UGBA 180 Lecture Notes - Lecture 6: Operating Expense, Cash Flow, Tax Deduction
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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find more resources at oneclass.com
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.