Chapter 2 Flashcards
Debtors
- hold rights to contractual cash flow payable by borrowers
- lower risk due to preferential claim over equity holders
- cashflow contractually specified, there is more certainty regarding future cash flows from debt instruments.
Equity Assets
- give investors residual or secondary claims
- higher risk as value of equities is dependent on dividends distributed by firm and risks surrounding these payouts
- investors benefit from upside potential generated by superior firm performance.
Capital Structuring: equity capital & debt capital
Equity: earnings in form of dividends or distribution income
Debt: Interest payment + repayment of principal.
LESS equity, MORE debt
Earnings go to paying Interests, before paying out dividends or distribution income
MORE equity, LESS debt
More earnings in form of dividends or distribution income BUT poor Return on Equity (ROE)
Public market
- platforms in which small homogeneous units of ownership in assets are traded
- more liquid than private
- informationally efficient since the asset share prices can adjust rapidly to relevant news.
- company’s shares not listed on stock exchange.
why public market is more liquid than private?
cuz investors can readily sell units of the assets at or near the last quoted price.
private markets
- w aid of intermediaries
- less liquid
- information inefficiency = hard for participants to ascertain a fair transaction price
- company’s shares not listed on stock exchange
why private markets are less liquid?
takes longer to locate buyers
Types of Real Estate Investment
- Real Property
- Real Estate Equities
- Real Estate Bonds
- Mortgage Backed Securities
- REITs
Real Property
- capital intensive
- needs active asset and property management
- relatively illiquid and investment in them incur high transaction costs
how do investors benefit from investing in real property
- cash flows of the property, like rental income & other income such as parking income, advertising income etc.,
- capital gains upon subsequent sale.
illiquid and capital intensive nature of real property leads to the rise and popularity to the…
securitisation of real estate assets.
What is securitization
- transformation of illiquid assets into securities that are tradable in a capital market.
- can be in form of equity or debt.
what are example of illiquid assets
residential mortgages, leases, auto loans, credit card receivables
Real Estate Equities
- Equity holders own a share of the real estate company that engages in property investment & development activities.
- have residual or subordinate claims
- realise profits from the capital gains of the stock and dividend distribution and can benefit from potential upside if company performs well.
- have infinite life, meaning that there is no maturity date to the asset.
meaning of residual or subordinate claims
are only entitled to cash left after paying senior claimants
(debt holders and preferred equity holders).
What is valuation of real estate equities based on?
- expected cash flows in the future
- explaining why stock markets are usually more volatile and riskier than other investment classes.
Real Estate Bonds
- Debt instruments issued by real estate companies to investors to raise capital for operations.
- Fixed income securities pay steady stream of income to bondholders over term of bond.
- Bond yield (coupon rate or interest rate) computed as percentage of principal borrowed & is influenced by credit rating of issuer, term of bond, embedded options, etc.
- Upon maturity, bonds are redeemed at face value of principal borrowed.
- Typically safer than equities as bondholders have preferential claims on cash flows and assets of the issuing company.
- Liquid & can be traded publicly over secondary market, at prices above or below face value depending on interest rate conditions & financial health of issuer.
- Various types of bonds, like convertible bonds (option to convert to equities), perpetual bonds (no maturity date) and zero-coupon bonds (no coupon payments), are introduced to cater to needs of issuers & investors.
Mortgage Backed Securities (MBS)
- bonds backed by pools of mortgages that provide investors claim on cash flows of underlying mortgages.
- Concept of MBS is to redistribute risk by unbundling mortgage credit risk into securities with diff levels of credit risk & return to match needs of different investors.
- MBS are publicly traded in exchanges with high levels of liquidity.
Mortgages
- originated in the primary market by lenders
- pooled together by investment banks and transferred to a trust, which sells a number of different bond tranches.
- Each tranche is characterized by the priority of claim to the cash flows from the pool.
- Investment grade tranches with the highest credit quality have the first claim to the cash flows and are least risky.
Real Estate Investment Trusts
- investment vehicles that own & manage a portfolio of real properties.
- Provide a liquid & inexpensive way for investors by denominating illiquid & capital intensive real estate into smaller units.
- Each unitholder owns a portion of the assets under management & is entitled to the cash flows generated by the property portfolio.
- Increasingly popular amongst investors as they are publicly traded like shares and they enable investors
- Main responsibilities are to manage assets and to source for deals to maximize the profits generated by portfolio.
- Exempted from corporate taxation if they distribute more than 90% of its annual taxable net income as dividends
each year. - To be classified as S-REITs, the majority of the assets they hold & the activities they undertake must be real estate related.
How are S-REITs managed?
- can be either internally or externally
- but external is more common
What happens when S-REITs are exempted from corporate taxation when they distribute more than 90% of its annual taxable net income as dividends each year?
- attractiveness of S-REITs increase (to investors)
- also means that S-REITs are unable to retain cash for future acquisitions & have to rely heavily on external financing.
People involved in REITs
- Trustee
- REIT manager
- Property Manager
- Sponsor
- Unit holders
Trustee in REITs
- responsible for holding assets on behalf of the S-REIT
- represents interests of unitholders
- duties include ensuring compliance with all applicable laws, taking custody of the real estate assets, protecting certain rights of unit holders.
- the trustee is paid a fee for providing this service.
The REIT Manager
- responsible for managing the S-REIT, including the acquisition & divestment of the underlying properties.
- REIT manager charges a management fee that includes a base fee & performance fee.
- May also charge additional fees such as acquisition & divestment fees.
The Property Manager
- typically appointed by the REIT manager to manage the underlying real estate properties of the S-REIT.
- oversees renting out the property to achieve the best tenancy mix & rental income, running marketing events or promotional programs & upkeep the property in general.
- Is paid a property management fee out of the assets of the S-REIT.
The Sponsor
- the majority of S-REITs are supported by a sponsor.
- sponsors usually provide the properties that are injected into the initial portfolio of the S-REIT around the time of its initial public offering (IPO) & may continue to provide a pipeline of assets to the S-REIT post-IPO.
- Typically own stakes in the REIT manager & the S-REIT.
The Unit holders
- are public stakeholders in a S-REIT who contribute equity to the trust scheme & in return, are issued units in the S-REIT, each of which represents an undivided share in the beneficial interest of the trust scheme.
- they are the owners and they can trade their units.
How is risk captured in portfolio diversitification?
- By the volatility (standard deviation)
of its return. - By allocating funds equally between different assets that have low correlation in returns, overall portfolio performance is less likely to be affected by underperformance of certain asset classes, minimizing the volatility of returns.
Diversification
spreading of investments over a range of different assets and asset classes to maximize expected returns for a specified level of risk.
ways to diversify a portfolio
- asset classes
- different types of an asset
- geographical regions
Why is Real Estate a popular asset class with investors?
It exhibits a low correlation with the returns of stocks and bonds
