Methodology for analyzing real estate investments. Mortgage and investment analysis. Assessing the attractiveness of investment projects. The concept of mortgage investment analysis. Approaches to its assessment of the cost of own and borrowed sources of finance

3. Determination of the cost of invested capital based on capitalization of income

3.3. Mortgage and investment analysis

Mortgage investment analysis consists of determining the value of property as the sum of the costs of equity and borrowed capital. In this case, the investor’s opinion is taken into account that he is not paying for the cost of real estate, but for the cost of capital. A loan is seen as a means of increasing the invested funds necessary to complete the transaction. The cost of equity capital is calculated by discounting the cash flows coming to the investor's equity capital from regular income and from reversion, the cost of borrowed capital is calculated by discounting debt service payments.

The current value of the property is determined depending on discount rates and cash flow characteristics. That is, the current value depends on the duration of the project, the ratio of equity and debt capital, the economic characteristics of the property and the corresponding discount rates.

Let's consider a general algorithm for mortgage investment analysis to calculate the value of property, the purchase of which is financed with borrowed capital, and, accordingly, the cash flows of periodic income and from reversion will be distributed between the interests of equity and borrowed capital.

Stage 1. Determining the present value of regular income streams:

– a report on income and expenses is compiled for the forecast period, while the amounts for debt servicing are calculated based on the characteristics of the loan - the interest rate, the full amortization period and repayment terms, the size of the loan and the frequency of payments to repay the loan;
– cash flows of own funds are determined;
– the rate of return on invested capital is calculated;
– based on the calculated rate of return on equity, the current value of regular cash flows before tax is determined.

Stage 2. Determining the present value of the reversion proceeds minus the outstanding loan balance:

– income from reversion is determined;
– the remaining debt at the end of the period of ownership of the object is deducted from the income from reversion;
– based on the rate of return on equity capital calculated at stage 1, the current value of this cash flow is determined.

Stage 3. Determining the value of property by summing up the current values ​​of the analyzed cash flows.

Mathematically, determining the value of an asset can be represented as a formula

where N01 is the net operating income of the nth year of the project; DS is the amount of debt service in the nth year of the project;

TG – reversion amount excluding sales costs;

UM – unpaid loan balance at the end of the project term P;i – return on equity; M – The original loan amount or the current principal balance.

This formula can be used as an equation in the following cases:

– if the amount of reversion of property is difficult to predict, but it is possible to determine trends in its change in relation to the initial value, then in calculations you can use the amount of reversion expressed as a fraction of the initial value;

– if the problem statement does not define the amount of the loan, but only the share of the loan.

Let's consider the main criteria for the effectiveness of investment projects.

Net present value - a criterion that measures the excess of benefits from a project over costs, taking into account the current value of money

,

where NPV is the net present value of the investment project; Co – initial investment; С i – cash flow of period t; i, – discount rate for period t.

A positive NPV value means that the cash flows from the project exceed the costs of its implementation.

Steps to apply the net present value rule:

– forecasting cash flows from the project over the entire expected tenure, including income from resale at the end of this period;
– determination of the alternative cost of capital in the financial market;
– determining the current value of cash flows from the project by discounting at a rate corresponding to the opportunity cost of capital and subtracting the amount of initial investment;
– selection of a project with the maximum NPV value from several options.

The higher the NPV, the more income the investor receives from investing capital.

Let's consider the basic rules for making investment decisions.

1) The project should be invested if the NPV value is positive. The considered efficiency criterion (NPV) allows us to take into account changes in the value of money over time, depending only on the projected cash flow and the opportunity cost of capital. The net present values ​​of several investment projects are expressed in today's money, which allows them to be correctly compared and added up.

2) The discount rate used in calculating NPV is determined by the opportunity cost of capital, i.e. the profitability of the project is taken into account when investing money with equal risk. In practice, the profitability of a project may be higher than that of a project with alternative risk. Therefore, a project should be invested if the rate of return is higher than the opportunity cost of capital.

The considered rules for making investment decisions may conflict if there are cash flows in more than two periods.

Payback period – the time required for the total cash flows from a project to equal the amount of the initial investment. This investment performance meter is used by investors who want to know when a full return on their invested capital will occur.

Disadvantage: payments following the payback period are not taken into account.

Mortgage investment analysis consists of determining the value of property as the sum of the costs of equity and borrowed capital. In this case, the investor’s opinion is taken into account that he is not paying for the cost of real estate, but for the cost of capital. A loan is seen as a means of increasing the invested funds necessary to complete the transaction. The cost of equity capital is calculated by discounting the cash flows coming to the investor's equity capital from regular income and from reversion, the cost of borrowed capital is calculated by discounting debt service payments.

The current value of the property is determined depending on discount rates and cash flow characteristics. That is, the current value depends on the duration of the project, the ratio of equity and debt capital, the economic characteristics of the property and the corresponding discount rates.

Methods of mortgage investment analysis

The analysis uses two methods (two techniques): the traditional method and the Ellwood technique. The traditional method explicitly reflects the logic of investment and mortgage analysis. Ellwood's method, reflecting the same logic, uses ratios of profitability ratios and proportional ratios of investment components.

Disadvantage: payments following the payback period are not taken into account.

23. Ellwood technique in mortgage analysis. It is used in investment and mortgage analysis and gives the same results as the traditional technique, since it is based on the same set of initial data and ideas about the relationship between the interests of equity and borrowed capital during the development period of the investment project. The great thing about Ellwood’s technique is that it allows you to analyze property relative to its price based on the return ratios of equity indicators in the investment structure, changes in the value of total capital, and quite clearly shows the mechanism of changes in equity capital over the investment period.

