Chapter 10 - Real Estate Equity Investments

Question 1

Keyword ‘After-tax approach’

Answer 1

After-tax cash flows are used in the numerator (as the cash flows to be received), and a tax-adjusted discount rate in the denominator

Question 2

Keyword ‘Appraisals’

Answer 2

Professional opinions that are a common way to estimate the market value of a real estate property.

Question 3

Keyword ‘Backward induction’

Answer 3

Backward induction is the process of working from the final decision nodes toward the first decision node.

Question 4

Keyword ‘Business risk’

Answer 4

Risk from changes in general economic conditions

Question 5

Keyword ‘Closed-end real estate mutual funds’

Answer 5

Exchange-traded mutual fund that has a fixed number of share outstanding.

Question 6

Keyword ‘Commingled real estate funds’

Answer 6

Pool of investment capital raised from private placement that are commingled to purchase commercial properties.

Question 7

Keyword ‘Comparable sale prices’

Answer 7

For non-income producing properties.

Question 8

Keyword ‘Data smoothing’

Answer 8

Occurs in a return series when the prices used in computing the return series have been dampened relative to the volatility of the true but unobservable underlying prices.

Question 9

Keyword ‘Decision node’

Answer 9

A decision node is a point at which a decision must be made by the holder of the option.

Question 10

Keyword ‘Decision tree’

Answer 10

A decision tree shows the various pathways that a decision maker can select and the points at which uncertainty is resolved.

Question 11

Keyword ‘Depreciation’

Answer 11

Noncash expense that is deducted from revenues in computing income. Depreciation is the decline of an asset’s value, either the true economic decline that the asset experiences or an accounting value that purports to represent that decline.

Question 12

Keyword ‘Depreciation tax shield’

Answer 12

Stream of reduced taxable income due to depreciation.

Question 13

Keyword ‘Discounted cash flow (DCF) method’

Answer 13

Discounted cash flow; estimating future cash flows, discounting them.

Question 14

Keyword ‘Effective gross income’

Answer 14

Potential gross income - vacancy loss rate

Question 15

Keyword ‘Effective tax rate’

Answer 15

Actual reduction in value that occurs in practice when other aspects of taxation are included in the analysis, such as exemptions, penalties, and timing of cash flows.

Question 16

Keyword ‘Equity residual approach’

Answer 16

Subtract the interest expense and other cash outflows due to mortgage holders and to discount the remaining cash flows using an interest rate reflective of the required rate of return on a leveraged real estate investment.

Question 17

Keyword ‘Exchange traded funds (ETF)’

Answer 17

Represent a tradable investment vehicle that tracks a particular index or portfolio by holding its constituent assets or a subsample of them.

Question 18

Keyword ‘Financial risk’

Answer 18

Risk associated with the financing used is higher as the quantity of debt (i.e. the leverage) increases.

Question 19

Keyword ‘Fixed expenses’

Answer 19

Examples property tax and insurance

Question 20

Keyword ‘FTSE NAREIT Composite Index’

Answer 20

Equity REITs, Mortgage REITs and Hybrid REITs

Question 21

Keyword ‘Gearing’

Answer 21

Gearing is the use of leverage.

Question 22

Keyword ‘Hedonic price index’

Answer 22

A hedonic regression explains prices based on underlying characteristics, in this case explaining property prices using characteristics such as size, quality, location and other factors.

Question 23

Keyword ‘Income approach’

Answer 23

Discounted cash flow; estimating future cash flows, discounting them.

Question 24

Keyword ‘Inflation risk’

Answer 24

Likelihood that the real value of investment holdings will decrease because of the effects of unanticipated inflation.

Question 25

Keyword ‘Information node’

Answer 25

Information nodes denote a point at which new information arrives.

Question 26

Keyword ‘Legal risks’

Answer 26

Dispersion in economic outcomes results from uncertainty from legal events such as securing and maintaining a clear claim to a real asset.

Question 27

Keyword ‘Liquidity risk’

Answer 27

Difficulties arise from the inability to sell a property on a timely basis and at a competitive price.

