3.5 Real Estate Equity Flashcards

1
Q

Steps in the RE development process

A

1) Purchasing land/building
2) Estimating projects expected profits and potential interests from buyers/renters
3) Designing the building structure/improvements
4) Getting public approvals/permits
5) Acquiring financing
6) Building/remodeling the structure
7) leasing/selling the property

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2
Q

Real option is what type of option? 3 types of real options?

A

An option on a real asset.

3 types: option to buy and asset, option to sell a real asset, option to exchange non-cash assets

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3
Q

What is a fair investment?

A

Investment with an expected value of zero

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4
Q

What is a decision node?

A

Point in a decision tree when a decision is made

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5
Q

What is an information node

A

Point when new information is revealed that may affect future decisions

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6
Q

Backward induction?

A

Start from the final nodes and go to the earlier nodes one step at a time and decide to accept or not accept the project at the first node

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7
Q

5 common approaches to valuing private commercial real estate equity

A

1) comparable sale price approach
2) profit approach
3) cost approach
4) income (discounted cash flow) approach
5) Multi-factor transaction based approach

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8
Q

When and how is comparable sales price approach used?

A

Non income producing real estate properties are compared to comparable recently sold properties

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9
Q

When using the comparable sales approach is not viable due to limited recent, comparable real estate transactions, alternative approaches may be used based on one or both of two components:

A
  1. The structure’s replacement costs.
  2. The site’s estimated market value for its most profitable use.
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10
Q

When is cost approach used?

A

Typically used to value new structures and in market with substantial new construction

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11
Q

CAP Rate formula, description of inputs

A

NOI / Property Value

NOI = normalized, annual cash flow IGNORING financing cost

Property value = market value

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12
Q

When were CAP rates higher and lower?

A

Higher: mid 90s & 2002

Lower: pre 2007 GFC and 2021

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13
Q

Pros / cons of income approach valuation?

A

Pros: value property’s unique characteristics

Cons: needing to estimate a discount rate and exposures to errors in forecasting cash flows

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14
Q

Description of transaction based real estate valuation methods?

A

Use large data sets of property transaction prices in a specific time period to determine value based on MULTIPLE factors

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15
Q

When transaction-based valuation methods may serve as a reliable basis for real estate valuation?

A

As long as the following holds:

  1. They are applied using adequate data and rigorous econometric methods.
  2. Differences among the properties are modeled well.
  3. Statistical noise in the data is minimized.
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16
Q

The two main transaction-based valuation methods are

A

1) repeat-sales

2) hedonic pricing methods

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17
Q

Pros / cons of appraisal over transaction based models?

A

Pros:
1. They do not suffer from a small sample size bias.
2. All properties can be appraised frequently and by several experts (although this would be costly)

Cons:
1) Appraisals are subjective and backward-looking
2) Properties in appraisal-based real estate price indices are not reappraised as often as the index is reported (appraisals performed annually).
3) Values of appraisal-based indices are smoothed
4) Quality of the appraisal depends on the relevance and quality of available data.

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18
Q

What is stale appraisal effect?

A

Errors due to using dated appraisals, which contributes to the lagged price changes in appraisal-based indices.

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19
Q

NCREIF Property index (NPI) characteristics?

A

Popular, large, value weighted index published QUARTERLY based on UNLEVERAGED commercial property appraisals

7500 properties, total value $600 billion

1977 started

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20
Q

How is NPI calculated?

A

Each quarter the price of property is calculated AS IF it was sold at begging of quarter appraised value and then sold at the end of quarter appraised value

If property is sold, its price is used.

Calculated as if bought for 100% equity and on a PRE-TAX basis

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21
Q

How is NPI total return calculated?

A

NPI return = income return + capital value return

Income return = NOI / Property value (beginning appraised value adjusted for improvements, reinvestments and sale)

Capital value = change of property value

22
Q

UK alternative to NPI

A

Investment Property Databank (IPD) available monthly and annually

23
Q

NCREIF’s hedonic index that uses transaction data from NCREIF database?

A

Transaction based index (TBI)

24
Q

Net operating income formula

A

NOI= Effective gross income - Operating expenses

OR

[Potential gross income X (1-Vacancy loss rate) ] - (fixed + variable expenses)

25
Q

Effective gross income formula

A

Effective gross income = Potential Gross income - Vacancy Loss

OR

Potential gross income - (1 - Vacancy loss rate)

Vacancy loss rate - proportion of unoccupied properties

26
Q

Pro forma report includes what?

