1. CHAPTER 19 Analyzing Income Producing Properties This chapter discusses the various forms of real estate equity ownership, the advantages and disadvantages of real estate as an investment and the evaluation of individual income-producing real estate projects in a decision-making framework.

2. Advantages of real estate investment Attractions of real estate as an investment Cash flows from operations Appreciation Portfolio diversification Financial leverage

3. Disadvantages of real estate as an Investment: Large initial outlay usually required Financial risk Low liquidity Need for management

4. Financial Decision Making: Wealth maximization The NPV rule Using the NPV rule

5. The Discounted Cash Flow Model: Applying the discounted cash flow model Initial Equity

6. Forecasting Before-Tax Cash Flow (BTCF) (Table 17.1): Potential Gross Income (PGI) - Vacancy and credit losses (VCL) =Effective Gross Income (EGI) - Operating Expenses (OE) = Net Operating Income (NOI) - Annual Debt Service (ADS) = Before-Tax Cash Flow (BTCF)

7. Forecasting After-Tax Cash Flow (ATCF): BTCF - Taxes* = ATCF * Net Operating Income - Interest Expense - Depreciation = Taxable Income (loss) x Marginal Tax Rate = Taxes (Tax Savings)

8. After-Tax Equity Reversion (ATER): Gross Sale Price - Selling Expenses =Net Sale Proceeds - Amount Outstanding Debt = Before-Tax Equity Reversion (BTER) - Taxes Due on Sale (TDS)* = After-Tax Cash on Sale * Net Sales Price - Purchase Price * As shown in text + Accumulated Depreciation Table 16.4 = Taxable Gain (Loss) * This is not really the x MTR correct process = Tax (Savings)

9. Capital Gains Lower tax rates for capital gains has traditionally benefited real estate investors. Under current rules, gain realized in the sale of an asset will be taxed at a maximum rate of 20 percent (18 percent maximum if held for at least five years)-and possibly lower.

10. A simplified Example As stated often throughout this chapter, the tax law incorporates far more complexity and technical nuances than discussion here can adequately explain. Nevertheless, the following example does illustrate the basics of capital gain taxation:

11. A simplified Example (Cont.) Sale Price $600,000 Taxes Original cost $300,000 Less: Accrued depreciation 100,000 Adjusted basis 200,000 Total gain 400,000 Less: Depreciation recapture 100,000 at 25% = $25,000 Capital Gain 300,000 at20% = 60,000 Total taxes $85,000

12. A simplified Example (Cont.) As you can see, under current law, accrued depreciation is recaptured at a tax rate of 25 percent, and the remaining part of the capital gain is taxed at the rate of 20 percent. Obviously, these reduced rates result in the lower taxes. However, if you fit into 15 percent ordinary income tax bracket (as opposed to the 28 percent or 39.6 percent bracket), your capital gains are taxed 10 percent rather than 20 percent. The depreciation recapture remains at the 25 percent rate