Presentation on theme: "Investment and Financial Analysis for International Real Estate."— Presentation transcript:
Investment and Financial Analysis for International Real Estate
2 Course Overview Case 1: Mr. Chen Case 2: Dr. Garcia Case 3: EuroVest HP-10BII Calculator Exam
Chapter 1: Preparing for an International Transaction Preparing for an International Transaction
4 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
5 Globalization Globalization is the movement by countries, companies, organizations and people toward a single market environment.
6 Real Estate Investors examine and invest in markets that best match the risk and return objectives of their portfolios.
7 Capital Flow Capital flow is a complex interplay of foreign exchange instruments that move currency, assets, credits and debt around the world almost instantaneously.
8 Currency Investors will buy real estate because of the favorable trend of the investor’s currency against a foreign currency.
9 Country Assessment Model Cultural Influences Relationships Historical influences Negotiating behavior Religion Conducting business Banks and financial institutions with international experience International transactions similar to domestic ones
10 Preparing for an International Transaction Six Steps 1.Develop client profile 2.Make necessary conversions 3.Determine investment objectives 4.Determine purchasing motivations 5.Assemble a team 6.What does your market have to offer?
12 Objectives Discuss types of residency status Discuss ownership options Review basic income tax laws for non-resident aliens
13 Residency Status 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
14 Residency Definitions Types Green Card Holder Physical Presence Test Substantial Presence Test
15 Ownership Entities Direct Indirect Through USA entity Through foreign entity These decisions should be made by the client after consultation with a legal professional.
16 Location of Income Source Competent tax counsel is needed to determine how the latest tax laws will treat the investor.
17 Tax Liabilities Income Tax USA-sourced income subject to USA tax Nonresident alien and USA taxpayer treated the same Passive Income Rents, dividends and interest Subject to 30% withholding tax Based on gross income No deductions allowed
18 Gains Tax Liability FIRPTA Applies to nonresident alien individuals and corporations that buy or sell USA real estate Designed to equalize the treatment of domestic and foreign investors
19 DEFRA Requires withholding/reporting/transmitting 10% of amount realized to IRS within 10 days of transfer. Real estate agents may be liable Residential, non-business property, with a value up to $300,000 is exempt IF property has been used as a primary residence by seller and will be used as a primary residence by buyer.
20 Transfer Tax Liability USA imposes tax on gifts and bequests TAMRA established tax rate on foreign-owned estates Apply only to USA-located assets of USA- domiciled, nonresident, aliens No USA gift tax on share transfer of USA companies Company assets must not exceed a certain percent of real estate Joint ownership may lower estate tax liability
23 Row 1 Row 5 Row 6 Row 7 Row 8 Row 2 Row 3 Row 4 1 234 5 ALL CLEAR Row 1 Primary Keys Enter data left to right
24 Row 1 Row 5 Row 6 Row 7 Row 8 Row 2 Row 3 Row 4 1 234 5 ALL CLEAR Secondary function on bottom of key in GOLD All keys have 2 functions GOLD KEY [Shift key] activates second function Primary function on top of key in WHITE GK
25 Row 1 Row 5 Row 6 Row 7 Row 8 Row 2 Row 3 Row 4 1 234 5 POWER Turn ON--Press Turn OFF Press 0.00 GK ON OFFON ON ON GK ON OFFON
26 GK Display 1.Change numerals to right of decimal 2.Can go out 9 places 3.Internal calculations continue to 12 4.Change places by: 5.GK, DISP, desired number of places 6. 6 0.000000 GK DISP
27 Clearing Data Clears last digit Clears entire number GK C ALL Clears all memory Clears all memory & resets calculator GK C ALL
35 What We Know Name: Mr. Chen Nationality: Taiwanese Occupation: Securities Trader Employer: Tiger Securities Company Home Phone: Cell Phone: Fax:
36 What We Know Mailing address: Residency Status Family: Married with 3 children 6, 9, 15 Requirements: 4-bdrm, den, study on one floor 90-95 pings of living space 30 minutes to work Price range: Up to NT$20,000,000 Knowledge of market: Location and type of funds:
37 What We Know Financing: Yes at no more than 7.5% interest Client cash involvement: 20% down Objectives and Motivations: To be discussed Cultural Considerations: “Other requirements”
46 Motivations Vary greatly Some may never be revealed Cultural aspects play large role More family coming? Common language with neighbors? Solitary or group decision to buy? What are their agent expectations?
