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CAIA Level One > 3. Real Assets > Flashcards

3. Real Assets Flashcards

1
Q

Real Asset

A

Physical economic resource, direct creator of consumption opportunity.

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2
Q

Undeveloped Land

A

Real asset that is not currently being used. Value of undeveloped land lies in the future consumption.

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3
Q

Land Banking

A

Investors purchase undeveloped land for the purpose of developing the land in the future. Key, is they plan on selling it to home-builders in the future.

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4
Q

Paper Lots

A

Lots are vacant, but zoned for development.

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5
Q

Blue Top Lots

A

Process of development has begun, rough grading and temporary drainage. Some development and building permit fees have not been paid.

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6
Q

Finished Lots

A

Lots are ready for construction and all developmental fees paid. Only remaining, payment of building permit fees and property inspection.

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7
Q

Key Risks of Undeveloped Residential Land

A
  1. Type: more uses for a property, higher value. Thus, single use property risky.
  2. Location: lots in path of development or near cities, high value. Thus, rural lots risky.
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8
Q

Land as a Call Option

A

Strike: construction and other costs incurred for development.
Time to Exp: generally unlimited
Underlying Asset: combination of land and improvements
Option Payoff: diff. between value of completed project and all costs of development& construction

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9
Q

Binomial Option Pricing Model to Evaluate Land

A

current value of improved property=

(UpVal x UpProb) + [DownVal x (1-UpProb)]

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10
Q

Timberland

A
  • long term investments in wood via existing forestland

- returns exhibit low correlation to with stock and bond returns

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11
Q

Advantages of Timberland Investing

A
  • low correlation with stocks and bonds
  • may act as hedge against inflation
  • invest in real asset, land
  • renewable resource although long growth cycle
  • flexibility of harvesting
  • timber used for variety of products
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12
Q

Disadvantages of Timberland Investing

A
  • trees destroyed by fire
  • value tied to cyclical industries
  • supply not fixed
  • tech and recycling may reduce need
  • investment horizon long
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13
Q

Farmland

A
  • real asset that generates crop income

- more closely related to commodity prices than rent

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14
Q

Farmland Benefits

A
  • renewable annual cash flow
  • steady cash stream
  • short growth cycle
  • multi-purpose option
  • expected increase in world population
  • not dependent on local economies, listed on international futures
  • scalable: strong competition to lease farmland
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15
Q

Farmland Disadvantages

A
  • agency risks
  • political risks
  • less harvest flexibility
  • natural forces can destroy
  • farm specific inefficiencies
  • revenues driven by market factors
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16
Q

Option to Produce Alternative Crop

A

Based on

  • correlation
  • volatility
  • current closeness to profitability
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17
Q

Farmland Exposure

A
  • best way is to own
  • two indices: DAX Global Agribusiness Index & Thomson Reuters in the Ground Global Equity Index
  • ETF: MOO
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18
Q

Infrastructure

A

broadly defined as the underlying foundation of basic services, facilities, and institutions upon which society depends

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19
Q

Greenfield Projects

A

infrastructure investments that must be constructed

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20
Q

Brownfield Projects

A

infrastructure projects that may already exist and could be transferred from public to private sector

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21
Q

Government Influence on Infrastructure Projects

A 
Positive: 
- significant need
- economic growth tied
- proceeds from sale can be used for other things
Risks:
- regulatory risk
- continued government influence
- right to revoke a lease
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22
Q

Types of Infrastructure Investments

A
  • Listed Stocks and Listed Funds
  • Closed End Funds: structured like private equity
  • Unlisted (evergreen) Open End Funds
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23
Q

Intellectual Property

A

intangible asset that can be owned

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24
Q

Intellectual Property Modeling

A
  • discounted cash flow model

V = (p x CF1)/(r-g)

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25
Q

Smoothing

A
  • results in lower price and return volatility, which makes assets look less risky than they might be
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26
Q

Historical Performance of Timber and Farmland (January 2000- December 2010)

A
  • returns were generally positive and volatility low
  • strong Sharpe ratio
  • returns based on appraisal
  • tendency to smooth
  • based on quarterly
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27
Q

Fixed Rate Constant Payment, Fully Amortized Mortgage

A
  • requires the borrower to pay a constant periodic amount, usually monthly, that will completely pay off the loan amount with the last payment
  • over time larger amount becomes principal repayment, less interest
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28
Q

Monthly Mortgage Payment Calculation

A 
MP = MB x [i/ (1 -i)^-n)]
where:
MP= constant monthly payment
MB= mortgage balance at beginning of loan
i = monthly interest rate
n = number of months in the loan term
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29
Q