Ellwood mortgage ratio: C = Y e + p(sff, Y e ) -R m, where p is the share of the current loan balance amortized over the forecast period,

Expression 1/(1 + Δ n A) in the equation is a stabilizing factor and is used when income is not constant, but changes regularly. Usually, the law of change in income is specified (for example, linear, exponential, according to the savings fund factor), in accordance with which the stabilization coefficient a is determined according to pre-calculated tables. The value is determined by dividing the income for the year preceding the valuation date by the capitalization rate, taking into account the stabilization of income. In the future, we will consider Ellwood’s technique only for permanent income.

Ellwood shows that this expression actually reflects all the elements of the transformation of equity and debt combined in invested capital, in particular financial leverage, amortization of the mortgage loan and the increase in equity as a result of loan amortization.

24. Investment group technique in mortgage analysis

Investment Group Technique

Investment Group Technique is a method of calculating the total rate of return based on the annual mortgage constant and the cash flow rate on home equity. From market information about these ratios, the market total rate of return can be determined. The latter is calculated as the average of the required mortgage constant and the rate of cash receipts on equity capital, weighted by the shares of the mortgage and investor's capital in the total purchase price.

The investment group technique is used to estimate the value of a property in the absence of sufficient information on the sales prices of comparable properties and reliable data on net operating income. However, in the absence of information on comparable transactions, it is often difficult to determine the required equity cash flow rates, mortgage debt ratios and other indicators necessary for the investment group's technique to calculate the overall rate of return.

In the conditions of the emergence of the real estate market, objects are purchased mainly at the expense of one’s own funds. The world practice of market economy countries proceeds from the fact that almost all real estate transactions are carried out with the assistance of mortgage loans, that is, financial leverage is used.
Loans to finance real estate transactions are attracted for a number of reasons, the main ones being the following:
The cost of real estate is high, and only a few buyers have enough money to purchase it.
Those who have sufficient funds seek to reduce the risk of capital investments, that is, they seek to diversify their investments.
The use of loans allows the investor to control large amounts of income-generating property.
Savings through tax reduction (in most countries, interest on loans is not taxed).
Therefore, real estate investment in most cases consists of two components: mortgage credit and equity. In this case, the capitalization rate must satisfy market income requirements for both parts of the investment. Otherwise, these investments in the form of own funds and loans will be invested in another more profitable project.
Thus, the capitalization rate is divided into two components: mortgage constant and capitalization rate on equity

25. Application of the traditional model of mortgage-investment analysis The prerequisite of the traditional model of mortgage-investment analysis is the provision that the total value of property is equal to the sum of the present value of the interest of equity capital and the present value of the interest of borrowed capital. The value of equity interest is determined by discounting the cash flow before taxes, while the rate of return on equity capital, defined as the market average, is used as the discount rate.

Mortgage investment analysis models based on capitalization of income from the use of property. The most common approach to mortgage investment analysis of this group is to determine the overall capitalization ratio using the Ellwood formula. In addition, the investment group method and the direct capitalization method are used.

The traditional technique of mortgage investment analysis is a method of assessing the value of property, which is based on determining the total amount of the repurchase capital, including mortgage loans and equity investments. Under this technique, the value of a property is calculated by adding the present value of cash receipts and resale proceeds expected by the investor to the principal amount of the mortgage. Thus, both the entire projected net operating income and the amount of proceeds from the resale of the property are estimated.

The traditional technique requires estimates of the projected cash flows to be received by the investor, as well as the proceeds from resale. These two elements give the estimated current value of equity. The original loan balance (whether it is a new loan or a vested debt) is then added to the equity value to determine the market appraised value. If the new loan is provided on current market conditions and the final return on equity meets current market requirements, the result will be the estimated market value of the property. This technique does not take into account tax implications.

The principle underlying the traditional technique is that the assessed returns accrue to both investors and creditors.

The combined present value of the income of creditors and investors constitutes the maximum amount of redemption capital; accordingly it is the price that must be paid for the property. This technique improves on the equity cash flow valuation method because it takes into account resale proceeds. The latter includes the amount of increase (or decrease) in the value of the property and the depreciation of the mortgage received by the investor upon resale.

The returns received by both mortgage lenders and investors should include both return on investment and return on investment.

26. Land market, structure, functions, structure, objects, subjects

Land is the most important resource, occupying an exceptional place in the life and activities of any society. The land market has a number of specific features:

1. land is a free gift of nature, which allows us to talk about the irrational nature of its value. However, land is an object of sale and purchase; land lease relations are associated with it.

2. depending on certain natural and climatic conditions, as well as the location of plots of land, the latter are divided into the best, average and worst. This division is based on the natural fertility of the soil, on which the productivity of the land depends. But it can be improved as a result of additional investments in it of labor and capital. This improved soil fertility is called economic. Increasing the economic fertility of soil is practically possible in any area. However, it has certain boundaries associated with the well-known law of diminishing soil fertility, when, with the existing technology of land cultivation, each subsequent unit of expenditure provides less and less return.

3. As a result of the fixed area of ​​land by nature, the supply of land is characterized by complete inelasticity on a social scale. The limited supply of land resources is aggravated by the fact that land is assigned to private ownership. In market conditions, land owners are very reluctant to sell their land plots, giving preference to renting out land in the form of rent; they receive the right to receive a stable income, which is why at any given moment only a small part of the land fund is sold, this is the fundamental feature of the land market.

The land market creates conditions that stimulate the efficient use of land and forces individual entities to give up part of the land or the entire plot if it does not function effectively.