50 Your Market Prepare market information Include local newspapers What’s happening? Chamber of Commerce Is property appreciating? Are businesses coming to your area?
51 Mr. Chen Arrives Today Mr. Chen selects 1 of 3 homes shown Price: US$750,000 Size: 3350 square feet Reason selected: Proximity to work and schools Potential rental income Appreciation potential
52 Before Making an Offer… Mr. Chen would like an estimate of his proceeds if he sells the house in three years.
53 What You Know House reasonably priced at US$750,000. Comparable sales 3 years ago were US$634,300. First calculation is for annual rate of appreciation
55 Projected Sales Price Enter 3, N (Holding period) Enter 5.74%, I/YR Enter 750,000 (present value) Press +/- (Amount paid out) Press PV for Present value Solve for future value by pressing FV Answer: 886,700 (rounded)
56 Future Net Sales Proceeds After Taxes 1.Enter projected sales price $886,700 2.Calculate costs of sale at 7.5% a)$886,700 X 7.5% = $66,502 3.Calculate original loan amount a)$750,000 X 80% = $600,000 4.Calculate Remaining Loan Balance a)Interest Reduction Method b)Traditional Method
58 Tax Liability Mr. Chen tells us he will be living in the home for at least 2 years. Budget Act of 1997 relieves him of gains tax.
59 Final Calculations Projected Sales Price $886,700 (-) Costs of Sale 66,502 (-) Loan balance 582,085 (-) Tax Liability -0- (=) Net proceeds after taxes $238,113
60 Effect of Exchange Rates When the exchange rate decreases, the currency has __________________ When the exchange rate increases, the currency has __________________ strengthened weakened
61 Key Point Review Team of experts critical to success of international transactions. Present information in terms client can understand Always advise legal counsel for client Investment return depends on decisions before acquisition Residency status extremely important
65 Time Value of Money Risk Purchasing power Opportunity costs Compounding Discounting
66 Key Components Compounding--Determining the future value of an investment made today Single or series of payments Interest earned is reinvested Discounting—determining the present value of money received in the future Single or series of payments Increased time to maturity gives greater discounting
68 IRV Formula Stands for Income, Rate, Value Measures most forms of Yield If you have two numbers, solve for the 3 rd Divide bottom numbers into the top Multiply two bottom numbers
69 Capitalization Rate NOI Cap Rate Total Value
70 Cash-on-Cash (ConC) Cash Received Rate of Return Invested Cash
71 Key Point Review Four elements of investment income property are: Yield Safety Leverage Control Time Value of Money Compounding Discounting
72 Key Point Review IRV Formula Capitalization rate Cash-on-cash return
Dr. Garcia: Inbound Commercial Transaction Chapter 6
74 Objectives Apply 6-Step preparation process to Dr. Garcia’s case Calculate 5-year rent projections Calculate cap rate for each of the 5 years Measure yield using the IRR
75 Dr. Garcia Referral Step 1: Client Profile Dr. Garcia Mexican national Investor/businessman Non-resident status Various family members manage some of his businesses Safe real estate in Southwestern USA US$6-8 million
76 Step #2: Conversions Does not require any area or currency conversions at this time
77 Step #3: Client Objectives Invest US$6-8 million 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 5 years Title through single-asset domestic corporation Finance 50% of purchase price
78 Step #4: Client Motivations Spread risk by diversifying Safe harbor for part of family capital Minimize risk Minimize management requirements