Calculating Monthly Interest, Principal and the Outstanding Balance

A

Book One, Page 290

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30
Q

Unscheduled Principal Payments

A
  • borrowers may make additional payment
  • cause balance to decline more rapidly
  • benefit borrowers in a falling interest rate environment
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31
Q

Interest Only Mortgages

A

calls for interest only payments during the first part of the loan , and fully amortized payments during the second part of the loan

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32
Q

Variable Rate Mortgages (ARMs)

A

generally originate at one interest rate, after which, the interest rate fluctuates up or down during the loan term based on the movement of a published index

33
Q

Interest Rate Caps

A

limit the amount the interest rate may increase in any one adjustment period

34
Q

Graduated Payment Mortgage

A

allows borrowers to make lower monthly payments for the first few years of the loan (typically first 5 years) and larger payments for the remainder of the term

35
Q

Option Adjustable-Rate Mortgage Loans (option ARMs)

A

specialized version of adjustable rate mortgages that are structured to provide borrowers payment flexibility

36
Q

Balloon Payment Loan

A

when a mortgage requires periodic payment that will not fully amortize the amount of the loan by the end of the loan term, the final payment is an amount that is larger

37
Q

Debt to Income Ratio

A
  • sums the total housing expenses and divides the sum by the monthly income of the borrower
  • front end ratio: borrower may limit housing costs to gross income to 28%
  • back end ratio: borrower may limit housing costs and other debt such as auto and credit loans to 36% of gross income
38
Q

Loan to Value

A
  • the amount of the loan relative to the market or appraised value of the property
  • loan considered well collateralized is LTV 80% or less

LTV = balance of the loan/ market value of the property

39
Q

Commercial Mortgage Characteristics

A
  • borrowers: companies
  • income generation
  • balloon payment: generally not fully amortized
  • usage: long term invest prop, short term dev prop
  • covenant: usually several
  • cross collateral provisions: allow banks to pool to reduce risk
40
Q

Default Risk

A

more important in commercial than residential

41
Q

Interest Coverage Ratio

A

calculated as the property’s net operating income (NOI) divided by the amount of annual interest payable
- typical required 1.2 or greater

interest coverage ratio = NOI/ annual interest payment

42
Q

Debt Service Coverage Ratio (DSCR)

A

DSCR = NOI/ total loan payment

43
Q

Fixed Charges Ratio

A

fixed charges ratio = NOI/ all fixed payments

44
Q

Mortgage Backed Securities (MBS)

A

is an investment structure that promises payments that are secured by a pool of mortgages

45
Q

Collaterized Mortgage Obligations

A

are different from MBS in that investors self select into tranches that have different terms of principal and interest payments

46
Q

Prepayment Option

A

residential loan option that allows part of full payment early

47
Q

Conditional Payment Rate

A

annual reduction in the mortgage principal if the same percentage is repaid each month for an entire year

48
Q

PSA Prepayment Benchmark

A

Public Securities Association studied prepayments
Assumes:
- CPR of 30 year loan is .2% per month
- increased by .2 % by month until month 30
- at that pt, remains constant at 6% for the rest of the mortgage life

49
Q

Commercial Mortgage Backed Securities

A
  • backed by commercial real estate
  • key risk: default risk
  • LTV btw 65-80%
  • LTV > 75%, higher risk
    Exhibit following characteristics:
  • tranches
  • credit rating differ across tranches
  • tranche char- senior tranch, fixed income, junior based on underlying commercial loan risk
  • narrow tranches
50
Q

Collateralized Mortgage Obligations

A
  • structured product
  • ## different tranches to investors
51
Q

Sequential Pay CMOs

A
  • simplest form of a CMO
  • pays predetermined share of the interest to each tranche
  • principal payment receipts based on tranche seniority
  • many if not most of the underlying mortgages are insured
  • more effected by interest rate and prepayment risk than default risk
52
Q

Contraction Risk

A

as mortgage rates fall, prepayment increases and the average life of the pass-through security decreases

53
Q

Extension Risk

A

as mortgage rates rise, prepayment rates slow and the average life of the pass through security increases

54
Q

Other CMO Structures and Tranches

A
  • Accrual tranches or Z bonds- receive no interest payment
  • Principal only and interest only CMOs
  • Floating rate tranches
  • Planned amortization class (PAC) tranches - formed to provide a group of investors a more predictable cash flow stream
  • Targeted Amortization Class (TAC) tranches: like PAC, but with more complexity
55
Q

