Alternative Investments

Question 1

Private Real Estate

Answer 1

Direct investment in real estate equity (Sole Ownership, Joint Venture, Real Estate Limited Partnership, Commingled Real Estate Fund (CREF)) and debt (Mortgages).

Question 2

Public Real Estate

Answer 2

Equity (Shares of real estate operating companies (REOC) and shares of REITS) and debt (Mortgage Backed Securities)

Question 3

Private vs. Public Real Estate

Answer 3

Private real estate investments usually larger, requires property management. Public real estate investments are more liquid, allow for diversification, no property management expertise needed.

Question 4

Real Estate Characteristics

Answer 4

Heterogeneity, High Unit Value, Management Intensive, High Transaction Cost, Depreciation, Need for Debt Capital, Illiquidity, Price determination

Question 5

REIT

Answer 5

Actively traded, more likely to reflect market value, provide exposure to diversified real estate, property management expertise not needed

Question 6

Residential Real Estate

Answer 6

single-family homes or multi-family properties (apartments). Called “Commercial Real Estate Property” when purchased with the intent to produce income

Question 7

Non-Residential Real Estate

Answer 7

Commercial properties (office, industrial, retail, hospitality), farmland, timberland. Classified by end use. Mixed-use is when the property serves more than one end user.

Question 8

Reasons to Invest in Real Estate

Answer 8

Current income (rents, post expenses/taxes), Capital appreciation, Inflation hedge (rents and property values rise as inflation rises), Diversification, Tax Benefits (favorable tax treatment, higher depreciation expense = lower taxable income, in some countries you do not pay taxes on REITs)

Question 9

Principal Risk of Real Estate: Business Conditions

Answer 9

Demand for space depends on international, national, regional, and local economic conditions. GDP, employment, household income, interest rates, and inflation are particularly relevant to real estate.

Question 10

Principal Risk of Real Estate: New Property Lead Time

Answer 10

Market conditions can change considerably from when approvals are obtained, property is completed, and property is leased. If markets weaken, rents lower, vacancy rates are higher, and there are lower returns. If demand is greater, there will be a shortage of space to meet current demand.

Question 11

Principal Risk of Real Estate: Cost & Availability of Capital

Answer 11

Real estate competes with other assets for debt and equity capital. Willingness of investors to invest in real estate depends on the availability of debt capital, the cost of that capital, and expected return on other investments. A shortage of debt capital and high interest rates can significantly reduce the demand for real estate and lower prices. Alternatively, an environment of low interest rates and easy access to debt capital can increase the demand for real estate investments.

Question 12

Principal Risk of Real Estate: Unexpected Inflation

Answer 12

Real estate may offer some inflation protection if the leases provide for rent increases due to inflation or the ability to pass any increases in expenses due to inflation on to tenants.

Question 13

Principal Risk of Real Estate: Demographic Factors

Answer 13

Size and age distribution of the population in the local market, the distribution of socio-economic groups, and rates of new household formation

Question 14

Principal Risk of Real Estate: Lack of Liquidity

Answer 14

Real estate has low liquidity (high liquidity risk) because of the large value of an individual investment and the time and cost it takes to sell a property at its current value.

Question 15

Principal Risk of Real Estate: Environmental Issues

Answer 15

Real estate values can be affected by environmental conditions, including contaminants related to a prior owner or an adjacent property owner.

Question 16

Principal Risk of Real Estate: Availability of Information

Answer 16

A lack of information to do the property analysis adds to the risk of the investment. Real estate indexes have become available in many countries around the world. These indexes allow investors to benchmark the performance of their properties against that of peers and also provide a better understanding of the risk and return for real estate compared with other asset classes.

Question 17

Principal Risk of Real Estate: Management Expertise

Answer 17

Management involves the cost of monitoring an investment, it’s financial performance, day-to-day operation of the property and the physical maintenance of the property. Management risk reflects the ability of the property and asset managers to make the right decisions regarding the operation of the property, such as negotiating leases, maintaining the property, marketing the property, and doing renovations when necessary.

Question 18

Principal Risk of Real Estate: Leverage

Answer 18

Leverage affects returns on investments in real estate but not the value of the underlying real estate property. Higher LTV ratios mean greater amounts of leverage. Increasing leverage increases risk because the lender has the first claim on the cash flow and on the value of the property if there is default on the loan. A small change in NOI can result in a relatively large change in the amount of cash flow available to the equity investor after making the mortgage payment.