income (NOI)
• Oakwood Apartments
• Sell at EOY 5
• “Going-out” Cap Rate: 9%
• Selling Cost (of sales price): 5%
• Calculate the Selling Price

Solution

Y6 NOI
Selling Price = Net Returns = $11,800,478 x (100 - 5)%
Capitalization Rate

$1,062,043 = $11,210,455
=
9%

= $11,800,478

Source: Chapter 11, Investment Analysis and Taxation of Income Properties, Brueggeman, William B.
 Capitalization Rate
Capitalization Rate (Cap Rate): An “all-in” value metric which
reflects many dimensions that determine project value:

>> generally Cap Rate = ____NOI____

Project Value
• Prices paid for real estate are • Represents the return an
determined by cap rate applied investor will accept today for
to Nett Operating Income the price he/she pays

High Cap Rate = Low Capital Value

Low Cap Rate = High Capital Value

Source: Chapter 2, The Basics of Real Estate Finance, Finance for Real Estate Development, Charles Long
Chapter 10, Valuation of Income Properties: Appraisal and the Market for Capital, Brueggeman, William B.
 Capitalization Rate
• Indicates how the market values a stream of Net Operating Income (NOI)

OR, the same NOI with different:

1) Property Conditions
2) Sector
3) Regional and Local Market
4) Capital Market Conditions
…will have a different value, and that difference is reflected by the “all-in”
market indicator called a “cap rate”

• “Going-in” Cap Rate • Terminal/”Going-out” Cap Rate

 Known  Unknown or an estimate

Source: Chapter 2, The Basics of Real Estate Finance, Finance for Real Estate Development, Charles Long
 Capitalization Rate
Cap Rate reflects various project and economic dimensions as
well as investors’ expectations

DECLINING rents/
RISKIER operating cash flow HIGHER cap rate
INCREASING vacancies

VOLATILE/DECLINING
Attractive of Real estate INCREASES LOWER cap rate
alternative investments

GOOD quality building in HIGHER expectations of

LOWER cap rate
top locations capital gains

Source: Chapter 2, The Basics of Real Estate Finance, Finance for Real Estate Development, Charles Long
 Value of an “income” project
• E.g. apartments, offices, retail stores, industrial buildings, hotels,
business parks, etc.; i.e. real estate with a Net Operating Income.

NOI
Project Value =
Capitalization Rate

or
NOI
Capitalization
=
Rate Project Value

Is the cap rate an independent or dependent variable?

Source: Chapter 2, The Basics of Real Estate Finance, Finance for Real Estate Development, Charles Long
 Rate of Return

Current Price - Original Price

Rate of Return = x 100
Original Price

Source: https://www.investopedia.com/terms/r/rateofreturn.asp
https://www.investopedia.com/articles/investing/062215/how-calculate-roi-rental-property.asp
 Rate of Return
Example:
You are looking to purchase a home to rent
out to generate income

You are keen to find out what is the ROI of the

property:
1) with full equity payment
2) with full leverage
(i) Both interest and principal repayment
(ii) Interest repayment only

Source: https://www.investopedia.com/articles/investing/062215/how-calculate-roi-rental-property.asp
 Rate of Return
Example:
You are looking to purchase a home to rent
out to generate income

You are keen to find out what is the ROI of the

property:
1) with full equity payment
2) with full leverage
(i) Both interest and principal repayment
(ii) Interest repayment only

Source: https://www.investopedia.com/articles/investing/062215/how-calculate-roi-rental-property.asp
 Rate of Return
Example:
You are looking to purchase a home to rent
out to generate income

You are keen to find out what is the ROI of the

property:
1) with full equity payment
2) with full leverage
(i) Both interest and principal repayment
(ii) Interest repayment only

Source: https://www.investopedia.com/articles/investing/062215/how-calculate-roi-rental-property.asp
 Project Value
Q. Calculate the project value based on NOI
NOI Cap Rate Project Value

$3,000,000 5% $60,000,000

$3,000,000 6% $50,000,000
$2,000,000 4% $50,000,000

$2,000,000 5% $40,000,000

How is the difference in value reflected in the percentage increase between

the low and high cap rate?