The land market should be understood not only as the purchase and sale of land, but also as the provision of land for rent, as well as the entire market for agricultural products, in which land ownership relations are realized in one form or another.

The subjects of a market agrarian economy are two types of owners - the full owner and the owner by consumption (owner, user). The limited availability of land and the impossibility of its production contribute to the emergence of two types of land monopolies. The full owner exercises a monopoly of private property: he is free to allow or not to allow an entrepreneur to invest capital in his land; can rent it out. After concluding a lease transaction, a specific user of the land is determined who exercises a monopoly right to manage the given site.

27. Features of methods for assessing land plots for development

Land valuation methods

1. The normative method is to determine the normative price of land. It is used when transferring, purchasing land into ownership, establishing common joint (shared) ownership in excess of the free norm, transferring by inheritance or donation, obtaining a secured loan, withdrawal for state or public needs.

2. The sales comparison method is the simplest and most effective valuation method; it can be used to evaluate both actually vacant and supposedly vacant land; allows you to determine the specific price of a land plot by making percentage adjustments to the sales prices of analogues.

3. The method of capitalization of land rent is based on the fact that if there is sufficient information about the rental rates of land plots, it is possible to determine the value of these plots as the current value of future income in the form of rent for the land plot being assessed.

4. Method of distribution (method of ratio, correlation) - determination of the component value of a land plot based on a known ratio of the value of land and improvements in the property complex. The method is based on the principle of contribution and the assertion that for each type of property there is a normal relationship between the value of land and buildings.

5. The allocation (extraction) method is used to evaluate developed land plots if there is information on transaction prices for similar real estate objects.

6. The residual method is based on the investment group technique for physical components.

7. The subdivision method (development approach) is used in assessing land suitable for subdivision into individual plots.

28. Features of the use of the residual technique for assessing storage in the city.

The method is used to evaluate built-up and undeveloped land plots. The condition for applying the method is the possibility of developing the assessed land plot with improvements that generate income.

The method involves the following sequence of actions 16:

Calculation of net operating income attributable to improvements for a certain period of time as the product of the cost of reproduction or replacement of improvements by the corresponding capitalization ratio of income from improvements;

Calculation of the amount of ground rent as the difference between the net operating income from a single property for a certain period of time and the net operating income attributable to improvements for the corresponding period of time;

Calculation of the market value of a land plot by capitalization of land rent.

The method also allows the following sequence of actions:

Calculation of the cost of reproduction or replacement of improvements corresponding to the most efficient use of the assessed land plot;

Calculation of net operating income from a single property for a certain period of time based on market rental rates;

Calculation of the market value of a single property by capitalizing net operating income for a certain period of time;

Calculation of the market value of a land plot by subtracting the cost of reproduction or replacement of improvements from the market value of a single property.

These loans are issued at a fraction of the value of the property, largely depending on the lender's perception of the liquidity of the asset being invested. Joint participation in this case, the lender participates in the distribution of profits from income and or increase in the value of assets, in addition to interest payments, by providing a loan at a more preferential interest rate. Analysis of mortgage circumstances as an integral part of an investment project creates the necessary basis for determining cash flows of the current value of assets and...

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Topic 8. Fundamentals of investment and mortgage analysis.

Plan:

1. Types of loans and collateral legislation.
2. Methods of investment and mortgage analysis.
3. The impact of a mortgage loan on the price-value ratio.

1. The impact of financial leverage.

As financing institutions develop and the availability of loans increases, an increasing number of investors are attracting borrowed funds to develop investment projects related to real estate. If the borrower's invested asset serves as collateral for a long-term debt obligation, then such a loan is called a mortgage loan. It is this form of lending that is most typical for transactions involving the transfer of rights to real estate, and is most preferable for minimizing risks for lenders. Interest in the use of borrowed capital, along with reducing investment risk, is also caused by a number of other economic reasons.

The main one is that, under certain conditions, the use of a loan increases the income of its recipient, since the profit earned with the help of these funds, in an amount exceeding the interest paid, increases the investor's equity capital if the return on the entire invested capital exceeds the cost of borrowed funds . This is the effect of financial leverage, which is usually defined as the use of borrowed funds to implement an investment project.

2. Types of loans and collateral legislation.

Currently, there are many mortgage lending schemes, which differ mainly in the terms of obtaining loans, interest payment schemes and amortization of the principal amount. In Russia, mortgage lending is currently very limited, the loans themselves are very expensive, and long-term loans are practically non-existent. This is mainly due to the significant risks that the Russian real estate market is burdened with and the lack of private ownership of land, which is the main component of real estate collateral. In addition, there is no law on mortgage lending yet.

However, there is no doubt that in the near future the institution of mortgage lending will inevitably take on civilized forms. Consequently, analysts working in the field of evaluating investment projects related to real estate must be well versed in the forms of mortgage lending, schemes for fulfilling borrowed obligations of investors and the influence of these factors on the price of invested objects.

The most common types of loans are:

• With balloon payment
• Self-cushioning
• With variable interest rate
• Canadian roll-over
• Final Mortgage
• Joint participation
• Loan with discount points.

Loans with balloon paymentprovides for payment and interest on the principal amount at the end of the loan term. There are intermediate options, such as periodic interest payments and repayment of the debt amount at the end of the loan period. Balloon loans are most typical for investors who seek to minimize costs during the development of the project and at the end of this period fulfill debt obligations after the sale of their assets.

Self-amortizing loanprovides for equal periodic payments, including interest payments that fall as the debt is amortized and growing payments for loan amortization. These loans are issued in amounts that are a fraction of the value of the property, largely depending on the lender's perception of the liquidity of the investment asset. A self-amortizing mortgage loan is most convenient when analyzing the structure of investments and the economic characteristics of income-producing real estate, therefore, in the future, when considering methods of mortgage investment analysis, we will use a loan of this particular type.

