Chapter 15 CAIA Flashcards - Real Estate Equity Investments
Risk in Real Estate Investing
The primary risks involved in real estate development center around the possibility that a project will fail to progress successfully into realization of the perceived potential.
Real Option
A real option is an option on a real asset rather than a financial security. The real option may be a call option to purchase a real asset, a put option to sell a real asset, or an exchange option involving exchange of nonfinancial assets.
Decision Tree
A decision tree (as depicted in Exhibit 15.1) shows the various pathways that a decision maker can select as well as the points at which uncertainty is resolved. A decision tree enables analysis and solutions regarding the choices that should be made based on various decision-making points and on new information as that information becomes available.
Decision Node
A decision node is a point in a decision tree at which the holder of the option must make a decision.
Information Node
An information node denotes a point in a decision tree at which new information arrives.
Backward Induction
Backward induction is the process of solving a decision tree by working from the final nodes toward the first node, based on valuation analysis at each node.
Real Estate Valuation
Real estate 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
The income approach values real estate by projecting expected income or cash flows, discounting for time and risk, and summing them to form the total value.
Comparable Sales Approach
The comparable sale prices approach values real estate based on transaction values of similar real estate, with adjustments made for differences in characteristics.
The Profit Approach
The profit approach to real estate valuation is typically used for properties with a value driven by the actual business use of the premises; it is effectively a valuation of the business rather than a valuation of the property itself. The profit approach can be used when the value of the property is based primarily on the value of the business that occupies the space.
Net Sales Proceeds
The net sale proceeds (NSP) is the expected selling price minus any expected selling expenses arising from the sale of the property at time T.
Net Operating Income
Net operating income (NOI) is a measure of periodic earnings that is calculated as the property’s rental income minus all expenses associated with maintaining and operating the property.
Vacancy Loss Rate
The vacancy loss rate is the observed or anticipated rate at which potential gross income is reduced for space that is not generating rental income.
Effective Gross Income
The effective gross income is the potential gross income reduced for the vacancy loss rate. Assuming a 10% vacancy loss rate and no other income, the effective gross income from the building in the first year will be $300,000 – ($300,000 × 0.1) = $270,000.
Commingled real estate funds (CREFs)
Commingled real estate funds (CREFs) are a type of private equity real estate fund that is a pool of investment capital raised from private placements that are commingled to purchase commercial properties.
Syndications
Syndications are private equity real estate funds formed by a group of investors who retain a real estate expert with the intention of undertaking a particular real estate project.
Gearing
Gearing is the use of leverage.
Open-end real estate mutual funds
Open-end real estate mutual funds are public investments that offer a non-exchange-traded means of obtaining access to the private real estate market.
Closed End Fund
A closed-end fund is an exchange-traded mutual fund that has a fixed number of shares outstanding. Closed-end funds issue a fixed number of shares to the general public in an initial public offering, and in contrast to the case of open-end mutual funds, shares in closed-end funds cannot be obtained from or redeemed by the investment company. Instead, shares in closed-end funds are traded on stock exchanges.
Effective Tax Rate
The effective tax rate is the 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.
Depreciation Tax Shield
The reduced taxation afforded by depreciation is due to the depreciation tax shield. A depreciation tax shield is a taxable entity’s ability to reduce taxes by deducting depreciation in the computation of taxable income.
Data Smoothing
Data smoothing 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.
Hedonic Price Index
A hedonic price index estimates value changes based on an analysis of observed transaction prices that have been adjusted to reflect the differing characteristics of the assets underlying each transaction.
