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Real Estate Investment Analysis

Comprehensive Real Estate Appraisal Seminar and


Training
Philippine Investment Climate
Philippine Investment Climate

December 11, 2014 Moody's Investors


Service has today upgraded the rating of the
Government of the Philippines by one notch
to Baa2 from Baa3, which was also upgraded
from Ba1 more than a year ago. The factors
that prompted the review remain intact,
namely the sustainability of the country's 1)
robust economic performance; 2) ongoing
fiscal and debt consolidation; and 3) political
stability and improved governance.

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Philippine Investment Climate

May 8, 2014 Standard & Poor (S&P) again


raised the rating on the Philippines long-term
foreign-currency- denominated debt, one level
to BBB from BBB-, which was also raised from
BB+ last year, with a stable outlook.
March 27, 2013 - Debt watcher Fitch Ratings lifted
the countrys credit rating to BBB- from BB+,
with a stable outlook, less than a month after its
team visited the Philippines for a diligence
review of the countrys macro fundamentals.
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Philippine Investment Climate

In addition, the stability of the Philippines'


funding conditions -- during the recent bout of
market volatility in emerging markets -- points
to the country's relative lack of vulnerability to
external financial shocks, such as those
arising from anticipated tapering by the US
Federal Reserve of its quantitative easing
policy.

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Philippine Investment Climate

Philippines is now investment grade


What it means for Phl: An investment grade
rating means the Philippines has a strong
ability to meet its financial commitments
fully and on time

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Philippine Investment Climate

While credit ratings do not indicate


investment merit, credit risk is one of the
factors taken into consideration by
businessmen.
An investment grade sends a message that
the Philippines is a safe place for
investments, including big-ticket ones that
generate much-needed employment.

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Philippine Investment Climate

Borrowing costs will also go down for debtor


nations seen as unlikely to default.

The Philippines, whose debt payments eat


up the largest chunk of the annual national
budget, can then channel savings to
development efforts and improvement of
basic services.

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Real Estate Investment
Real Estate Investment Analysis

Real estate investment involves a critical


investment decision that requires
substantial funds outlay with the expectation
of financial benefits generally over a long
period or time horizon.

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Real Estate Cycle

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Real Estate Cycle Investment Strategy

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Real Estate Risk and Return

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Investment Decision Process
Investment Decision Process

Evaluating and
Identification of the analyzing the Implementation of the
type(s) of real estate identified type(s) of final decision by
you intend to invest. real estate for their preparing an action
costs and financial/ plan:
productive potentials.

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Real estate markets in most countries are not as
organized or efficient as markets for other, more liquid
investment instruments.

Individual properties are unique to themselves and not


directly interchangeable, which presents a major
challenge to an investor seeking to evaluate prices and
investment opportunities.

For this reason, locating properties in which to invest


can involve substantial work and competition among
investors to purchase individual properties may be highly
variable depending on knowledge of availability.
Information asymmetries are common in real estate
markets. This increases transactional risk, but also
provides many opportunities for investors to obtain
properties at bargain prices.

Real estate investors typically use a variety of appraisal


techniques to determine the value of properties prior to
purchase.
Typical sources of investment properties include:
. Market listings (through a Multiple Listing Service
or Commercial Information Exchange)
. Real estate agents
. Wholesalers (such as bank real estate owned
departments and public agencies)
. Public auction (foreclosure sales, estate sales,
etc.)
. Private sales
Identify
SWOT Strengths
Analysis Weaknesses
Opportunities
Threats
.Legally Permissible
Highest and .Physically Possible
Best Use
(HBU) .Financially Feasible
Analysis
.Maximally Productive
Financial Evaluation Techniques

1. Payback Period
2. Accounting Rate of Return
3. Net Present Value (discounted
cash flows analysis)
-Profitability Index
4. Internal Rate of Return
Financial Evaluation Techniques

1. Payback Period
. Measures the length of time to recover
from the expected future cash flows, the
original investments.
2. Accounting Rate of Return
. It determines the average rate of return the
investment will generate over its whole life
to the capital invested.
Payback Period/Accounting Rate of
Return (ARR)