Question 28

Keyword ‘Loan-to-value (LTV) ratio’

Answer 28

% of a fund’s capital that is financed by debt divided by the % of all long-term financing (e.g. debt plus equity)

Question 29

Keyword ‘Management/Operational risk’

Answer 29

Most RE investments depend on effective management of properties to maintain occupancy rates, preserve the value of the property, and control expenses. Management risk; economic in outcomes caused by unexpected managerial effectiveness.

Question 30

Keyword ‘NCREIF property index (NPI)’

Answer 30

National Council of Real Estate Investment Fiduciaries Property Index, collects data quarterly. Proxy for performance of direct investments in commercial real property.

Question 31

Keyword ‘Net lease’

Answer 31

Tenant is responsible for almost all of the operating expenses.

Question 32

Keyword ‘Net operating income (NOI)’

Answer 32

Property’s rental income minus all expenses associated with maintaining and operating the property.

Question 33

Keyword ‘Net sale proceeds (NSP)’

Answer 33

Expected selling price minus selling expenses, arising from the sale of the property at time T.

Question 34

Keyword ‘Open-end real estate mutual funds’

Answer 34

Public investments that offer a non-exchange-traded means of obtaining access to the private real estate market.

Question 35

Keyword ‘Operating expenses’

Answer 35

Fixed and variable expenses

Question 36

Keyword ‘Potential gross income’

Answer 36

Gross income that could be potentially received if all leases were occupied.

Question 37

Keyword ‘Pre-tax approach’

Answer 37

Example pretax bond payments and the pretax payments of other taxable securities are discounted on a pretax basis.

Question 38

Keyword ‘Private equity real estate funds’

Answer 38

Privately organized funds similar to other alternative investment funds, such as private equity funds and hedge funds. 3 types; Commingled RE Funds, Syndications, JV’s.

Question 39

Keyword ‘Profit approach’

Answer 39

Typically used for properties with a value driven by the actual business use of the premises.

Question 40

Keyword ‘Real estate development projects’

Answer 40

RE development projects can include one or more stages of creating or improving a RE project, including the acquisition of raw land, the construction of improvements, and the renovation of existing facilities.

Question 41

Keyword ‘Real estate joint ventures’

Answer 41

PE RE funds that consist of the combination of two or more parties embarking on a business enterprise such as the development of RE properties. Example; institutional investor with no expertise in RE but with an interest in investing in RE, who agrees to form a JV with a developer.

Question 42

Keyword ‘Real estate valuation’

Answer 42

RE valuation is the process of estimating the market value of a property and should be reflective of the price at which informed investors would be willing to both buy and sell that property. (Income approach/DCF, or comparable sale prices)

Question 43

Keyword ‘Real option’

Answer 43

A real option is an option on a real asset rather than a financial security.

Question 44

Keyword ‘Risk premium approach’

Answer 44

In the case of RE investments, the discount rate is often estimated using a risk premium approach (liquidity risk and risk premium).

Question 45

Keyword ‘Stale pricing’

Answer 45

Use of prices that lag changes in true market prices.

Question 46

Keyword ‘Syndications’

Answer 46

PE RE funds formed by a group of investors who retain a real estate expert with the intention of undertaking a particular RE project.

Question 47

Keyword ‘Vacancy loss rate’

Answer 47

Vacant leases

Question 48

Keyword ‘Variable expenses’

Answer 48

Examples maintenance, repairs, utilities and supplies.

Question 49

What is the frequency with which the National Council of Real Estate Investment Fiduciaries (NCREIF) Property Index (NPI) is calculated and how often are the underlying appraisals fully performed?

Answer 49

The index is computed quarterly, but the underlying appraisals are performed on a variable basis-typically less often than quarterly.

Question 50

True or False: The relatively high liquidity of closed-end real estate mutual funds shares contrasts to the illiquidity of the underlying real estate assets held in the fund’s portfolio.

Answer 50

True. The shares of closed-end real estate mutual funds trade in stock exchanges and are therefore more liquid than the real estate assets underlying these funds.