Loan with variable interest rateusually used when investors and lenders seek to take into account the rapidly changing price situation in the capital and resource markets. In this case, the interest rate can change either directly or through a change in the size of payments or amortization periods.

Canadian roll-overa form of variable-rate loan where the interest rate is adjusted at predetermined time intervals (usually several years).

Final Mortgagepresented by a third party or by the holder of the first mortgage, creating a junior mortgage. The owner of the closing lien assumes the balance of the first loan, demanding higher payments on the closing loan amount, which includes the balance of the old and the own loan. Thus, the new lender uses financial leverage for its own loan.

Joint participationin this case, the lender participates in the distribution of profits from income and (or) increase in the value of assets in addition to interest payments, providing a loan at a more preferential interest rate.

Loan with discount pointsmeans that the borrower actually receives an amount less than that specified in the loan agreement. However, interest and amortization payments must be paid on the entire debt amount. The investor agrees to a discount on the loan amount in exchange for a low interest rate, while the lender, by providing a loan at a discount, increases the final return relative to the actual loan. The discount on the agreed amount is measured in discount points. One discount point is equal to one percent of the contractual debt amount.

In practice, several other types of mortgage loans are used, but they are all modifications of the above.

Analysis of mortgage circumstances as an integral part of an investment project creates the necessary basis for determining cash flows, the current value of assets and equity. The appraiser needs to know the current interests and preferences of owners and creditors, as well as the current conditions on the capital market, in order to correctly adjust the nominal value of borrowed obligations as an integral part of the current value of the owner.

When analyzing real estate as an object of financing, the appraiser must be well versed in the law, in particular, know whether this real estate is subject to rights such as the right of alienation, the right of negotiability and the right to be the subject of mortgage lending.

Let's consider the main provisions of the draft Federal Law “On Mortgage (Pledge of Real Estate)”, which it is advisable for a practicing real estate appraiser to focus on.

• The basis for the emergence of a mortgage is an agreement on the pledge of real estate (mortgage agreement), according to which the mortgagee, who is a creditor under a loan obligation secured by a mortgage, has the right to secure his monetary claims from the value of the pledged property of the mortgagor.
• The right of pledge applies to land plots, enterprises, buildings, structures, apartments and other real estate within the limits established by federal laws.
• The subject of the mortgage may be real estate, the rights to which are subject to state registration:

1. land
2. enterprises, as well as buildings, structures and other real estate used in business activities
3. residential buildings, apartments and parts of residential buildings and apartments, consisting of one or more isolated rooms
4. cottages, garden houses, garages and other consumer buildings
5. air and sea vessels of inland navigation and space objects.

• The right of pledge can be encumbered by property that belongs to the pledgor on the basis of ownership or the right of economic management.
• Real estate for which foreclosure is prohibited under federal law and does not provide for mandatory privatization or prohibition of privatization cannot become the subject of a mortgage agreement.
• The mortgage agreement must contain the result of the property valuation, which is determined by agreement between the mortgagor and the mortgagee.
• The cost of a land plot cannot be determined below its regulatory base.
• When assessing the collateral, subjects of a mortgage agreement can use the services of an independent professional organization.
• Mortgage is subject to state registration by judicial authorities in the unified state register of rights to real estate and transactions with it.
• Possible alienation of real estate pledged under a mortgage agreement by the mortgagor to another person as a result of “sale, gift, deception, making it as a contribution to a business partnership or society or a contribution to a production cooperative or in another way only with the consent of the mortgagee, unless otherwise provided by the agreement on mortgage."
• It is possible to conclude another mortgage obligation (subsequent mortgage) in relation to property already intended under the mortgage agreement to secure a previous obligation (previous mortgage), unless this is prohibited by the previous mortgage. A subsequent mortgage is not allowed if the previous one is certified by a mortgage.
• Satisfaction of the mortgagee's claims under the prior mortgage has priority over satisfaction of the mortgagee's claims under the subsequent mortgage.
• Rights under a mortgage agreement, if it is not certified by a mortgage, may be sold by the mortgagee to another person, unless this is prohibited by the agreement. The person to whom the rights under the mortgage agreement are transferred also receives the rights under the main obligation secured by the mortgage.
• The mortgage may be transferred to another person with the transfer of rights under the obligation secured by the mortgage, and also pledged to another person in accordance with the obligation under the loan agreement between this person and the mortgagee.
• The court decision to foreclose on the mortgaged property must indicate the initial sale price of the property for its sale at public auction.
• Under a mortgage agreement, land plots owned by citizens and legal entities can be mortgaged.
• Land plots that are in state or municipal ownership may be mortgaged under a mortgage agreement, except for public lands, protected areas, areas on which construction is prohibited, territories with special conditions of use and areas the mortgage of which is not permitted by federal law.
• A mortgage agreement regarding an enterprise, building or structure is possible only in conjunction with the land plot on which these objects are located, or with a functionally necessary part of this plot or the right to lease this plot. The right to permanent use of a land plot is not subject to pledge, but is transferred upon foreclosure of the real estate located on this plot.
• Valuation of an enterprise's assets is mandatory and is an annex to the mortgage agreement for an enterprise or part of its property complex.
• Mortgaging of individual and multi-apartment residential buildings and apartments is allowed if they are privately owned, and is not allowed if these objects are in state or municipal ownership.

