Structuring Financial

Instrument
&
Real Estate Investment
Performance Measurements
Group 3
BL Gamboa, JS Farolan, JP Dial, SC-Tala, AA. Perez

1
 A Brief introduction

Chapter 5:
Structuring Financial Instruments
1.Leverage 2.Debt 3. Equity 4. Partnership 5. Blended
AGENDA Financing & Weighted Average Cost of Capital 6. Options

Chapter 6
BSREM- Real Estate Finance Class
Professor Marigold Yong-Cura
Real Estate Investment Performance
Measurements & Ratios
December 5, 2020
1. NetIncome Return on Investment 2. Cash Return on
Investment 3. Total Return of Investment 4. Net Operating
Income 5. Capitalization Ratio 6. Debt Servicing Coverage
Ratio 7. Operating Efficiency Ratio 8. Gross Rent Multiplier
9. Operating Ratios 10..Break-Even Ratio

Q&A/Builds

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 A Brief
Introduction
• RE Investing = Investment Property
• Buys or sells property with the
intention to earn a return through
rental income, resale or both, either on
short or long-term periods
• Not primarily as residence or second
home
• Investors perform studies, use metrics
to valuate a property to determine its
highest & best possible profitability
• Basis for all decisions founded on the
fundamental principles of finance as
applied to real estate valuations

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Structuring Financial
Instruments

Chapter 5

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 What is Structuring
Financial
Instrument?

• Management of risk and development of

financial markets for complex emerging
markets
• Mix of debt and equity instruments that a
company use to finance its operations
• Evaluation of the financial structure to
decide between managing a private or public
business and the capital opportunities that
come with each

Source: Investopedia 5
How Leverage Works

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 Is the use of borrowed money to finance
Leverage the purchase of assets with the expectation
that the income from the new asset will
exceed the cost of borrowing.

Example 1: Cost of loan is 6%

▪ Expected Return on Asset 10%
▪ Therefore, the leverage is positive and would
represent a viable investment opportunity.

Example 2: Cost of Loan is 8.5%

▪ Expected Return on assets is 5.75%
▪ It is said to be negative and would not represent a
viable investment opportunity.

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 Is the most common type of financing.
Debt It comes in the form of a loan from
any number of sources.

▪ Debt is lower cost of capital than other forms

of financing such as equity

▪ Debt is typically readily available

▪ Key disadvantage is that Debt needs to be

serviced. Periodic payments made with
predetermined terms and conditions

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Debt
(Home Loans)

BDO PS BANK

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Debt

Key Points of Debt

▪ Structure the servicing of debt without

the negative cash flow.
▪ Should have free cash after all
expenses and taxes to ensure you meet
the debt requirements.
▪ You must be in control of your debt,
don’t let your debt control you.

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Equity
If Debt is money that is borrowed,
Equity is money that is invested.

▪ Sources of Equity – family, friends,

business associates or private
investors.
▪ Repayment is expected
a) Deferred until property is Sold
b) Percentage of Profit
- Income
- Capital Gains

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Equity
(at work)

New company
App Shopping Investor/s
Platform

Shopee
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 Combining resources with those of a
Partnerships partner is another way to raise financing
in the investment of properties

▪ Can be structured in any manner both parties

agree on
▪ Repayment
– can be in debt form
- Principal + Interest
- Interest Only
- Deferred payment until Sold

▪ There is a promissory note and is not based on

the profitability of the property
▪ Biggest Challenge – finding the right partner and
consider how a potential failure can affect your
relationship with your partner

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Partnerships

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 Blended Financing & WACC

The combination of debt and equity,

usually by larger investors by combining
several sources of financing to produce
income generating properties.
▪ Different sources of financing most
likely will charge different rates, a
blended rate must be calculated. This
is called WACC (Weighted Average
Cost of Capital)

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 Blended Financing & WACC
WACC Formula:

B - is the value of the Bonds or Debt Financing

S - is the value of Stocks or equity financing
RB - is the cost of debt or Interest Rate
RS - is the cost of equity or the return of equity
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 Blended Financing & WACC
EXAMPLE: An investor buying a $1M commercial
building must pull out $200,000 out of her mutual fund,
which has been averaging a 12% rate of return. She will
borrow the remaining $800,000 at an interest rate of 6%.
What is the WACC?

WAC = 800,000 x 6%+ 200,000 x 12%

800,000+200,000 800,000+200,000

= 800,000 x 6%+ 200,000 x 12%

1,000,000 1,000,000

= ( .80 x 0.600) + ( .20 x .1200)

= .0480 + .0240
= . 0720

WACC = 7. 2% 17
Blended Financing & WACC
(continuation)

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Option

A contract giving a buyer the right, but not

the obligation to buy or sell the underlying
asset at a specific price on or before a
certain date.

▪ In Real Estate , an option is when an

investor has the legal right to buy a
specified piece of property at a
predetermined price within a specified
time frame.