79 Step #5: Assemble a Team What team members might you need for Dr. Garcia?
80 Step #6: Local Market Investment Opportunities 1.Group of 4 steak houses 2.Build-to-suit office building leased to a start-up software firm 3.Warehouse and distribution center Dr. Garcia decides to investigate the warehouse
81 Question #1: Dr. Garcia asks for a five-year projection of rents and the cap rate for each year. What you know 1 st year rent is $59,250 per month Property is net leased Where to begin Organize data to calculate NOI
82 Net Operating Income Gross potential rental income (-) vacancy and credit losses (=) Effective gross income (+) other income (=) Gross operating income (-) operating expenses (=) Net operating income (NOI)
83 Determine Property NOI NOI = Rate x Purchase Price NOI Rate Purchase Price $7,900,000.09 $711,000 X The warehouse must generate $711,000/year rent to meet Dr. Garcia’s 9% cap rate requirement on his $7,900,000 investment
91 Annual Debt Service (ADS) Formula: Monthly payment X 12 = ADS $36.617 X 12 (=) $ _____________ $439,404
92 Cash Flow Before Taxes Cash-on-Cash Yield (CFBT-ADS) Formula: CFBT ÷ Original investment (including points) = ConC Yield Calculate Dollar Cost of Points Formula: Loan Amount X Cost of Points = Dollar cost of points $3,950,000 X.015 = ___________ $59,250
93 Calculate Original Amount Invested Formula: Initial investment + Cost of Points = Total initial investment $3,950,000 + $59,250 = _____________ $4,009,250
94 Using IRV to Calculate ConC Divide CFBT by Value of original investment V alue of Investment R ate of return ConC I ncome before taxes (CFBT)
95 Cash-on-Cash (ConC) Yield NOI(-) ADS(=) CFBT(÷) DP with Points (=) ConC Yield Year 1$711,000439,404271,5964,009,250 Year 2$732,330439,404292,9264,009,250 Year 3$754,300439,404314,8964,009,250 Year 4$776,929439,404337,5254,009,250 Year 5$800,237439,404360,8334,009,250 6.77% 7.31% 7.85% 8.42% 9.0%
96 Dr. Garcia’s Response One objective was to obtain a 12% before-tax cash-on-cash yield with financing. Does this investment meet that objective? What off-setting points can you present?
97 Question #3 Dr. Garcia requests: 5-year projection of rents Projected sales price Selling after 5 th year
98 What You Know Use 6 th year income figures Determine sales price using 9% cap rate First $50,000 of income taxed at 15% Balance taxed at 25% Depreciated over 39 years Land is worth 20% of total purchase price
99 Net Sales Proceeds Before Tax Cash Flow Before Tax Net Sales Proceeds Before Tax Before Tax After Sale Proceeds
100 Net Sales Proceeds Before Tax Formula: Sales price (Yr. 6 NOI ÷ 9% Cap rate = projected price) (-) Mortgage balance (-) Costs of sale (=) Net sales proceeds before taxes
101 Remaining Loan Balance 1., C ALL 2.1, 2,, P/YR 3.1, 5,, xP/YR 4.7.5, I/YR 5.3,950,000 PV 6.0, FV 7.PMT 8.Answer: 36,617 GK C ALL PMT P/YR xP/YR I/YR PV FV
107 Calculate Annual IRR 1., C ALL 2.4,009,250, +/-, CFj 3.271,596, CFj 4.292,926, CFj 5.314,896, CFj 6.337,525, CFj 7.360,833, + 5,432,399= CFj 8., IRR/YR 9.Answer: 13.19 GK C ALL CFj IRR/YR +/- +
108 Key Point Review 6-Step Preparation Process helps organize client data Purchasing decisions are based on a variety of financial calculations The international real estate agent must be prepared to: Apply necessary calculations Satisfactorily explain the meaning of each The IRR is a tool for measuring yield
110 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.