3. Methods of investment and mortgage analysis.

The basis of investment and mortgage analysis is the idea of ​​property value as a combination of the value of equity and borrowed funds. In accordance with this, the maximum reasonable price of the property is determined as the sum of the current value of cash flows, including the proceeds from reversion attributable to the investor's funds, and the amount of the loan or its current balance.

When investing and mortgage analysis, the investor’s opinion is taken into account that he is not paying for the cost of real estate, but the cost of equity, and the loan is considered as an additional means to complete the transaction and increase equity capital. The analysis uses two methods (two techniques): the traditional method and the Elwood technique. The traditional method explicitly reflects the logic of investment and mortgage analysis. Elwood's method, reflecting the same logic, uses ratios of profitability ratios and proportional ratios of investment components.

Traditional method.This method takes into account that the investor and lender expect to receive a return on their investment and return it. These interests must be ensured by the total income for the entire amount of investment and the sale of assets at the end of the investment project. The amount of investment required is determined as the sum of the present value of the cash flow consisting of the investor's equity and the current debt balance.

The present value of an investor's cash flow consists of the present value of periodic cash receipts, the increase in the value of equity assets resulting from loan amortization. The value of the current debt balance is equal to the present value of loan service payments for the remaining term, discounted at the interest rate.

Cost calculation in traditional technology is carried out in three stages.

Stage I. For the accepted forecast period, a statement of income and expenses is drawn up and cash flow before tax is determined, i.e. on own capital. The stage ends with determining the current value of this flow in accordance with the forecast period and the final return on equity expected by the investor Ye.

Stage II. The proceeds from the resale of property are determined by subtracting from the resale price the costs of the transaction and the remaining debt at the end of the forecast period. The present value of the proceeds is assessed at the same rate.

Stage III. The current value of equity capital is determined by adding the results of the stages. The value of equity and current debt balance is assessed.

The traditional technique of mortgage investment analysis allows one to draw certain conclusions regarding the influence of the forecast period on the assessment results. An important factor limiting the holding period from an investor's point of view is the reduction over time of depreciation (assets) and interest deductions from pre-tax earnings. In addition, more preferable investment options may emerge (external factors). On the other hand, the current value of the current debt ratio gradually decreases, which leads to the effectiveness of financial leverage. Analysis using traditional techniques of options with different tenures shows the obvious influence of the forecast period on the value of the estimated value. Moreover, the dependence is such that with an increase in the predicted tenure, the value of the assessed value decreases, provided that the value decreases over the forecast periods.

Elwood technique. It is used in investment and mortgage analysis and gives the same results as the traditional technique, since it is based on the same set of initial data and ideas about the relationship between the interests of equity and borrowed capital during the development period of the investment project. The difference between Elwood’s technique is that it is based on the return ratios of equity indicators in the investment structure, changes in the value of total capital and quite clearly shows the mechanism of changes in equity capital over the investment period.

General view of the Elwood formula:

where R 0 - overall capitalization rate

WITH Ellwood mortgage ratio

Fractional change in property value

(sff, Y e ) replacement fund factor at the rate of return on equity capital

Share change in income for the forecast period

Stabilization coefficient

Elwood Mortgage Ratio:

C = Ye + p(sff, Ye) Rm

Where p is the share of the current loan balance amortized over the forecast period

Rm A mortgage constant relative to the current debt balance.

The expression in the equation is a stabilizing factor and is used when income is not constant, but changes regularly. Usually, the law of income change is specified (for example, linear, exponential, according to the accumulation fund factor), in accordance with which the stabilization coefficient is determined according to pre-calculated tables. The value is determined by dividing the income for the year preceding the valuation date by the capitalization rate, taking into account the stabilization of income. In the future, we will consider the Elwood technique only for permanent income.

Let's write Elwood's expression without taking into account changes in the value of real estate at constant income:

This expression is called the basic capitalization ratio, which is equal to the rate of final return on equity capital adjusted for financing conditions and depreciation.

Let's consider the structure of the overall capitalization ratio in Elwood form without taking into account changes in property values, for which we use the investment group technique for rates of return. This technique weighs the rates of return on equity and debt in their respective shares of total invested capital:

Yo = m*Ym + (1 m)*Ye

In order for this expression to become equivalent to the base coefficient r , two more factors need to be taken into account. The first is that the investor must periodically deduct from his income to amortize the loan, reducing his equity. Therefore, it is necessary to adjust the value Yo in the previous expression by adding a periodically paid share of the total capital at interest equal to the rate of interest on the loan. The expression for this adjustment is the gearing ratio m , multiplied by the compensation fund factor at the interest rate(sff, Ym). Quantity (sff, Ym) is equal to the difference between the mortgage constant and the interest rate, i.e. Rm Ym . Thus, taking into account this amendment:

Yo = m*Ym + (1 m)*Ye + m*(Rm Ym)

The second adjustment term must take into account the fact that the investor's equity as a result of reversion increases by the amount of the portion of the loan amortized over the holding period. To determine this adjustment, you need to multiply the depreciated amount as a share of the total original capital by the replacement fund factor at the rate of final return on equity (realization into equity occurs at the end of the holding period). Therefore, the second correction term has the form: mp(sff, Ym) , and with a minus sign, since this amendment increases the cost.

Thus:

Yo = m*Ym + (1 m)*Ye + m(Rm Ym) mp(sff, Ye)

And after combining similar members and replacing Yo on r (we do not take into account changes in property value):

R = Ye m*(Ye + (p(sff) Rm))

Thus, we obtain the basic capitalization ratio of the Elwood expression. Progressing from the investment group technique through the necessary adjustments to Elwood's expression shows that this expression actually reflects all the elements of the transformation of equity and borrowed funds combined in the invested capital, in particular financial leverage, amortization of the mortgage loan and the increase in equity as a result of amortization of the loan.