A

Rental income per lease, other income, and unexpected vacancy allowance

i.e. provides a projection of property’s future cash flows

27
Q

In practice what does RE property valuation include?

A

Info on properties:
- cash flows
- expenditures (capital & tenant improvements, leasing commissions)
- accounts for depreciation
- income tax
- financing costs

28
Q

How to find APPRAISED VALUE using discounted cash flow analysis?

A

Find the cash flows for each year, the discount rate and calculate the NPV or PV

29
Q

2 types of private RE investment vehicles?

A

1) Private Equity RE funds

2) limited partnerships

30
Q

PE RE Funds investment strategies

A

Collect funds from investors and invest in the equity or debt of private real estate

Active management approach

Long term, hold to liquidation funds

Lifespan about 10 yrs, first 2-3 yrs are called investment years

31
Q

Private equity RE Funds 3 disadvantages?

A

1) Investors do not have direct control over the underlying portfolio
2) Often lack a liquid exit strategy.
3) Unreliable reporting of values

32
Q

3 types of PE RE Funds

A

1) commingled RE funds (CREFs)

2) syndications

3) joint ventures

33
Q

Main advantage of PE RE Funds?

A

Access to real estate properties that are too large to be held by one institution

OR

Access to a portfolio that small funds could not create on their own

34
Q

Commingled RE funds (CREFs) characteristics?

A
  • structured as Close ended funds.
  • investors receive negotiable ownership certificate = proportional claim to underlying RE asset
  • unit prices are determined using regular appraisals
  • main difference to other PE RE funds - negotiability
35
Q

RE Syndications characteristics

A

A syndicators (general manager) receive a fee for pooling and actively managing RE investments

Allows smaller investors to access investments outside of their expertise

Passes depreciation deductions = avoids double taxation

36
Q

Joint ventures in RE

A

When 2 or more parties each bringing unique expertise.

Usually small number of individual or institutional investors

37
Q

Limited partnerships in private RE investment characteristics?

A

Have a Fund sponsor (GP) responsible for raising capital from investors (LPs, typically institutional investors

Often use aggressive levels of debt (around 75%)

Have a 1-2% management fee and 20% performance fee

Capital is drawn when suitable investments are identified

38
Q

What is GEARING? How is it expressed?

A

gearing = Using leverage

Expressed using LTV or Debt / Equity ratio

39
Q

5 public RE investment vehicles?

A

1) Open ended mutual funds
2) Options and futures on RE indices
3) Exchange rated funds on RE indices
4) Close ended RE mutual funds
5) REITs

40
Q

Open ended RE funds characteristics

A

Investors can redeem their shares daily at the NAV (net asset value)

Some investors arbitrage Stale prices by entering at specific times

41
Q

Difficulties of options and futures on RE Indices

A

The difficulty of pricing the options/futures because of the illiquidity and heterogenous (dissimilar) qualities of RE

42
Q

How are ETFs based on RE Indices issued and redeemed?

A

At about the same price as the NAV

43
Q

Closed ended RE mutual funds characteristics

A

No redemption issues, shares are traded on secondary market

Usually trade at a premium or discount to the NAV

Typically liquidate portfolio after 15 years

44
Q

Majority of equity REIT holdings represent?

A

Equity claims on RE

45
Q

Equity REIT characteristics

A

Main income from rent, some degree from increases in property values

Potential hedge against inflation

Market returns correlated to small and mid cap stocks = suggests more reflective of stock market fluctuations than RE market prices

46
Q

Correlation level of NCREIF Property Index compared to REIT index is?

A

Less correlated with the stock market

47
Q

Each step in the development process is equivalent to buying a…? Why?

A

Call option

Because the developer has the option of either scrapping the project or moving on to the next step.

48
Q

What most accurately reflects the risk-adjusted return and risk (measured by standard deviation) of equity REITs over the past 18 years compared to global equities? Which measurement reflects this?

A

Slightly higher risk-adjusted return and higher risk.

Sharpe ratio = risk adjusted return

49
Q

Which real estate investment imposes the LEAST capital constraints on small investors?

A

Open ended RE funds

50
Q

Characteristics of equity REIT returns VS global equities from 2000 to 2020?

A
  1. Larger volatility than global equities
  2. Moderate Sharpe ratio (> global equities)
  3. Moderately negatively skewed (similar to global equities)
  4. Large excess kurtosis (> global equities)
  5. Very large maximum drawdown (> global equities)