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    Investment / Investor         Investment CapRate, IRR, CashOnCash, DebtCoverageRatio        analysis "Terms" definitions
             1)   Capitalization Rate  
             2)    Cash on Cash Return
             3)   Debt Coverage Ratio
             4)   Depreciation
             5)   Gross Rent Multiplier
             6)   After-Tax IRR  
             7)   Loan-to-Value Ratio
             8)   MIRR for Future Wealth   
             9)   Net Income Multiplier
            10)  Leverage
      
             Capitalization Rate:                                                                      Back to Menu
             The Capitalization Rate or "Cap Rate" is a ratio used to estimate the  value of income
             producing properties.  Put simply, it is the net operating income  divided by the sales
             price or value of a property expressed as a percentage.  It is one of many financial 
             tools used by investors, lenders and appraisers to establish a reasonable purchase 
             price for a given investment property in a specific market.  
             Cap rates may vary in different areas of a city for many reasons such as desirability
             of location, level of crime and general condition of an area.  Investors expect larger  
             returns when investing in high risk income properties.  In a real estate market  
             where net operating incomes are increasing and cap rates are declining over time 
             for a given type of investment property such as office buildings, values will be 
             generally increasing.  If cap rates are increasing over time and net operating 
             incomes are decreasing for residential income property in a particular market
             place, residential  income property values will be declining.  If you would like to 
             find out what the cap rate is for a particular type of property in a given market, 
             check with an appraiser or lender in that area.  Since the frequency of sales for  
             commercial income properties in a given market place may be low, reliable cap
          rate data may not be available.
             If you are able to obtain cap rate data from an appraiser or lender for the type of 
             property you are evaluating, check to see if the cap rate value was determined with 
             recent sales of comparable properties or if it was constructed.  When adequate
             financial data is unavailable, appraisers may construct a cap rate through analysis 
             of it's component parts thus reducing the credibility of the results.  Cap rates which
             are determined by evaluating the recent actions of buyers and sellers in a particular 
             market place will produce the best market value estimate for a property. 
             If you are able to obtain reliable cap rate data, you can then use this information to  
             estimate what similar income properties should sell for.  This will help you to gauge
             whether or not the asking price for a particular piece of property is over or under 
             priced.   
                                                  NOI                                                                    NOI
                       Cap Rate  =     --------                        Estimated Value  =    ------------- 
                                              Value                                                              Cap Rate
             Example 1:   A property has a NOI of $155,000 and the asking price is $1,200,000.
                                                   $155,000
                        Cap Rate =       --------------        100   =  12.9 rounded
                                                  $1,200,000
             Example 2:  A property has a NOI of $120,000 and Cap Rates in the area for this
             type of property are 12%.       
                                                                             $120,000
                         Estimated Market Value  =     ------------     =     $1,000,000
                                                                                   .12
             Net operating income is equal to gross income minus the vacancy amount
             and operating expenses.  Operating expenses include such items as advertising,
             insurance, maintenance, property taxes, property management, repairs, supplies
             and utilities and does not include depreciation, interest and amortization.
             Appraisers use the Income Approach, Cost Replacement and Market Comparison
             methods to estimate the value of property.  The Income Approach utilizes the
             theory of Capitalization.
             Cash on Cash Return:                                                                         Back to Menu
             Cash on Cash Return is a percentage that measures the return on cash invested in an 
             income producing property.  It is calculated by dividing before-tax cash flow by the 
             amount of cash invested and is expressed as a percentage.  If before-tax cash flow for 
              an investment property is equal to $15,000 and our cash invested in the property is 
             $100,000, cash on cash return is equal  to 15%.
                                                                   Before-Tax Cash Flow                                  $15,000
                   Cash on Cash Return  =     ------------------------------       100     =        -------------        100     =     15%
                                                                           Cash Invested                                        $100,000
            The following shows how before-tax cash flow is derived. 
                     Gross Income                                   54,500
                         Less Vacancy Amount                  2,500
                     Gross Operating Income                52,000 
                          Less Operating Expenses         17,000  
                     Net Operating Income                    35,000
                          Less Annual Debt Service        20,000
                     Before-Tax Cash Flow                    15,000
            Cash on Cash Return is used to evaluate the profitability of income producing 
            properties.  It can be useful when comparing investment properties, but is just
            one of many analysis tools.  It only considers before-tax cash flow and doesn't 
            take into account an investors individual income tax situation and it doesn't consider 
            the wealth building potential of a property via appreciation.  A property in one area 
            of a city may have a better Cash on Cash Return then a property in another 
            location, but it may not appreciate as fast because of it's location.  One location
            may be more desirable than the other.