The Elwood equation expressed in terms of the debt coverage ratio.Financing projects associated with significant risks regarding the receipt of stable income may change the orientation of lenders regarding the criterion determining the amount of borrowed funds. The lender believes that in this situation it is more appropriate to determine the loan size not on a price basis, but on the basis of the ratio of the investor’s annual net income to annual payments on the loan obligation, i.e. the creditor requires guarantees that the value of this ratio (naturally, greater than one) will not be less than a certain minimum value determined by the creditor. This ratio is called the debt coverage ratio:

DCR = NOI/DS

In this case, the mortgage debt ratio in the Elwood equation should be expressed through the debt service coverage ratio DCR:

DCR = NOI/DS = RV/(Rm*Vm) = R/(Rm*m), or

M = R/(DCR*Rm)

After substituting this expression instead m we obtain the Elwood equation expressed in terms of the debt coverage ratio:

4 . The impact of a mortgage loan on the price-value ratio.

As already mentioned, the main interest of the investor is to increase his own capital as a result of the implementation of the investment project. The owner must optimize the capital structure by weighing all costs, risk and debt service costs and comparing them with the future efficiency of using equity and borrowed funds. The investor believes that a project using low-cost credit with a desired debt ratio, a long amortization period, and a rate of return on equity that meets his requirements is considered successful. For the implementation of these conditions, the investor is willing to pay a price greater than the market value of the property. Thus, the specific financing terms affect the amount of money paid for the property in a particular sale transaction, but not its value. Financing terms do not affect the physical nature of the property and rental payments. To translate price into value (sometimes the term “money equivalent of market value” is used), the appraiser must have a good understanding of the typical preferences of lenders and investors.

In order to determine the value of real estate, which, in accordance with the basic meaning of investment and mortgage analysis, is the sum of the current market interests of financial components, it is necessary to determine the market value of the debt obligation and add it to the buyer’s equity (payment).

Mortgage-equity models determine the true value of property based on the ratio of equity and debt capital. Mortgage-equity analysis, or capital structure analysis, is an analytical tool that can in many cases facilitate the valuation process. It has been theoretically proven that debt capital plays a major role in determining the value of real estate.

Almost all real estate investment transactions are made using mortgage loans. By using mortgage lending, investors gain financial leverage, which allows them to increase current returns, benefit more from property appreciation, provide greater asset diversification, and increase deductions for interest and depreciation for tax purposes. Mortgage lenders receive a reasonably guaranteed amount of income securing the loan. They have the right of first claim to the borrower's operating income and its assets in the event of a breach of debt obligations. Mortgage investment analysis is a residual technique. Equity investors pay the balance of the initial costs.

They receive the remainder of the net operating income and resale price after all payments to creditors have been made, both during the current use and after the property is resold.

The period of realization of ownership of real estate can be divided into three stages, at each of which capital investors receive residual income:

1. acquisition of an asset - the investor makes a mandatory cash payment, the amount of which is equal to the remaining price after subtracting from it the mortgage loan, which turns into debt;

2. use of property - investors receive residual net income from the use of property after deducting mandatory debt service payments;

3. liquidation - when the property is resold, the owner of the capital receives money from the sale price after repaying the balance of the mortgage loan.

There are two approaches to conducting mortgage investment analysis:

1. Traditional - the premise of the traditional model of mortgage investment analysis is that the total value of the property is equal to the sum of the present value of the equity interest and the present value of the debt capital interest. The value of equity interest is determined by discounting the cash flow before taxes, while the rate of return on equity capital, defined as the market average, is used as the discount rate.

2. Mortgage investment analysis models based on capitalization of income from the use of property. The most common approach to mortgage investment analysis of this group is to determine the overall capitalization ratio using the Ellwood formula. In addition, the investment group method and the direct capitalization method are used.

Traditional mortgage investment analysis technique is a method of estimating the value of property that is based on the determination of the total amount of the repurchase capital, including mortgage loans and equity investments. Under this technique, the value of a property is calculated by adding the present value of cash receipts and resale proceeds expected by the investor to the principal amount of the mortgage. Thus, both the entire projected net operating income and the amount of proceeds from the resale of the property are estimated.

The traditional technique requires estimates of the projected cash flows to be received by the investor, as well as the proceeds from resale. These two elements give the estimated current value of equity. The original loan balance (whether it is a new loan or a vested debt) is then added to the equity value to determine the market appraised value. If the new loan is provided on current market conditions and the final return on equity meets current market requirements, the result will be the estimated market value of the property. This technique does not take into account tax implications.

The principle underlying the traditional technique is that the assessed returns accrue to both investors and creditors.

The combined present value of the income of creditors and investors constitutes the maximum amount of redemption capital; accordingly it is the price that must be paid for the property. This technique improves on the equity cash flow valuation method because it takes into account resale proceeds. The latter includes the amount of increase (or decrease) in the value of the property and the depreciation of the mortgage received by the investor upon resale.

The returns received by both mortgage lenders and investors should include both return on investment and return on investment.

As for a mortgage, the current income on it represents debt service. Self-amortizing mortgages provide for the simultaneous payment of interest (income on the principal amount of the loan) and amortization (repayment of the principal amount of the mortgage) over a specified period. The principal balance at any point in time is equal to the present value of all payments remaining before the loan is fully amortized, discounted at the nominal interest rate of the mortgage. Mortgages are often paid off before the full amortization period has expired. In this case, the balance of the mortgage is paid in a one-time cash payment, thereby eliminating the debt. The par value of a debt obligation is equal to the sum of the present value of periodic cash payments and the present value of a lump sum cash payment when repaying the loan, discounted at the nominal interest rate of the mortgage.

