The final course of the specialization expands the knowledge of a construction project manager to include an understanding of economics and the mathematics of money, an essential component of every construction project. Topics covered include the time value of money, the definition and calculation of the types of interest rates, and the importance of Cash Flow Diagrams.

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Real Estate Finance for Development Projects

Professor Anthony Webster introduces real estate finance providing an overview of the real estate project lifecycle, a discussion on zoning code parameters, and examples of estimating the sales price of a property.

Instructor, Department of Civil Engineering and Engineering Mechanics, Columbia University Director of Research and Founder, Global Leaders in Construction Management

Okay, hello again.

This is once again, Professor Webster from the NYU Bachelor of

Science in Real Estate program, where I am chair of that program.

And also President of Westend Advisors financial real estate consulting firm.

Okay, so this is the second module in our series on

real estate finance as it applies to construction management.

And what we're going to do here is we're going to review a little bit of

the mathematics of money, time value of money,

that Professor Odell went over with you.

And we're going to introduce a few new concepts related to

evaluating real estate finance projects using time value of money concepts.

Okay, so let's get the show on the road.

First to make sure we're all on the same page, some basic definitions.

And in finance, a project as it says here, is any venture done by one person,

a group or an entity requiring one or more cash outflows

[COUGH] and resulting in one or more cash inflows.

And an investment is always a synonym for a project in finance,

in finance generally as well as real estate finance.

And similarly, an investor is short for any person, group or

entity that is evaluating a project from their own perspective.

Okay, so what do projects include from finance perspective and

real estate finance perspective?

For example, buying a company, buying part of a company,

[COUGH] generally from the purchasers perspective.

A product launch or expansion,

which would generally be from a parent company's perspective.

Making a loan, buying a bond bond from an investor's perspective, okay?

Investors in finance, which are going to be things like,

in real estate finance, things like REITs, development companies,

individuals interested in real estate, are going to be evaluating projects

to find out how much a potential project will add to their wealth.

Or another way of saying that is, how much a potential project is worth to them.

In general, if they find that a potential project's

time-normalized cash inflows are greater than its time

normalized cash outflows, then the project is going to

be worth more than zero to this particular investor.

It would add to her wealth, and

should be pursued by the investor.

Time normalization of the inflows and

outflows is done by putting them all in present value terms,

as you learned with Professor Odell.

In other words, we're translating all of the cash flows for a given project for

a given player in the project, equity, debt, not mix them up.

The developer the lender, one at a time, don't mix them up.

We're translating all of those cash flows into their

equivalent if they happen today, and then considering them all.

And this gives us apples to apples comparison of cash flows,

which allows us to add them and subtract them.

And, as we know, if we don't do that, we're going to have some errors,

because cash is a function of time due to inflation and other items.

[COUGH] So we can evaluate any project if we're

going to use discounted cash flow methods,

which is going to be the subject of this module and the next module.

We can evaluate any project happily using its time-normalized

positive cash flows, its time-normalized costs, and

it's riskiness, which is going to be measured by the discount rate for

the project or the interest rate, mathematically they're the same thing.

Usually we use discount rate when we're going back in time and

interest rate when we're going forward in time.

And of course, the project's cash flows.

And then if the present value of

these cash flows, the positive cash flows for the project,

is greater than the present values of the sum of the negative cash flows for

the project, then we'd want to proceed, okay?

And so we have a nice little diagram of this down here,

there should be an arrow there.

And we've got time on the x axis here,

And we have a project where, say a developer might

have to initially invest in some architects and

engineers for design, and then construction costs.

After they buy a property, it might be producing cash flows as a parking lot or

something, so they get that.

Have to put more money in for more construction costs.

And then when they sell the property, they get another cash flow out,

something like that.

And all these cash flows happen at different points in time.

One thing very important to remember is we're going to consider cash flows for

one player at a time, okay, for just the developer or just the lender, etc.

And never mix up who we're considering cash flows for.

Okay, so we're going to be looking at, once we do a little more review but

not much, discounted cash flow evaluation methods for

general finance projects and real estate finance projects.

And we're always going to be using the present value of cash flows,

cash flows translated back to time T = 0.

And discount rates or interest rates,

which you've seen as r, maybe you've seen ROCC which stands for

for opportunity cost of capital, etc, okay?

In real estate finance, the two most important discounted cash flow

methods are the net present value method and the internal rate of return method.

And before we get started on both of those methods, I'd like to

go over several key points that apply to both methods.

I have found that some of my students and

entry level employees typically get these three things screwed up sometimes.

So let me go over them with you.

Again, as I've said three or four times already, can't emphasize it enough,

we always want to evaluate a project for one participant at a time.

And we're only going to consider cash inflows and

outflows to or from this project for this player.

We're in general using the DCF methods, we're not going to care about

what they may have in the bank, as long as it stays there.

We might not care what they have hidden under their pillow or

stashed away in some other country.

All we care about are cash flows into that player for

this project and cash flows out from that player for this project.

And finally, we're going to be evaluating evaluating all our cash flows at T = 0.

Typically that means we're going to discount our future

cash flows back to time T = 0 using the appropriate discount rate.

Okay, another announcement on helpful materials for all of my modules.

Again, a self-serving and gratuitous plug starts us off

in the beginning here with introduction to my business finance package.

Actually everything we're covering in this module is covered in great gory detail

in my Introduction to Business Finance Package.

So it maybe helpful for you to get through this module.

And again, another very good resource is Introduction to

Real Estate Finance, by Edward Glickman.

That will be useful, not so much in this module, but

in the first module that I gave you, and

for the module coming up where we're actually going to do financial plans.