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Option
(illustrations)

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Real Estate Investment
Performance
Measurements & Ratios

Chapter 6

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 What is Investment
Performance
Measurement & Ratios?
• Investors need to quantify and look both at
measuring risk with the variability of returns as
part of managing investment portfolio
• Portfolio performance measures are key factors in
investment decision
• Tools provide the necessary information for
investors to assess how effectively their money has
been invested (or may be invested).
• Portfolio returns are only part of the story. Without
evaluating risk-adjusted returns, an investor cannot
possibly see the whole investment picture, which may
inadvertently lead to clouded decisions.

Source: Investopedia 22
Net Income Return On
Investment (Net ROI)
Captures net income or profit (after all expenses)
return vs invested capital.

Hypothetical Example: (Flipping Property, 12 mos. Loan)

▪ Capital Investment : Php 1,00,000.00

▪ Improvements : 500,000.00
▪ Price Sold : 2,000,000.00
▪ Profit Before Tax (PBT): 500,000.00
▪ ROI (%) 33.3%

*ROI measures the gain or loss generated on an investment

relative to the amount of money invested, expressed in
percentage.

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 Cash Return On
Investment (Cash
ROI)
Provides the ratio between the remaining
cash after debt service and invested
capital.

Hypothetical Example:

▪ As in earlier example:
• Assume, P500,000 loan with 8%/annum or
.66%/mo. x 12 months. Interest/month is
P3,300.00. Monthly amortization at P40,000 incl
factor rate & other charges. PBT is P500,000

▪ Cash ROI = remaining cash after debt service/cap

investment
▪ Remaining Cash: P500,000 – 40,000 = 460,000.00
▪ Cash ROI: 460,000/1,000,000 = 46%
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Total Return On
Investment (Total ROI)
Represents the total return of an investor’s capital
by capturing both the cash and non-cash
portions.

Hypothetical Example:
▪ Monthly Repayment: P40,000
• Interest: P3,300 (P500,000 x .66% = P3,300)
• Principal: P36,700 (P40,000 – 3,300 = P36,700)

▪ Formula Total ROI = remaining cash after debt service + principal

▪ reduction / cash investment
▪ Total ROI = P460,000 + 36,700 = P496,700 / 1,5000,000
▪ Total ROI % : 33.1%

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 Net Operating Income

Income after all operating expenses have been

paid that can be used to service or pay the
property’s debt .

Hypothetical Example:
▪ Gross Income: P500,000.00
Less:
Total OPEX: 250,000.00
Taxes (30%) 150,000.00
▪ Net Operating Income 100,000.00

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Capitalization Ratio
The ratio between net operating income and sales
price into a single unit expressed as percentage

▪ Hypothetical Example:

▪ Formula: Cap Rate = NOI / Sales Price

▪ Cap Rate = P100,000.00 / 2,000,000.00
Cap Rate = 5%
▪ Cap Rate varies depending on location, type of property, and
income potential. It can be a tool for asset valuation to help
determine which property to invest in.

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Debt Service Coverage
Ratio
The relationship of cash generated from an
investment to the debt required to pay for that
investment.

Hypothetical Example:
▪ Formula: DSCR = NOI / Principal + Interest
▪ DSCR = 100,000 / 500,000 + 40,000
▪ DSCR = 100.000 / 540,000
▪ DSCR = 18.5%

▪ Benefits lenders more but also shows borrower his capability to

service loan. Lenders has different levels of DSCR requires as set
internally.
Assuming our lenders' DSCR minimum requirement is 20%, the 37%
DSCR more or less assures lender that the company can earn more
that enough to service the loan

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Operating
Efficiency Ratio
OER measures the operating expenses of
an investment property relative to its size.

• Hypothetical Example:
Formula: Total OPEX / SQM
• OER = 250,000 / 150sqm
• OER = P 1,666.66
• Example shows that it cost you 1,666.66 per sqm at
current level of operating expense. The lower the OER,
the better.
•

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 Gross Rent Multiplier
GRM measures the relationship between
the total purchase price of a property and
its gross scheduled income. It is the ratio
of price to income.

Hypothetical Example
▪ Formula: GRM = Total Expenses(incl taxes & Interest) /
Annual Rental Yield or Income
▪ Studio Unit Cost : 2,000,000.00
▪ Rental : 16,000/mo x 12 mos = 192,000.00

▪ GRM = P 1,940,000 / 192,000 ( 16,000 x 12mos)

▪ GRM = 10.1

▪ Initial GRM computation. Multiplier can change once

improvements/maintenance, taxes, rental increase are
factored in annually.

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Operating Ratio
The ratio between total operating
expenses and gross income used to
analyze income producing properties.

Hypothetical Example:
Formula: OR = Total Operating Expense / Gross Income

• OR = 250,000 / 500,000
• OR = 50%
• An ideal and balanced ratio. High OR may signify over
reporting of expenses; a lower OR may signify under-
reporting. Either way should be examined to make
appropriate action.

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Break Even Ratio

The point at which the total cash inflows

are exactly equal to the total cash
outflows.

Hypothetical Example:

Formula: : BER = Total Operating Expenses + Debt Service /

Gross Income

BER = 250,000 + 40,000 / 500,000

BER = 290,000 / 500,000
BER = 58%

• The example has a positive cash flow sufficient to sustain

operations. Above 101% ratio signals negative cash flow ie
expenses are higher than income.
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Group 3

THANK
YOU!
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