Uniform Streams of Cash Inflows


Example:
Assume that Real Estate Development
Company A, is planning to purchase a real
estate development project for P6,000,000
that will generate a net cash revenues of
P1,200,000 a year. The tax rate is 30%.
Solution to Example: Payback Period
Accounting Rate of Return (ARR)

Based on the same example:

ARR= Net Income after Tax


Cost of Investment
= P840,000/P6,000,000
= .14 or 14% (compared with the desired
rate of return (DRR) if equal or greater than
DRR, pursue the project otherwise, reject the
project.
Payback Period with Uneven Cash Flows
Payback Period with Uneven Cash Flows
Discounting Techniques

Discounting techniques require the application


of the concept of time value of money,
particularly the concept of Present Value

Present Value is the current equivalent of


future cash flow or series of cash flows
(annuity) when discounted by an appropriate
discounting rate over a period of time.

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Time Value of Money

Time value of money concept is based on the


assumption that a Peso received today is
more valuable or worth than a Peso received
tomorrow.

Because a Peso received today can be


invested to earn interest .

Interest is the amount received by an investor


and paid by the borrower for the money
invested and borrowed, respectively.
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Present Value

When the future value (amount needed


in the future) is known, the present
value is the amount that must be
invested today in order to accumulate
with compound interest and arrived to
that future value.

The process of computing the PV is


called Discounting.
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Present Value Example

Assume that Mr. Cruz wants P500,000 in 8


years.
Find how much Mr. Cruz must invest now if the
present interest rate is 6% per annum ,
compounded semi-annually in order to
accumulate P500,000 in 8 years from now.

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Present Value Computation

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Present Value of Annuity

Annuity is a series of cash flows of equal or


even amount made at equal intervals of time.

In case of annuity, the table factor to be used in


the PV of Annuity of 1

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Present Value of Annuity Example

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Computing Periodic Amortization Using
the PV Annuity Technique

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Future Value (FV)

FV is the compound amount of the principal


and accumulated interest.

FV is the amount to which an investment (PV)


will accumulate over time when a
compounding interest rate is applied.

The process of computing the FV is called


Compounding.

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Future Value (FV) Example

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Future Value (FV) Sample Problem

What is the future value of an annuity of


P10,000 per year , for 4 years, at 6%
interest compounded annually?

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Future Value (FV) Solution to Sample
Problem

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Compounding/Discounting Periods More
than Once a Year
When the frequency of compounding or
discounting periods is more than once a year
(semi-annually, quarterly or even monthly),
adjust first the i (interest rate) and the n (period)
before applying the appropriate table factor.
Example: i=6%, n=5 yrs compounding/
discounting period is semi-annually:
Adjustments: 1= 6%/2 = 3%
n=5 yrs x 2 = 10 periods

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Present Value/Future Value Variables

Present Value Future Value


Future Value Present Value
Discounting rate (i) Compounding rate (i)
Discounting period (n) Compounding period (n)

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Evaluation Techniques
(Discounting Methods)

Net Present Value


Present value is the current equivalent of
future cash flows to be generated by an
investment/project. (when discounted at its
cost of capital over a period of time).

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Net Present Value (NPV)

Formula:
Present value of cash inflows xxx
Less: Cost of Investments xxx
Net Present Value xxx
When the NPV is positive, the investment/project
is acceptable.

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Example of NPV - Annuity

Assumed data:
Cost of Investment P12,950,000
Annual Cash Inflows P 3,000,000
Estimated Holding Period 10 years
Cost of Capital 12%
(Minimum Required Rate of Return)

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Solution to Example of NPV - Annuity

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Example NPV-Uneven Cash Flows

Assumed data:
Cost of Investment P31,000,000
Estimated Annual
Cash Inflows (net)
Years Cash Inflows
1 P 10,000,000
2 20,000,000
3 10,000,000
4 10,000,000
5 5,000,000
Cost of Capital 14%
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Solution to Example NPV-Uneven Cash
Flows

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Internal Rate of Return (IRR)
The IRR when used as the discounting rate of
the present value of future cash inflows, the
NPV is equivalent to ZERO.

The IRR is determined by a trial and error


process and then compared with the
investments cost of capital.