The present value of an equity investment is equal to the sum of the income stream and the proceeds from liquidation (resale), discounted at the rate of return on equity. Under certain mortgage terms, the equity price is justified by the cash flows as well as the resale proceeds that investors expect to receive. Therefore, the current value of equity is equal to the sum of the present value of cash receipts and the present value of proceeds from resale, discounted at the rate of final return on equity, taking into account the associated risks. Thus, the amount and timing of benefits received by investors are taken into account.

The value of property or its price is calculated using formula (1):

Price = Cost of Equity + Mortgage Loan , (1)

The cost of equity is defined as the sum of two elements: cash receipts and resale proceeds. Both elements are discounted at the appropriate rate of return and their present values ​​are calculated using present value factors.

If projected cash receipts are expected to be uniform, then their annual amount is multiplied by the annuity factor. Reversion or resale proceeds are valued using the current unit value factor since the proceeds are received as a lump sum.

The formula for calculating the cost of equity capital (investment in equity capital), taking into account the above - formula (2) - has the following form:

Cost of equity = PWAF * (CF) + PWF * (PS), (2)

where PWAF is the factor of the current value of the annuity at the rate of return on equity,

CF - cash receipts,

PS - proceeds from resale.

To estimate the value of the property, the current mortgage balance must be added to the equity value. All income is assessed in this way. The remaining balance on the mortgage is equal to the present value of the required debt service payments, discounted at the nominal interest rate of the mortgage. Thus, the general formula for estimating property value (3) is as follows:

V = PWAF * (CF) + PWF * (PS) + MP, (3)

where V is the value of the property (initial),

PWAF - factor of the current value of the annuity at the rate of return on equity capital,

CF - cash receipts,

PWF is the factor of the current value of reversion at the rate of return on equity capital,

PS - proceeds from resale,

MP is the current principal balance of the mortgage.

If we accept that

CF = NOI - DS , (4)

where NOI is net current operating income,

DS - debt service (annual), and

PS = RP - OS , (5)

where RP is the resale price of the property,

OS - the balance of the mortgage debt upon resale;

then formula 3 will take the form:

V = PWAF * (NOI - DS) + PWF * (RP - OS) + MP, (3*)

The use of traditional technology involves a three-stage calculation for a certain forecast period. The forecast period is the period during which the owner expects to hold the property being valued.

Table 1. Stages of traditional mortgage investment analysis techniques

The monthly mortgage repayment payment is calculated based on formula (6) for calculating the unit depreciation contribution (self-amortizing mortgage):

where DSm is monthly debt service,

I - initial mortgage loan amount,

i is the annual interest rate on the loan,

t is the term (years) for which the mortgage loan was granted.

The annuity factor (formula 7) reflects the current value of a unit annuity at a given discount rate:

where Y is the rate of return on equity capital,

The current value factor of reversion (Formula 8) reflects the current cost of a unit for a period at a given discount rate:

The balance of the mortgage debt with equal payments is determined as the present cost of debt service payments over the remaining amortization period (formula 9):

The resale price of a property is calculated taking into account the increase or decrease in the value of the property per year (d):

RP = P * (1 + d) T , (10)

where RP is the resale price of the property;

P is the initial cost of the property;

d - increase (decrease) in property value over the year;

T is the period of ownership of the property.

So, the traditional technique of mortgage investment analysis is an assessment method within the framework of the income approach. When conducting a mortgage investment analysis, either the principal amount of the mortgage loan or the mortgage debt ratio must be known. The analysis should include an estimated resale price or percentage change in value over the forecast period.

This technique can be used if the investor assumes an existing debt or if a new loan is attracted. It can be modified to take into account more than one mortgage and changes in cash flow. If the price is known, the technique can be used to estimate the rate of return on equity.

The traditional technique of mortgage investment analysis is a flexible method that can take into account any situation. However, due to the assumptions made, objectively obtained estimates are approximate.

Mortgage investment analysis based on income capitalization

The capitalization method converts annual income into property value by dividing the annual income by the appropriate rate of return or multiplying it by the appropriate income ratio.

Determination of property value based on the general capitalization ratio is carried out according to formula (11):

Where V- property value;

NOI- net operating income;

k- general capitalization ratio.

To determine the overall capitalization ratio within the framework of mortgage investment analysis, the following is used:

· Ellwood Mortgage and Investment Technology;

· Investment group method;

· Direct capitalization method.

The basis of investment and mortgage analysis is the idea of ​​property value as a combination of the value of equity and borrowed funds. In accordance with this, the maximum reasonable price of the property is determined as the sum of the current value of cash flows, including the proceeds from reversion attributable to the investor's funds, and the amount of the loan or its current balance.

When investing and mortgage analysis, the investor’s opinion is taken into account that he is not paying for the cost of real estate, but the cost of equity, and the loan is considered as an additional means to complete the transaction and increase equity capital. The analysis uses two methods (two techniques): the traditional method and the Elwood technique. The traditional method explicitly reflects the logic of investment and mortgage analysis. Elwood's method, reflecting the same logic, uses ratios of profitability ratios and proportional ratios of investment components.

Traditional method. This method takes into account that the investor and lender expect to receive a return on their investment and return it. These interests must be ensured by the total income for the entire amount of investment and the sale of assets at the end of the investment project. The amount of investment required is determined as the sum of the present value of the cash flow consisting of the investor's equity and the current debt balance.