Source: Chapter 2, The Basics of Real Estate Finance, Finance for Real Estate Development, Charles Long
 Capitalization Rate
• Can be used to estimate rate of return

E.g. Oakwood Apartments

Changed Cap Rate Expectation = Changed IRR

Source: Chapter 10, Valuation of Income Properties: Appraisal and the Market for Capital, Brueggeman, William B.
 Income-producing Asset
• Shopping Malls in the Bugis Area: CapitaLand Mall Trust

Value (S$ Million) NOI (S$ Million) Cap Rate

Plaza Singapura 1,283 66.7 5.20%

Bugis+ 345 23.6 6.84%

Average 6.02%

Q. Given that NOI of Bugis Junction is S$61.1m, estimate its value.

• Calculated Value = S$1,015m based on 6.02% Cap Rate
• Actual Value = S$1,068m
• Actual Cap Rate = 5.72%
(As of 1Q18)
Actual value is higher and actual cap rate is lower
than theoretical. WHY?
Source: http://www.cmt.com.sg/bugis-junction.html
Income-producing Asset

36
 Internal Rate of Return (IRR)
• Discount rate at which a stream of income overtime produced by an investment
which has zero net present value

• Is the most accurate measurement of project viability, but requires detailed and
accurate information on costs and income

• May be unavailable in the early phases of a project

Cashflow

CF0 CF1 CF2 CF3 CF4

-$100 $6 $7 $8 $110

IRR 7.63%

Source: Chapter 2, The Basics of Real Estate Finance, Finance for Real Estate Development, Charles Long
 Net Present Value (NPV)

-C0 = Initial Investment

NPV = C0+ PV C = Cash Flow
r = Discount Rate
= Initial Investment (Negative) +
T = Time
Future Investment Returns
(Positive)

Aside: which items are real, which items are imaginary?

Which items are more imaginary than the others?
Source: https://www.investopedia.com/terms/n/npv.asp
 Net Present Value (NPV)

Source: https://www.investopedia.com/terms/n/npv.asp
 Net Present Value (NPV)
IS OAKWOOD APARTMENT A GOOD INVESTMENT?

7%

Source: Chapter 17, Financing Land Development Projects , Brueggeman, William B.

 Cash-on-cash return
• Rate of return often used in Real Estate transactions that calculates the cash
income earned on the cash invested in a property
*Does not include property appreciation, which is a non-cash flow item until the year of sale

Net Cash Flow

Cash-on-Cash Return =
Net Investment

Scenario
An investor purchases a rental property, and placed only 10% for a cash
down payment. Cash-on-cash return measures the annual return the
investor made on the property in relation to the down payment only.

Source: https://www.investopedia.com/terms/c/cashoncashreturn.asp
 Cash-on-cash return
A commercial real estate investor invests in a piece of property that does not produce
monthly income.
•After one year, the investor has paid $25,000 in loan payments ($5,000 is principal
repayment, rest is interest)
•Sales Price (after 1 year): $1.1 million
Q. Calculate the Cash-on-cash return
Information
Total Purchase Price: $1 million

Down Payment: $100,000

Loan: $900,000
Closing Fees: $10,000

Sales Price: $1.1 million

Source: https://www.investopedia.com/terms/c/cashoncashreturn.asp
 Cash-on-cash return

• Calculate total cash outflow

• $100,000 + $10,000 + $25,000 = $135,000

• Calculate remaining balance loan

• $900,000 - $5,000 = $895,000

• Calculate cash inflow

• $1.1mil - $895,000 = $205,000

• Cash-on-cash return:
• ($205,000 - $135,000) / $135,000 = 51.9%

Why is cash-on-cash an important concept?

Compared with “risk free”?