If the IRR is equal or greater than the cost of


capital, the investment/project is acceptable,
if less than the cost of capital, the
investment/project is rejected.
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Example - IRR
Based on the above example:

The IRR is computed as follows:


Since the cash inflows are not even, we have to compute
the IRR by trial and error:
Compute for the tentative IRR PVAF by:
Cost of Investment/Average of annual cash flows =
P31,000,000/P11,000,000 = 2.818
Based on the PVA Table @ n=5, the IRR is between
approximately 22% and 24%.
Since this is higher than the cost of capital of 14%, the
project is acceptable. To compute for the precise IRR, we
have to interpolate the factors of 22%, 24% and 2.818.
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Example IRR (Even Cash Inflows)

Assumed an investment of P5,000,000 will yield


an average annual cash inflows of P750,000 for
10 years. Compute for the IRR.
1) Compute for the IRR PVA factor:
P5,000,000/P750,000 = 6.66667
2) Based on the PVA Table of 1 for 10 years, the
interest rate that gives the nearest to 6.66667 is
between 8% and 10%.

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Example IRR (Even Cash Inflows)

3) To get the exact IRR, interpolate table factors between 8%


and 10%:
At 8% ,n=10, table factor 6.71007
IRR table factor (step 1) 6.66667
At 10%, n=10, table factor 6.14456
Exact IRR = LR +[(6.66667 6.71007)/(6.14456 - 6.71007) x
(10%-8%)] = 8% + [(0.043/0.566) x 2%]
= 8% + .15% = 8.15%

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Profitability Index

The ratio of the total present value of future cash


inflows to the cost of investment.
The index measures the desirability of the
project.
Profitability Index = PV of cash inflows/cost of
investment
The higher the index , the more desirable the
project. (If the index is 1 or more =accept
project; If index is less than 1, reject project)

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Profitability Index

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Profitability Index

Based on the example, we can rank the projects


as follows:
Rank 1 - Projects B and C
2 - Project A
Decision: Invest in projects B and C.
The Indexes of B and C are higher than A; the
total NPVs of B and C are higher than A; can
afford to invest in both B and C.

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Capital Rationing Analysis

Capital rationing is having several project


opportunities with positive NPVs but with
limited budget.

Capital rationing analysis gives the basis


for efficient and effective decision analysis
as to which project or combination of
projects will be pursued or implemented.

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Capital Rationing Analysis

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Capital Rationing Analysis

The foregoing projects are not mutually


exclusive and therefore can be implemented
simultaneously subject to the limited budget of
P720,000.

Identify the project or combination of projects


that can be profitably implemented based on
their NPV or combined NPVs and at
maximized capital outlays.

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Capital Rationing Analysis

Suggested projects to be implemented based


on the rankings of NPVs and combined NPVs:
Outlays
Project C NPV is + 95,000 300,000
Project G NPV is +180,000 400,000
Total NPVs +275,000 700,000
The excess P20,000 of the budget can be
placed in a short-term investments to earn
prevailing market rate.

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Cost-Volume-Profit (CVP) Analysis

By CVP analysis breakeven point is


determined.

Breakeven point is the level of activity


(production and sales) at which the revenue
generated is equal to costs and expenses.

The calculation of breakeven point would


require the following variables: variable
costs/expenses, fixed operating expenses
and contribution margin.
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Cost-Volume-Profit (CVP) Analysis

Variable costs/expenses:
These are costs and expenses that vary or
change in proportion to the change in the
level of production and sales.
Fixed operating expenses:
These are expenses that do not vary or
change regardless of change in the level of
production and sales.
Contribution Margin:
The difference between revenue and
variable costs/expenses.
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Cost-Volume-Profit (CVP) Analysis

Formula for breakeven point-

For breakeven point in revenue volume/units


=Fixed costs/expenses
Contribution Margin (volume/unit)

For breakeven point in Peso revenue:


=Fixed costs/expenses
Contribution Margin (ratio/percentage)

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Cost-Volume-Profit (CVP) Analysis

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Cost-Volume-Profit (CVP) Analysis

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Breakeven Point (Multi-Products)

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Breakeven Point (Multi-Products)

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Breakeven Point (Multi-Products)

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Marissa Benitez
Director | Valuation & Advisory Services
+63 917 860 0952
Marissa.benitez@colliers.com

Colliers International | Manila


11F Frabelle Business Center
111 Rada Street, Legaspi Village
Makati City, Philippines
TEL +63 2 888 9988

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