UGBA 180 Lecture Notes - Lecture 6: Operating Expense, Cash Flow, Tax Deduction

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Lecture 6
2/8/18
Recap: Single-Family Housing
Big Picture
Gola: decide whether or not it’s worth it to buy or rent (from an investment perspective)
Method: lay out the cash flows from owning and calculate the IRR
2 Primary Elements
Annual cash flow from owning (BT+AT)
Cash flow from sale (BT+AT)
Annual Cash Flow from Owning
Cash outflows
Property taxes
Insurance
Maintenance
Mortgage payments
Cash inflows
Tax savings (from mortgage interest and property tax deduction)
Rent saved
Net cash flow = cash inflow - outflow
Cash Flow from Sale
Cash inflow
Sale price
Cash outflow
Selling expenses
Mortgage balance
Capital gains tax
Net cash flows = cash inflows - cash outflows
Capital Gains vs. Net Cash Flow
Capital gains: increase in the value of the asset over the holding period
Net of selling expenses has the property appreciated in value relative to its initial
purchase price
Only matters for calculating how much is owed in capital gains tax
Only capital gains in excess of $250k are subject to taxation
Net cash flow from sale: cash in your pocket resulting from the sale transaction
Is the sale price > (selling expenses + mortgage balance + capital gains tax)?
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Interpretation
In year 0 you have $30k available to invest and are looking for a 4 year investment
Option 1: buy this house and sell it at the end of year 4
Calculate the IRR = 12.34%
Option 2: invest $30k in an alternative investment that is of equal risk to the housing
investment and that returns IRR of x% over 4 years
What should you do?
If x>12.34% choose option 2 and rent
If x<12.34% choose option 1 and buy
Other Considerations
1. Frequent relocation
2. Lack of funds for a down payment
3. No desire to bear the risk of ownership and volatility in house prices
4. Desire to shift maintenance, security and management to others
Income Producing Properties
Property Types
Residential
Single family
Multifamily
Apartment buildings
Nonres
Office
Retail
hotel/motel
Industrial
Mixed use
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Risk
Market rents depend on
Changes in demand
Expected changes in supply
Real estate is a long term investment
Hence in-depth market analysis are very important
Determinants: D & S
Demand
Apartments
Number of households
Age of persons in households
Size of household incomes
Interest rates
Home ownership
Affordability
Apartment rents
Housing prices
Office spaces
Categories of employment with very high proportions of office use include
service and prof employment
Warehouse space
Categories of employment with high concentrations in warehouse use
including:
Wholesaling
Trucking
Manufacturing etc
Retail space
Demand indication include household income
Age
Gender
Population
Size
tastes/preferences
Supply influences
Vacancy rates
Interest rates and financing availability
Age and combination of existing supply stock
Construction costs
Land cost
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Document Summary

Gola: decide whether or not it"s worth it to buy or rent (from an investment perspective) Method: lay out the cash flows from owning and calculate the irr. Tax savings (from mortgage interest and property tax deduction) Net cash flow = cash inflow - outflow. Net cash flows = cash inflows - cash outflows. Capital gains: increase in the value of the asset over the holding period. Net of selling expenses has the property appreciated in value relative to its initial purchase price. Only matters for calculating how much is owed in capital gains tax. Only capital gains in excess of k are subject to taxation. Net cash flow from sale: cash in your pocket resulting from the sale transaction. In year 0 you have k available to invest and are looking for a 4 year investment. Option 1: buy this house and sell it at the end of year 4.

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