111 Effect of Taxes Profound effect on investment return Tax depends on several variables Tax laws change frequently Every investment is unique Tax treaties may influence return Consult tax and legal experts
112 Holding Period Information Estimated profit after five years is $5,432,399 Pre-tax cash flow IRR would be 13.19%
113 Depreciable Basis Land is not depreciable Land assumed to be 20% of total property value Deduct land cost from purchase price Improvements are depreciable
114 $7,900,000 X 20% = $1,580,000 (land) $7,900,000 X 80% = $6,320,000 (improvements) $7,900,000 X 20% = $1,580,000 (land) $7,900,000 X 80% = $6,320,000 (improvements) Calculating Depreciable Basis
115 Straight-line Depreciation Cost Recovery Formula: Divide 100 by number of depreciable years Assume a 39-year straight-line depreciation 100 ÷ 39 = 2.564% (depreciation/year) Dr. Garcia’s annual depreciation: $6,320,000 X.02564 = $162,044.80
116 Mid-Month Convention Formula: Divide months of partial year by full year. Multiply answer by 2.564 (depreciation factor) 11.5 ÷ 12 X 2.564 = _______________ (partial year depreciation factor) $6,320,000 X.02457 = ________________ (Dr. Garcia’s 1 st year depreciation) 2.457% $155,282.40
117 Deduction of Mortgage Points Pro-rata annual portion is deductible Points amortized over life of loan Unamortized points expensed at time of sale Formula: Loan amount X % cost of points = Total cost of points $3,950,000 X.015 = ________________ $59,250 ÷ 15 = _____________/year $59,250 $3,950
121 Calculating Capital Gains Formula:Sales Price$9,158,267 (-) Selling Costs 641,079 (-) Adjusted basis (=) Gain (X) Tax Rate (25%) (=) Capital Gains Tax Liability
122 Calculating Adjusted Basis Formula: Purchase Price (+) Capital Improvements (-) Cost Recovery Taken (=) Adjusted Basis Purchase Price$7,900,000 (+) Capital Improvements 0 (-) Cost Recovery Taken 803,462 (=) Adjusted Basis ___________ $7,096,538
123 Adjusted Basis You can now calculate Capital gains Tax liability Sales proceeds after taxes Yield on CFAT
124 Calculating Capital Gains Formula:Sales Price$9,158,267 (-) Selling Costs 641,079 (-) Adjusted basis (=) Gain (X) Tax Rate (25%) (=) Capital Gains Tax Liability $ 7,096,538 1,420,651 355,163
125 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 $5,077,237
127 IRR Annual Yields Before Tax IRR13.19% After Tax IRR10.25%
128 Key Point Review Pre-Tax and After-Tax investment yield calculations influence purchasing decisions. Know steps in setting up and completing necessary calculations Capital gains, tax liability, sales proceeds after taxes and yield on CFAT calculated from adjusted basis. T-Bar is useful tool for calculating yield.
Chapter 8 EuroVest Case Study An Outbound Commercial Transaction
130 Objectives Analyze potential before-tax and cash- on-cash return Project sales proceeds Estimate the internal rate of return (IRR) Evaluate currency fluctuations on IRR Utilize APOD and international cash flow analysis worksheet to organize data
131 Client Profile Name: EuroVest Nationality: Brazilian Business: Pension fund investing in net- leased European real estate Objectives: Provide capital and financing expertise to creditworthy USA firms Price: 30,000,000 BRL (minimum)
132 Client Objectives Investment decisions based on Economic feasibility of individual real estate project Confidence in the business Creditworthiness of the tenant Stability of the target market Suitability of the target location to the tenant’s business
133 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 hectares (20,000 m²)
134 Tenant Data Name: OptiGro Location: Chicago, IL, USA Requirements: 100,000+ square feet Budget: $16 per sq. ft. per year net
135 Revised Client Objectives 1 st year minimum ConC yield of 11% 18% minimum IRR on 5-year-hold An option to sell at end of 5 th year
136 Estimating Return Determine how much EuroVest will pay for Dos Cantos based on 11% ConC first year return Calculate yearly yield of 5 year holding period Determine IRR if Dos Cantos sold after 5 years See if numbers meet client’s target return
137 Convert m² to Square Feet Conversion Factor: 1m² = 10.7639 sq. ft. Formula: # m² X 10.7639 10,000 m² X 10.7639 = _____________ sf. 107,639
138 Calculating Rent Formula: # Sq. Ft. X Rent/sq. ft. = Total rent _________ sq.ft. X $16 = __________ Total Rent 107,639 $1,722,224
139 Convert US$ to Euro’s Formula: USD X Conversion Factor Assume US$1 = €1.25 ___________ USD (rent) X €1.25 = €_____________ (rent in euros) 1,722,224 2,152,780
140 Assumptions Five year holding period 2% rent escalation 11% cap rate at sale No vacancy Initial investment = total acquisition costs 0 expenses
141 Currency Assumptions Euro (EUR) = 2.73 real (BRL)1 BRL =.365 EUR 1 US dollar (USD) = 1.25 EUR1 EUR =.799 USD Which currency is strongest?