             Debt Coverage Ratio (DCR):                                                             Back to Menu
             Also known as Debt Service Coverage Ratio (DSCR).  The debt coverage ratio is
            a widely used benchmark which measures an income producing property's ability 
            to cover the monthly mortgage payments.  The DCR is calculated by dividing the
            net operating income (NOI) by the annual debt service.  Annual debt service is 
            equal to the annual total of all interest and principal paid for all loans on a property. 
            A debt coverage ratio of less than 1 indicates that there is inadequate cash flow 
            generated by an income property to cover the mortgage payments.  For example, a
            DCR of .9 indicates a negative cash flow.  There is only enough income available 
            to pay 90% of the annual mortgage payments or debt service.  A property 
            with a DCR of 1.25 generates 1.25 times as much annual income as the annual 
            debt service on the property.  In this example, the property creates 25% more 
            income than is required to cover the annual debt service.
            Example:  We are considering buying an investment property with a net operating
            income of $24,000 and annual debt service of $20,000.  The DCR for this property
            would be equal to 1.2.   This means that it generates 20% more annual income than  
            is required to cover the annual mortgage payment amount.
                                                                Net Operating Income              $24,000
                 Debt Coverage Ratio    =     ------------------------------      =     -----------       =    1.2
                                                                  Annual Debt Service               $20,000
            Many lending institutions require a minimum debt coverage ratio value to procure 
            a loan for income producing properties.   DCR requirements for lending institutions 
            may vary from as low as 1.1 to as high as 1.35.   From a lending institutions 
            perspective, the higher the DCR value, the more income there is available to cover 
            the debt service and thus the less the risk.
            Net Operating Income (NOI) is calculated as follows.
                Income
                    Gross Rents Possible                       35,000
                    Other Income                                      2,000
                Total Gross Income                              37,000
                    Less Vacancy Amount                        3,000
                Gross Operating Income                      34,000
                    Less Operating Expenses                10,000
                 Net Operating Income                         24,000
            Operating Expenses include the following items; advertising, insurance, 
            maintenance, property taxes, property management, repairs, supplies and
            utilities.
             Depreciation:                                                                                   Back to Menu
            Depreciation is the loss in value of an asset / building over time due to wear and  
            tear, physical deterioration and age.  The cost of reproducing an income property
            can be recovered over the useful life of the asset which is determined by law.  Only
            the building can be depreciated and not the land.  Residential income property must
            be depreciated over a 27.5 year period using straight line depreciation.  Commercial
            income property must be depreciated over 39 years using straight line depreciation.
            Straight line depreciation stipulates that an asset must be depreciated by equal 
            amounts each year over its useful life.   
            Example:    You purchase a warehouse for $900,000.  The land where the warehouse
            resides is valued at $120,000.  The building is valued at $780,000.  Current law 
            allows you to depreciate commercial properties by equal amounts annually over 39
            years.  Your depreciation deduction for the first year is based on the mid month
            convention.  The day of the month that you purchase the property doesn't matter.
            You can only deduct half of the first months depreciation.  If you put the warehouse
            into service on June 1, you are allowed to deduct 6 and 1/2 months of depreciation
            for the first year.
            780,000 
            -----------     =    $20,000      
                39
                                                                          20,000
             First Year Depreciation =   6.5   (  ---------  )     =    $10,833 
                                                                              12
            Accountants calculate a full year of depreciation for the  above warehouse 
            (commercial properties) by multiplying 2.56 % times 780,000 which equals 19968.    
            A full year of depreciation for residential income properties would be calculated
            by multiplying 3.64 % times the building basis.
            The depreciation deductions that you write-off in any year reduce you taxable 
            income thus increasing your profit for that year.  
            Capital improvements are subject to the same depreciation laws.  Capital 
            improvements include the following;  a new roof, a new furnace, an addition to a 
            building, siding, etc. 
            Example:  You have owned the above warehouse for about 7 years now and it is in 
            need of a new roof.   The cost of the new roof is $19,500.  You are allowed to  
            depreciate thecost of the roof over 39 years.  If you put the new roof on in July, you 
            are allowed to deduct 5 and 1/2 months of depreciation in the first year.  
             19,500
             ---------    =  $500
                 39
                                                                                        500
             First Year Depreciation (roof)  =   5.5      (  -----   )    =   $229
                                                                                         12
             Accountants would calculate a full year of depreciation for the roof by multiplying 
             2.56 % times $19,500 which equal 499.