CMO Financial Crisis

A
  • 1994: crisis as prepayments fell as interest rates rose
56
Q

Real Estate Investment Trust (REITs)

A
  • trade on exchanges
  • 75% income must be from RE investments
  • liquid
57
Q

Benefits of Investing in REITs

A
  • No corporate taxes
  • Liquidity
  • May be margined
  • Asset allocation
  • Professional management
  • Income: REITs have to distribute 90% income
  • Corporate governance: no more 50% held by 5 or fewer
58
Q

Risk and Return of Mortgage REITs

A
  • solid 12.8% return
  • high standard deviation (22.4%), next commodities
  • negative skewness and leptokurtosis
  • min return -24.1%, max drawdown -69.1%
  • positive correlation with global equity and bond
  • zero correlation with commodities
  • neg corr with VIX, i.e. greater uncertainty in equity market is negatively related to mortgage returns
59
Q

Backward Induction Process

A

working backwards on a decision tree from the final nodes

60
Q

Profit Approach

A

if valuing a real estate firm rather than a property

61
Q

Equity Residual Approach

A

valuation approach for real estate

- subtracting interest and other cash flowed owed and discounting remaining cash flows

62
Q

Discounted Cash Flow Approach for Real Estate Investments (Income Approach)

A
  • most common method used for appraising
63
Q

Potential Gross Income

A

income if all offices and space are occupied

64
Q

Effective Gross Income

A

potential gross income less the vacancy loss

65
Q

DCF Decision Outcomes

A
  • if NPV greater than zero, project should go forward

- if IRR is greater than the discount rate, project should move forward

66
Q

Real Estate Investment Risk Factors

A
  • Financial Risk
  • Business Risk
  • Operational Risk
  • Liquidity Risk
  • Inflation Risk: may be good inflation hedge
  • Legal Risk
67
Q

Private Equity Real Estate Funds

A
  • invest pooled capital in private real estate
  • 10 year with 2-3 years investment period\
    Advantages:
  • access
  • access to fund management
    Disadvantages:
  • lose direct control
  • lack liquidity
  • performance difficult to measure
68
Q

Commingled Real Estate Funds (CREFs)

A
  • specific type of private equity RE fund

- first type

69
Q

Syndications

A
  • financing mechanisms that allow investors to raise capital and hire expert
  • limited partnerships or REITS or corporations
  • if limited, depreciation tax deductions may be passed directly
70
Q

Open Ended RE Mutual Funds

A 
Advantages: 
- gain access with limited amount of capital
- funds generally buy and sell
- more liquidity 
- regulated by SEC
Disadvantages:
- right to defer redemptions
- stale prices
- fees
- tax inefficient compared to ETF
71
Q

ETF

A
  • tradable investment that track a particular index

- Do Jones U.S. Real Estate Index

72
Q

Closed End RE Mutual Funds

A 
- exchange traded mutual funds
Advantages:
- liquidity
- purchased on margin
- can take long or short position 
- increased transparency
- regulated by SEC
Disadvantages:
- difficult to get exposure to what you want
- tax inefficient
73
Q

Equity REITs

A
  • must have 75% or more underlying RE holding claims to RE
  • highly correlated with over market
  • more highly correlated with small cap than large cap
74
Q

Depreciation

A

reduction in value of an asset with the passage of time

75
Q

Principals of Depreciation

A
  1. when depreciation is not allowed, the after tax IRR will be less than the pre-tax IRR reduced by the tax rate
  2. the effective tax rate is equal to the stated tax rate when tax deductible depreciation equals economic depreciation
  3. after tax IRR is slightly higher in the accelerated depreciation than in nonaccelerated
  4. when outlays can be fully expensed for tax accounting purposes, the after tax return will generally be approximately equal to the before tax
76
Q

Accelerated Depreciation

A

allows a firm to write off the value of an asset more quickly than the true economic decline in the asset

77
Q

Real Indices Based on Appraisal

A

National Council of RE Investment Fiduciaries
NPI calculated:
- appraised
-unleveraged basis
- before tax
- value weighted
NPI used as proxy for commercial RE investment

78
Q

Hedonic Price Index

A

uses the underlying characteristic of an asset to estimate prices of the assets in the index

79
Q

Equity REIT Performance

A
  • strong 14.5% return
  • largest max gain 31%
  • max drawdown -68.3%
  • negative skewness and leptokurtosis
  • high positive correlation with global equity and high yield bond
  • neg corr with VIX
  • low positive correlation with commodities

CAIA Level One (8 decks)

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