142 Five-Year Cash-on-Cash Returns YR1 YR2 YR3 YR4 YR5 YR6 Gross Rental Income Net Operating Expenses Net Operating Income Annual Debt Service Cash Flow Before Taxes 2,152,780 2,195,836 2,239,752 2,284,547 2,330,238 2,376,843 In EUR 0 2,152,780 0 X= X 1.02 =
143 Five-Year Cash-on-Cash Returns YR1 YR2 YR3 YR4 YR5 YR6 Net Operating Income Interest Cost Recovery Taxable Income X Tax Rate = Liability 2,152,7802,195,836 2,239,7522,284,5472,330,238 2,376,843 In EUR 0 0 0 0
144 Five-Year Cash-on-Cash Returns YR1 YR2 YR3 YR4 YR5 YR6 Cash Flow Before Taxes Minus (-) Tax Liability Cash Flow After Taxes Divided by Investment Amount Cash-on- cash Return 2,152,780 19,570,727 11.00% 11.22% 11.44% 11.67% 11.91% 12.14% 2,195,836 2,239,7522,284,5472,330,238 2,376,843 In EUR 0 2,152,7802,195,8362,239,7522,284,5472,330,2382,376,843 00000
145 Five Year Cash-on-Cash Returns YR1 YR2 YR3 YR4 YR5 YR6 Gross Rental Income Net Operating Expenses Net Operating Income Annual Debt Service Cash Flow Before Taxes 5,877,089 5,994,631 6,114,523 6,236,814 6,361,550 6,488,781 0 5,877,089 0 In BRL X = X 1.02 =
146 Five-Year Cash-on-Cash Returns YR1 YR2 YR3 YR4 YR5 YR6 Net Operating Income Interest Cost Recovery Taxable Income X Tax Rate = Liability 5,877,089 5,994,6316,114,5236,236,8146,361,5506,488,781 0 0 0 0 In BRL
147 Five-Year Cash-on-Cash Returns YR1 YR2 YR3 YR4 YR5 YR6 Cash flow before taxes Minus (-) tax liability Cash flow after taxes Divided by investment amount Cash-on- cash return 5,877,089 53,428,085 11.00%11.22%11.44%11.67%11.91%12.14% 5,994,6316,114,5236,236,814 6,361,255 6,488,781 0 In BRL 5,877,089 5,994,6316,114,5236,236,814 6,361,255 6,488,781 00000
148 Projected Sales Price Yr. 6 NOI 2,376,843 (euros) Cap Rate 11% Sales Price 21,607,664 (euros) 21,607,664 (euros)
149 B. Calculation of Gain and Tax 21,607,664 Sales price21,607,664 (-)1,512,536 (-) selling costs (7%) 1,512,536 (-)19,570,727 (-) adjusted basis19,570,727 (=)524,400 (=) Taxable gain 524,400 (x)0% (x) Rate 0% (=)0 (=) Capital gains tax 0 21,607,664 Sales price21,607,664 (-)1,512,536 (-) selling costs (7%) 1,512,536 (-)19,570,727 (-) adjusted basis19,570,727 (=)524,400 (=) Taxable gain 524,400 (x)0% (x) Rate 0% (=)0 (=) Capital gains tax 0
150 Calculation of Sales Proceeds After Tax 21,607,664 Sales price21,607,664 (-)1,512,536 (-) selling costs 1,512,536 (-)0 (-) loan balance 0 (=)20,095,128 (=) Sales proceeds before tax 20,095,128 (-) 0 (-) Capital gains tax 0 (=)Net sales proceeds after tax20,095,128 (=) Net sales proceeds after tax20,095,128
156 Currency Values EURBRL Year 012.73(+), (5), (%), (K), (=) Year 112.86(=) Year 213.00(=) Year 313.16(=) Year 413.31(=) Year 513.48(=)
157 Currency Values EURBRL @ 2.73 Weakens 5% Year 12,152,7805,877,0896,156,951 Year 22,195,8365,994,6316,587,508 Year 32,239,7526,114,5237,077,616 Year 42,284,5476,236,8147,561,850 Year 52,330,2386,361,5508,109,228 Total30,584,60735,493,153
159 Currency Value Effect on IRRCausation BRL weakens again 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
160 Currency Values EURBRL Year 012.73(-), (5), (%), (K), (=) Year 112.59(=) Year 212.46(=) Year 312.34(=) Year 412.22(=) Year 512.11(=)
162 Key Point Review Exchange rates have a significant effect on investment objectives. Real estate professionals must know how to organize and calculate certain financial projections so they may provide clients with accurate assessments of potential return.
Investment and Financial Analysis for International Real Estate Ready for the Test?