Source: https://www.investopedia.com/terms/c/cashoncashreturn.asp
 Liquidity
Most Liquid

Money

Stocks and Bonds

Precious Metals

Real Estate

Art Pieces

Least Liquid

Source: https://www.investopedia.com/terms/l/liquidity.asp
 Illiquidity

High Initial
capital outlay

Affected by
local markets

Source: https://www.investopedia.com/terms/l/liquidity.asp
 Depreciation

Source: https://www.youtube.com/watch?v=RaE5ZO9q5Qc
 Depreciation

2. An accounting method of allocating the cost of a tangible asset over

its useful life and is used to account for decline in value over time

Source: https://economictimes.indiatimes.com/definition/depreciation Source: https://www.tochigi-flower.info/depreciation-graph.html

https://www.investopedia.com/terms/d/depreciation.asp
https://dictionary.cambridge.org/dictionary/english/depreciation
 Depreciation Methods

1. Straight Line Depreciation

2. Double Declining Balance
3. Sum of Years Digits

Source: https://www.accountingtools.com/articles/2017/5/17/double-declining-balance-depreciation
https://www.thebalancesmb.com/how-do-i-calculate-depreciation-397879
https://www.accountingformanagement.org/sum-of-the-years-digits-method/
 Depreciation Methods
1. Straight Line Depreciation rate (e.g. %, factor, fraction)

Useful life of asset - Residual value

Depreciation of an
=
asset
Cost of asset

OR

Depreciation of an
= (Cost - Residual value) x Rate of Depreciation
asset

1
Rate of Depreciation = X 100%
Useful Life

Source: https://www.thebalancesmb.com/how-do-i-calculate-depreciation-397879
 Depreciation Calculations
Type 1: Percentage depreciation (%)

•Fixed depreciation percentage

•Value will never decline to 0

•E.g. Straight line depreciation rate: 20%

Depreciated Asset
Year Asset Cost Depreciation Amount
Value

1 $100,000 $20,000 $80,000

2 $80,000 $16,000 $64,000

3 $64,000 $12,800 $51,200 Salvage value =

residual value
4 $51,200 $10,240 $40,960
5 $40,960 $8,192 $32,768

Source: https://www.thebalancesmb.com/how-do-i-calculate-depreciation-397879
https://www.accountingtools.com/articles/2017/5/17/double-declining-balance-depreciation
 Depreciation Calculations
Type 2: Numerical depreciation

•Fixed depreciation $ value Initial Asset Cost - Residual Cost

•Residual value given Depreciation value=
Estimated Useful Life

•E.g. Residual value: $10,000

Depreciated Asset
Year Asset Cost Depreciation Amount
Value

1 $100,000 $18,000 $82,000

2 $82,000 $18,000 $64,000

3 $64,000 $18,000 $46,000 Salvage value =

residual value
4 $46,000 $18,000 $28,000
5 $28,000 $18,000 $10,000

Source: https://www.thebalancesmb.com/how-do-i-calculate-depreciation-397879
https://www.accountingtools.com/articles/2017/5/17/double-declining-balance-depreciation
Depreciation of HDB
 Valuation vs Market Value
Valuation
•Process of determining the current worth of
an asset or a company
•Techniques used to determine value:
• Rental comparison, Residual,
Contractor’s test, Profits method
• Purpose of valuation: Insurance,
Forced Sale, Depreciation, Estate and
Inheritance, Tax, Bank Loan, Balance
Sheet Valuation
VALUATION
Source: https://www.investopedia.com/terms/v/valuation.asp
SISV Valuation & Standards Guidelines
Market Value
•Estimated amount for which a property
should exchange on the date of valuation
between a willing buyer and a willing
seller in an arm’s length transaction after
proper marketing (SISV Valuation &
Standards Guidelines)
•Determined by demand and supply
MARKET VALUE
 Buyer Stamp Duty (BSD)
Rates for Residential Property

Purchase Price/ Before 20 Feb

After 20 Feb 2018
Market Value of Property 2018

First $180,000 1% 1%
Next $180,000 2% 2%
Next $640,000 3%
3%
Remaining Amount 4%
A condominium unit purchased on 30 March 2018 at $2,500,550, which is
reflective of the market value. BSD payable:

First $180,000 1% 1% x $180,000 = $1,800

Next $180,000 2% 2% x $180,000 = $3,600
Next $640,000 3% 3% x $640,000 = $19,200

Remaining $1,500,550 4% 4% x $1,500,550 = $60,022

Total $84,622
Source: https://www.iras.gov.sg/irashome/other-taxes/stamp-duty-for-property/working-out-your-stamp-duty/buying-or-acquiring-property/what-is-the-duty-that-i-need-to-pay-as-a-buyer-or-
transferee-of-residential-property/buyer-s-stamp-duty--bsd-/
 Additional Buyer Stamp Duty
ABSD Rates on the higher of the purchase price or market value
From 12th Jan 2013

Profile of Buyer ABSD Rates

Singapore Citizen (SC) buying first residential property Not Applicable

SC buying second residential property 7%

SC buying third and subsequent residential property 10%

Singapore Permanent Resident (SPR) buying first residential

5%
property

SPR buying second and subsequent residential property 10%

Foreigners (FR) and entities buying any residential property 15%

Source: https://www.iras.gov.sg/IRASHome/Other-Taxes/Stamp-Duty-for-Property/Working-out-your-Stamp-Duty/Buying-or-Acquiring-Property/What-is-the-Duty-that-I-Need-
to-Pay-as-a-Buyer-or-Transferee-of-Residential-Property/Additional-Buyer-s-Stamp-Duty--ABSD-/
 Additional Buyer Stamp Duty
Changes to ABSD rates and LTV rules
From 5th July 2018

Source: https://www.gov.sg/resources/sgpc/media_releases/mnd/press_release/P-20180706-3
 Seller Stamp Duty (SSD)
SSD Rate (on the actual price/market value, whichever is
higher)

Between 14th Jan 2011 and

Holding Period On and after 11th Mar 2017
10th Mar 2017 (all inclusive)

Up to 1 year 16% 12%

More than 1 year and up to

12% 8%
2 years

More than 2 years and up

8% 4%
to 3 years

More than 3 years and up

4%
to 4 years
No SSD payable
More than 4 years No SSD payable

Source: https://www.iras.gov.sg/irashome/Other-Taxes/Stamp-Duty-for-Property/Working-out-your-Stamp-Duty/Selling-or-Disposing-Property/Seller-s-Stamp-Duty--
SSD--for-Residential-Property/
 Property Tax Rates
Owner-Occupier Tax Rate

Annual Value ($) Effective 1 Jan 2015 Property Tax Payable

First $8,000 0% $0

Next $47,000 4% $1,880

First $55,000 - $1,880

Next $15,000 6% $900

First $70,000 - $2,780

Next $15,000 8% $1,200

First $85,000 - $3,980

Next $15,000 10% $1,500

First $100,000 - $5,480

Next $15,000 12% $1,800

First $115,000 - $7,280

Next $15,000 14% $2,100

First $130,000 - $9,380

Above $130,000 16%

Source: https://www.iras.gov.sg/irashome/property/property-owners/working-out-your-taxes/property-tax-rates-and-sample-calculations/
 Property Tax Rates
Q. Calculate the Property Tax payable for a owner-occupied residential
property with AV of $84,000.

Annual Value ($) Tax Rate Effective 2015 Property Tax Payable

First $8,000 0% $0

Next $47,000 4% $1,880

Next $15,000 6% $900

Remaining $14,000 8% $1,120

Property Tax Payable for 2015 $3,900

Source: https://www.iras.gov.sg/irashome/property/property-owners/working-out-your-taxes/property-tax-rates-and-sample-calculations/
 Property Tax Rates
Non Owner-Occupier Tax Rate

Annual Value ($) Effective 1 Jan 2015 Property Tax Payable

First $30,000 10% $3,000

Next $15,000 12% $1,800
First $45,000 - $4,800
Next $15,000 14% $2,100
First $60,000 - $6,900
Next $15,000 16% $2,400
First $75,000 - $9,300
Next $15,000 18% $2,700
First $90,000 - $12,000
Above $90,000 20%

Source: https://www.iras.gov.sg/irashome/property/property-owners/working-out-your-taxes/property-tax-rates-and-sample-calculations/
Thank you

Tutorial Discussion
Q&A

61