             All depreciation amounts that you write-off in each year for the building and  
             capital improvements reduce your adjusted basis for the property thus increasing     
             the taxable profit you must declare when you sell.    
          
             Gross Rent Multiplier:                                                                    Back to Menu  
            The Gross Rent Multiplier or GRM is a ratio that is used to estimate the value 
            of income producing properties.  It can be a useful estimation tool when current
            and detailed financial information is available for similar properties in a 
            particular area or market.  If current information is available, the average GRM
            of similar properties sold in an area can then be used to estimate the value of 
            other like properties.   The GRM is calculated by dividing the sales price by either 
            the monthly potential gross income or by dividing the sales price by the yearly 
            potential gross income.    
            Example 1:  If the sales price for a property is $200,000 and the monthly potential            
            gross rental income for a property is $2,500, the GRM is equal to 80.  Monthly 
            potential gross income is equal to the full occupancy monthly rental amount which
            assumes all available rental units are occupied.  Generally speaking, properties in  
            prime locations have higher GRM's than properties in less desirable locations.
            When comparing similar properties in the same area or location, the lower the GRM,  
            the more profitable the property from an income perspective.  This statement     
            assumes that operating expenses are proportionate for the properties being  
            compared.  Since the GRM calculation doesn't include operating expenses, this  
            statement might not hold true for similar properties where one of the properties
            has significantly higher operating expenses.
                                                                  Sales Price                                $200,000
                 GRM (monthly)  =   -------------------------------------------     =     ------------    =    80
                                                   Monthly Potential Gross Income              $2,500
            Example 2:  We have several similar properties that have sold recently and their
            average monthly GRM is 80.  We can use this information to estimate the value
            of comparable properties for sale.  If our monthly potential gross income for a  
            property is equal to $3,000, we would estimate its value in the following way. 
                  Estimated Market Value  =  GRM       Potential Gross Income 
                                                             =      80              $3,000      =      $240,000   
                                                      
           The GRM can provide a rough property value estimate when consistent and
           accurate financial information is available, but you should be aware of it's
           limitations.  Operating expenses, debt service and tax consequences are not 
           included in the GRM calculation.  We could have a situation where two
           properties have approximately the same potential gross income, but one 
           property has significantly higher operating expenses.  The above formula
           would result in a questionable estimation of the market value for these
           properties.  Also, the above GRM formula uses the monthly potential gross
           income and doesn't account for vacancy factor which could have an impact 
           on the accuracy of the property value estimates.  This is why it is important
           to have accurate and detailed financial information for comparable sales 
           when establishing a GRM or Cap Rate for income producing properties.
           The GRM is sometimes calculated using the effective gross income rather
           then the potential gross income thus incorporating the vacancy factor in the    
           GRM calculation.  Effective Gross income equals potential gross income
           minus the vacancy amount. When vacancy rates are a factor, using the 
           effective gross income will produce a more reliable estimate.
           The capitalization rate is a more reliable tool for estimating the value of 
           income producing properties since vacancy amount and operating   
           expenses are included in the cap rate calculation.   The GRM is useful   
           in providing a rough estimate of value.
         
            After-Tax IRR                                                                  Back to Menu
           IRR (Internal Rate of Return) put simply is the annual yield on an investment.         
    ( That rate of return at which the present worth of future cash flows is
    EQUAL to today's initial capital investment )
           After-Tax IRR calculation for each year uses the initial investment, the series of
           After-Tax Cash Flows and the After-Tax Sales Proceeds in a particular year to 
           establish a return on investment.  For example, if we were calculating an IRR 5  
           years in the future for an investment we would use the Initial Investment, the After-Tax
           Cash Flows for each of the five years and the After-Tax Sales Proceeds in year five, the 
           final year, to calculate an After-Tax IRR for the investment.  The real estate model
           calculates an After-Tax IRR in years 1 through 10 using this method.  Be aware of one 
           thing when looking at the IRR calculations.  If in year 5 you have a return of 15 %,    
           this means that your After-Tax Cash Flows in each year are ran forward at 15%.
           When calculating the MIRR for Future Wealth, On Target software allows you to determine
            what rate of return you would like to run your cash flows at.  The MIRR for Future    
            Wealth therefore provides a more accurate return on investment in each year.
                    
           Loan-to-Value Ratio:                                                            Back to Menu
            The loan-to-value or LTV is a ratio between the loan balance and the market value
            of a property expressed as a percentage.  For example, a property with a loan 
            balance of $400,000 and a market value of $500,000 has a LTV of 80%.  
                                      Balance of Loans                           $400,000     
                      LTV   =   -----------------------      100    =     ------------     100   =    80%
                                        Market Value                              $500,000
            The LTV can be used to estimate the amount of equity you have in a property.
