AI 2.2 Flashcards
What are the general benefits of investing in real estate?
Long-term stable income
Protection against inflation
low correlation with stocks & bonds
has a risk-return profile that falls somewhere between FI and equity.
REITs vs REOCS
RIETS are exempt from corporate income tax (has a tax advantage over REOCs)
REOCs are ordinary real state owning companies, mostly found in countries where tax-advantaged RIET doesn’t exist.
REOCs also focus on the development of real estate with an intention of sale. Primary income source is sale rather than rental income.
REOCs offer a combination of exposure to the rental income, property management and brokerage income, and development profits.
Private vs Public investments
Private are large investments and illiquid; require property management expertise
Public is where ownership claim on the property is divided. Properties are professionally managed.
Equity vs Debt
Equity has higher risk/reward than debt. Also has two components of returns -> Rent and Price appreciation
Debt only has returns from mortgage repayments.
What are some real estate investment characteristics?
Unique asset and fixed location, high unit value, Mgmt intensive, high transaction costs, Depreciation, need for debt to buy, price determination, Illiquidity.
Risk factors associated with Real estate investment?
Three major categories:
1. Property supply & Demand - Business conditions, demographics & excess supply are the common risks under this.
2. Valuation - Cost and availability of capital (availability relates to having more returns elsewhere which eradicates the need to invest in real estate), Availability of Info, Lack of liquidity, Rising Interest rates.
3. Property Operations - Management, lease provisions (direct impact to value of the property - how long should we rent? how much should the rent increase? etc.), leverage (Remember loan-to-value ratio), environmental (any environment factor has a direct impact on the value), Obsolescene (older constructions which don’t meet specifications of current demand can have negative impact on value), Recent and on-going disruptions (COVID).
What are the economic drivers that affect Real state value?
The major impact comes in from Economic activity (GDP growth, Wage growth, More jobs, Changes in regulations & taxes) and population growth. Rest of the drivers have some impact on some categories of real estate which is logical.
What are some motivations to invest in real estate in our investment portfolio?
Diversification being the most obvious, Inflation hedge (although not completely but to a great extent), Current income (earning rent), expectations of price appreciation and tax benefits if countries have tax advantages for investing in real estate.
Classifications of real estate properties (Based on most important ones in the curriculum)
Commercial category - Multi-family, Office, Industrial, Retail, hospitality and others.
What is the difference between Net lease & gross lease?
It’s basically about who pays/bears the operating expenses. Gross lease is where the owner of the property bears the risk of paying operating expenses (risk cos Operating expenses are a subject to change) whereas, Net lease is where the tenant pays the operating expenses. So, net lease is equivalent to gross lease - operating expenses paid by the tenant.
What are the major value determinants for commercial real estate property types?
Modern amenities and functionalities.
Location.
Some other with less impact are lease structure, all kinds of weird growth that aren’t in control -> population, economic and employment and consumer spending (basically saving rate also plays a role here).
What are the considerations in Analysis of real estate investments?
All the things which you aren’t aware but are related to dealing with real estate!
Market review, Lease & rent review, costs of re-leasing space, Looking at supporting documentation (cos we should be diligent enough to know if all the taxes are paid for the property or not), Looking at several years of audited financial statements (to know previous revenue levels, audit opinions, etc), Conduct a physical/engineering inspection and an environmental inspection to ensure that the property is structurally sound, Examine ownership history with attorney, examine service & maintenance contracts, conduct a property survey, verify that the property complies with all laws and regulations, parking ratios & other requirements, verify that property taxes, insurance, special assessments, etc have been paid.
Everything is being looked upon with the perspective of estimating future cash flows and liabilities. (as the perspective is of a direct investment to be made in real estate)
What is the primary purpose of due diligence?
Due diligence is basically done to avoid any kind of unanticipated problems which aren’t being told by the seller (legal, environmental, physical, etc) which can be costly to remediate or negatively affect value of the property. (Basically being safe while making a real estate purchase to avoid any unanticipated problems in future)
How are real estate indexes created?
There are two major types of creation:
A) Appraisal based - where estimates are used to calculate and determine the value of real estate property as transactions data isn’t available. Now, consider the times when an appraisal will happen? Prolly once a year or maybe twice. Thus, the current value is based on the previous appraisal value which has significant time lag. Therefore, volatility is understated in appraisal based-indexes.
B) Transaction based indexes (Further categorized into 2 sub categories)
1. Repeat sales index - Here we can determine the value of real estate property by looking at the newer transaction of the same property to know if the value has appreciated or depreciated.
2. Hedonic Index - Here we don’t have to wait for transactions to happen for the same property, we can just adjust certain variables(size, location, etc) to determine value by the transactions of relatable properties.
Appraisal based indexes vs Transaction based
Appraisal based lag transaction based indexes
Appraisal based have lower correlations with stocks/bonds (as there’s less volatility in values) whereas transaction based have a high correlation with stock and bonds.
Transaction based indexes values are more noisy (compared to appraisal based as they’re less volatile and smoother)
Appraisal based index can be used as a benchmark to compare investment managers of real estate who are using appraised values to calculate returns.
