7 Net Operating Income Calculation Income/Expense ItemSymbolPotential Gross Income(PGI)- vacancy and collection losses(VCL)+ Other Miscellaneous Income(MI)= Effective Gross Income(EGI)- Operating Expenses(OE)= Net Operating Income(NOI)
8 Net Operating Income Example ItemTotalPotential Gross Income$ 180,000- Vacancy and Collection Losses18,000+ Other Miscellaneous Income______0= Effective Gross Income162,000- Operating Expenses_72,900= Net Operating Income$ 89,100
9 Forecasted Cash Flows From Net Operating Income ItemYear1Year2Year3Year4Year5PGI$180,000$185,400$190,962$196,691$202,592- V&C18,00018,54019,09619,66920,259= EGI162,000166,860171,866177,022182,333- OE72,90075,08777,34079,66082,050= NOI$89,100$91,773$94,526$97,362$100,283
10 Forecasted Cash Proceeds From Sale ItemSymbolYear5Expected Sales Price(SP)$1,026,000- Selling Expenses(SE)51,300= Net Sales Proceeds(NSP)$974,700
11 Present Value Calculation YRInvest.NOINSP$$189,10079,554291,77373,161394,52667,282497,36261,8755100,283974,700605,974PV=$891,846
12 Net Present Value (NPV) The net present value is the present value of a project’s cash inflows minus the present value of the cash outflows.The cash flows are discounted at the investor’s required rate of return; in the example 12 percent.
13 Net Present Value Calculation YRInvest.NOINSP$-885,000189,10079,554291,77373,161394,52667,282497,36261,8755100,283974,700609,974NPV=IRR=$ 6,84612.2%
14 NPV Decision CriteriaIf NPV>0, the project exceeds the investor’s required rate of return.If NPV<0, the project does not meet the investor’s required rate of return.If NPV=0, the project’s expected return equals the investor’s required rate of return.
15 Internal Rate of Return (IRR) The internal rate of return is the discount rate at which NPV=0, the rate of return at which the present value of the cash inflows equals the present value of the cash outflows.
16 IRR Decision CriteriaIf IRR> the required rate of return, then accept.If IRR< the required rate of return, then reject.
17 NPV and the IRR NPV: cash flows assumed reinvested at discount rate Generally preferred to IRR for making decisionsIRR: cash flows assumed reinvested at the IRR rateMay provide inferior wealth maximizing ranking of alternative opportunities to the NPVMultiple solutions possibleEasily compared to other investments and widely used
20 Four Classes of Real Property Real estate held as a personal residenceReal estate held for sale to others– dealer propertyReal estate held for use in a trade or business– trade of business propertyReal estate held as an investment for the production of income– investment property
21 Types of Taxable Income Active Income (e.g., salaries, wages, bonuses, and commissions.)Portfolio Income (e.g., interest, dividends, and capital gains.)Passive Income (e.g., rents from real estate, and royalties from oil and gas rights.)
22 Passive Activity Loss Restrictions Passive losses cannot be used to reduce active or portfolio incomePassive losses may be used to reduce other passive incomePassive losses not used may be used in future years or at the same time of saleActive participants may deduct up to $25,000 in passive losses against other non-passive income, subject to limitations
23 Tax on Operations Item Symbol Net Operating Income (NOI) - Depreciation(DEP)- Interest Expense(INT)- Amortized Financing Costs(AFC)= Taxable Income(TI)x Tax Rate(TR)= Tax Liability(TAX)
24 After Tax Cash Flow From Operations ItemSymbolNet Operating Income(NOI)- Interest Expense(INT)- Principal Amortization(PA)= Before- Tax Cash Flow(BTCF)- Tax Liability(TAX)= After- Tax Cash Flow(ATCF)
25 Interest Expense and Amortized Financing Costs Interest and prepaid interestCosts of financingFinancing costs amortized over the term of the loanUnused balance taken in the year sold
26 Depreciation BasisThe original cost basis includes all costs associated with acquiring the property and transferring the titleLand value cannot be depreciatedThe depreciable basis is the total value that can be depreciated over the recovery periodDepreciable Basis= Cost Basis — Land Amount
28 Cost Recovery Period Residential income property (27.5 years) Other commercial income property (39 years)Personal property (3-15 years)
29 Original Cost Basis and Depreciation The original cost basis is affected by depreciation and substantial (capital) improvementsOriginal Cost BasisTotal Annual Depreciation+ Total Capital Improvements= Adjusted Basis
30 Tax Due on Sale Item Symbol = Net sale Proceeds (NSP) - Adjusted Basis (AB)= Total Taxable Gain(TG)- Depreciation Recapture(DR)= Capital Gain(CG)Capital Gain Tax(CGTAX)+ Depreciation Recapture Tax(DRTAX)= Tax Due on Sale(TDS)
31 After Tax Cash Flow From Sale ItemSymbolGross Sale Price(GSP)- Selling Expenses(SE)= Net Sale Proceeds(NSP)- Remaining Mortgage Balance(RMB)= Before- Tax Equity Reversion(BTER)- Tax Due on Sale(TDS)= After- Tax Equity Reversion(ATER)