            If the LTV for a property is 75%, your equity position in a property is 100 minus 
            75 or 25%.  You can then multiply .25 times the market value to determine the  
            equity amount.
            Lenders may require mortgage insurance on loans with LTV's that are greater
            than a predetermined amount, usually 80%.  This means that the purchaser of 
            a property will need to put a minimum of 20% down to avoid paying mortgage
            insurance premiums.  Mortgage insurance is a premium amount which is added
            to the monthly mortgage payment.
            The LTV is also used when an investor wishes to refinance a property.  For 
            example, you have owned an investment property for a number of years and  
            you would like to refinance the property to take cash out.  Most lenders will
            allow a maximum of 75% the appraised value for the new loan amount.  
            Lenders who refinance at LTV's greater than 75% will usually charge less
            favorable interest rates.
             MIRR for Future Wealth:                                                                   Back to Menu                  
            The Modified Internal Rate of Return on Future Wealth is the best indicator to
            evaluate the overall return on an income property investment.  Cumulative cash 
            flows and gains resulting from the sale of the property are accumulated on a 
            year-to-year basis to arrive at a Future Wealth amount.  You determine the rate of
            return you would like to run your cash flows forward at.  The IRR calculation 
            determines this value for you and may therefore exaggerate your return on cash flows.  
            Also overestimating the appreciation growth rate can distort Future Wealth.  Once 
            you've narrowed down  your property selections, you may want to run low, medium 
            and high appreciation growth rate scenarios through the model.  This will give  you a 
            range of Future Wealth possibilities. 
                     
             Net Income Multiplier:                                                       Back to Menu  
            The Net Income Multiplier or NIM is a factor that is used to estimate the market
            value of income producing properties.  It is equal to the market value of a property
            divided by the net operating income or NOI.
            Example 1:  A residential income property has an NOI of $15,000 and a market value 
            of $150,000.  
                                               Market Value                      $150,000
                       NIM  =      -----------------------------      =       ------------       =    10
                                         Net Operating Income                $15,000
            Example 2:  The average net income multiplier for comparable properties in a 
            particular area is 9 and the net operating income for a similar property we are   
            considering buying is $20,000.
                       Market Value  =  NIM     NOI   =    9      $20,000    =     $180,000
            The net income multiplier and the cap rate are financial tools used to estimate
            the market value of income properties.  The cap rate is better known and more
            widely used.   The cap rate and the NIM produce identical results when 
            estimating the market value of an income property since the net income 
            multiplier is the inverse of the cap rate.  The cap rate is equal to 100 divided by     
            the NIM and conversely the NIM is equal to 100 divided by the cap rate. 
                                                   100                                             100
                        Cap Rate  =     -------                      NIM   =    ------------ 
                                                  NIM                                        Cap Rate
            When using the capitalization rate and the net income multiplier to estimate the
            value of an income property, accurate and current financial data for comparable
            sales is required.  
             Leverage:                                                                             Back to Menu
            Leverage is the use of borrowed money to increase your profits in an investment.
            Building wealth via real estate requires the use of leverage.  Let's assume you have 
            $100,000 to invest and you purchase a small income property for $100,000.  Income    
            properties have been appreciating at an average of 7% per year.  At the end of the 
            first year of operation, your property is worth $107,000.  At the end of year two, it
            is worth $114,490.   Now let's assume that you put your $100,000 down on a $500,000   
            income property.  At the end of the first year, it is worth $535,000.  At the end of  
            the second year, it is worth $572,450.  By borrowing money to purchase a larger
            income property, you have increased your profit by $57,960 in just two years. 
            To get the full advantage of leverage, put the minimum down on a good property  
            which has a strong likelihood of appreciating in value.  Stay away from questionable
            properties in run down areas.
            When you purchase a piece of real estate, you make use of leverage when you
            borrow money towards the purchase price.  The principal of leverage can be
            demonstrated very easily with an investment model.  For those of you who own
            "ON TARGET", investment software, bring up Sample 1.  Run the model with the current data and go
            to the reports section.  Take a good look at the MIRR (Modified Internal Rate of
            Return) values on the Future Wealth report or print a copy of the report.  Go back
            to the input section by clicking on input.  Change Loan 1 Amount on the Property
            Data screen from $300,000 to $350,000.  This will reduce your down payment from
            $92,073 to $42,323.  Click on run and go back into the Future Wealth report.
            Your Before-Tax and After-Tax MIRR values have increased substantially for
            all years.  The model clearly demonstrates the principal of leverage.