The present value of an investor's cash flow consists of the present value of periodic cash receipts, the increase in the value of equity assets resulting from loan amortization. The value of the current debt balance is equal to the present value of loan service payments for the remaining term, discounted at the interest rate.

Cost calculation in traditional technology is carried out in three stages.

StageI. For the accepted forecast period, a statement of income and expenses is drawn up and cash flow before tax is determined, i.e. on own capital. The stage ends with determining the current value of this flow in accordance with the forecast period and the final return on Ye's equity capital expected by the investor.

StageII. The proceeds from the resale of property are determined by subtracting from the resale price the costs of the transaction and the remaining debt at the end of the forecast period. The present value of the proceeds is assessed at the same rate.

StageIII. The current value of equity capital is determined by adding the results of the stages. The value of equity and current debt balance is assessed.

The traditional technique of mortgage investment analysis allows one to draw certain conclusions regarding the influence of the forecast period on the assessment results. An important factor limiting the holding period from an investor's point of view is the reduction over time of depreciation (assets) and interest deductions from pre-tax earnings. In addition, more preferable investment options may emerge (external factors). On the other hand, the current value of the current debt ratio gradually decreases, which leads to the effectiveness of financial leverage. Analysis using traditional techniques of options with different tenures shows the obvious influence of the forecast period on the value of the estimated value. Moreover, the dependence is such that with an increase in the predicted tenure, the value of the assessed value decreases, provided that the value decreases over the forecast periods.

Elwood technique. It is used in investment and mortgage analysis and gives the same results as the traditional technique, since it is based on the same set of initial data and ideas about the relationship between the interests of equity and borrowed capital during the development period of the investment project. The difference between Elwood’s technique is that it is based on the return ratios of equity indicators in the investment structure, changes in the value of total capital and quite clearly shows the mechanism of changes in equity capital over the investment period.

General view of the Elwood formula:

where R 0 is the overall capitalization ratio

WITH– Ellwood mortgage ratio

- share change in property value

(sff,Y e ) – compensation fund factor at the rate of return on equity capital

- share change in income for the forecast period

- stabilization coefficient

Elwood Mortgage Ratio:

C = Ye + p(sff, Ye) – Rm

Where p is the share of the current loan balance amortized over the forecast period

Rm – mortgage constant relative to the current debt balance.

Expression
in the equation is a stabilizing factor and is used when income is not constant, but changes regularly. Usually the law of income change is specified (for example, linear, exponential, according to the accumulation fund factor), in accordance with which the stabilization coefficient is determined according to pre-calculated tables. The value is determined by dividing the income for the year preceding the valuation date by the capitalization rate, taking into account the stabilization of income. In the future, we will consider the Elwood technique only for permanent income.

Let's write Elwood's expression without taking into account changes in the value of real estate at constant income:

This expression is called the basic capitalization ratio, which is equal to the rate of final return on equity capital adjusted for financing conditions and depreciation.

Let's consider the structure of the overall capitalization ratio in Elwood form without taking into account changes in property values, for which we use the investment group technique for rates of return. This technique weighs the rates of return on equity and debt in their respective shares of total invested capital:

Yo = m*Ym + (1 – m)*Ye

In order for this expression to become equivalent to the basic coefficient r, two more factors must be taken into account. The first is that the investor must periodically deduct from his income to amortize the loan, reducing his equity. Therefore, it is necessary to adjust the value of Yo in the previous expression by adding the periodically paid share of the total capital at interest equal to the interest rate on the loan. The expression for this adjustment is the leverage ratio m multiplied by the recovery fund factor at the interest rate (sff, Ym). The value (sff, Ym) is equal to the difference between the mortgage constant and the interest rate, i.e. Rm – Ym. Thus, taking into account this amendment:

Yo = m*Ym + (1 – m)*Ye + m*(Rm – Ym)

The second adjustment term must take into account the fact that the investor's equity as a result of reversion increases by the amount of the portion of the loan amortized over the holding period. To determine this adjustment, you need to multiply the depreciated amount as a share of the total original capital by the replacement fund factor at the rate of final return on equity (realization into equity occurs at the end of the holding period). Consequently, the second correction term has the form: mp(sff, Ym), with a minus sign, since this amendment increases the cost.

Thus:

Yo = m*Ym + (1 – m)*Ye + m(Rm – Ym) – mp(sff, Ye)

And after combining similar terms and replacing Yo with r (we do not take into account the change in property value):

R = Ye – m*(Ye + (p(sff) – Rm))

Thus, we obtain the basic capitalization ratio of the Elwood expression. Progressing from the investment group technique through the necessary adjustments to Elwood's expression shows that this expression actually reflects all the elements of the transformation of equity and borrowed funds combined in the invested capital, in particular financial leverage, amortization of the mortgage loan and the increase in equity as a result of amortization of the loan.

The Elwood equation expressed in terms of the debt coverage ratio. Financing projects associated with significant risks regarding the receipt of stable income may change the orientation of lenders regarding the criterion determining the amount of borrowed funds. The lender believes that in this situation it is more appropriate to determine the loan size not on a price basis, but on the basis of the ratio of the investor’s annual net income to annual payments on the loan obligation, i.e. the creditor requires guarantees that the value of this ratio (naturally, greater than one) will not be less than a certain minimum value determined by the creditor. This ratio is called the debt coverage ratio:

In this case, the mortgage debt ratio in the Elwood equation should be expressed through the debt coverage ratio DCR:

DCR = NOI/DS = RV/(Rm*Vm) = R/(Rm*m), or

After substituting this expression for m, we obtain the Elwood equation, expressed in terms of the debt coverage ratio: