CHAPTER 4: REAL ESTATE & INFRASTRUCTURE

Question 1

RESIDENTIAL VS COMMERCIAL REAL ESTATE

Answer 1

1. Residential Sector:

• Includes single-family detached homes and multi-family units owned by residents.
• 75% of the global real estate market.

2. Commercial Sector:
   - Properties owned with the intent to rent are classified as commercial real estate.
   - Includes office buildings, shopping centers, and warehouses.
   - Also encompasses residential properties owned for rental purposes.

These sectors encompass the majority of real estate investments globally, with residential real estate dominating in terms of market share.

Question 2

Residential Real Estate:

Answer 2

Typical Property:
- Owner-occupied, single residences; single-family residential property.
- Residential properties owned for lease or rental.

Source of Equity:
- Owners directly.
- Privately held by owners.

Source of Debt:
- Directly: Lenders (banks) through residential mortgages.
- Indirectly: Investors in Mortgage-Backed Securities (MBS) that package residential mortgages.

Source of Return to Investors:
- Enjoyment of the property.
- Price, or capital, appreciation.

Question 3

Commercial Real Estate:

Answer 3

Typical Property:
- Office, retail, industrial, warehouse, hospitality, and mixed-use properties.

Source of Equity:
- Publicly held through investors.

Source of Debt:
- Directly: Lenders (banks) through commercial mortgages.
- Indirectly: Investors in Mortgage-Backed Securities (MBS) that package commercial mortgages.

Source of Return to Investors:
- Income, or cash flow, generated by the property.
- Price, or capital, appreciation.

Question 4

How real estate differs from other asset classes:

Answer 4

Real Estate Characteristics:

1. Indivisibility:
   - Requires large capital investments due to the high cost of property acquisition and maintenance.
2. Unique Characteristics:
   - No two properties are identical, leading to unique investment opportunities and risks.
3. Investment Alternatives:
   - Offers various investment options, ranging from relatively liquid, stable income-producing properties to illiquid investments spanning long development cycles.
4. Diversification Challenge:
   - Diversifying real estate investments can be challenging due to the large capital requirements and property-specific risks.
5. Investability of Indexes:
   - Indexes that replicate real estate performance are not directly investable, unlike stocks or bonds, which can be traded through financial markets.

Question 5

Opaque price discovery process in private real estate markets:

Answer 5

Price Discovery in Private Real Estate:

Opacity of Historical Prices:
- Historical prices may not accurately reflect current market conditions due to limited transparency and infrequent transactions.

Costly and Time-Consuming Transactions:
- Buying and selling properties in private real estate markets can be expensive and time-consuming, involving legal fees, inspections, and negotiations.

Limited Transaction Activity:
- Market activity may be restricted by factors such as limited supply or demand fluctuations, leading to less frequent transactions and potentially less reliable pricing data.

• Because of these unique features, real estate markets are typically fragmented.
• The local demand and supply conditions determine the value of a property, and
  local markets can be very different from national or global markets.

Question 6

Real estate investing can be categorized along two dimensions:

1. Public/private markets and
2. debt/equity based.

Answer 6

4 QUADRANTS:
PVT, PUBLIC, DEBT & EQUITY

Debt:
- Mortgage debt
- Construction loans
- Mezzanine debt
- Covered bonds

Equity:
- Direct ownership
- Sole ownership
- Joint ventures
- Limited partnerships

Private Real Estate Investments:
- Real estate funds
- Private REITs (Real Estate Investment Trusts)
- MBS/CMBS/CMOS (Mortgage-Backed Securities/Commercial Mortgage-Backed Securities/Commercial Mortgage-Backed Obligations)

Publicly Traded Real Estate Investments:
- Public REITs (Real Estate Investment Trusts)
- Mortgage REITs
- Mortgage ETFs (Exchange-Traded Funds)
- UCITS/Mutual funds/ETFs (Undertakings for Collective Investment in Transferable Securities/Mutual Funds/Exchange-Traded Funds)

Other Real Estate Investment Types:
- Operating
- Development
- Construction

Question 7

Equity-based Investments in Real Estate:

Answer 7

• Represent ownership of real estate properties.
• Ownership can be structured through:
  
  • Sole ownership
  • Joint ventures
  • Real estate limited partnerships

Question 8

Leveraged Ownership:

Answer 8

• Involves using both equity and mortgage financing to acquire a property.
• Example:
  
  • Assume a building costs $10 million.
  • You invest $3 million of your own money.
  • Borrow $7 million through a mortgage.
• This combination of equity and mortgage financing is referred to as leveraged ownership.

Question 9

Debt-based real estate investments:

Answer 9

Debt-Based Real Estate Investments:
- Involves lending money to a purchaser of real estate.
- Classic example: Mortgage loan, where the loan value is tied to the property’s value.

Question 10

LO. Explain features and characteristics of real estate.

Answer 10

1. Real estate includes two major sectors: residential and commercial.
2. Unique features of real estate are:
   heterogeneity
   fragmentation
   challenges in price discovery,
   costly and time-consuming transactions.

Question 11

Which of the following is least likely to be classified as a form of real estate investment?

A Mortgage-backed securities.
B Real estate limited partnerships.
C Leveraged buyouts.

Answer 11

C is correct. Leveraged buyout is an acquisition of an established public or private company with borrowed funds. It is a form of private equity investment rather than real estate investment. Securitization of retail and commercial mortgages such as in mortgage-backed securities and real estate limited partnerships are forms of real estate investment.

Real estate investing can be categorized along two dimensions: public/private markets and debt/equity based. FOUR QUADRANTS

Question 12

Which of the following statements about real estate is correct?

A The two categories of real property are privately held and publicly traded.
B Commercial real estate makes up some 75% of the real estate market globally.
C When residential real estate properties are owned with the intent to rent, they are classified as commercial real estate.

Answer 12

C is correct. Residential real estate includes individual single-family detached homes and multi-family attached units owned by the residents. However, when residential real estate properties are owned with the intent to rent, they are classified as commercial real estate.

A is not correct because the two categories of real property are residential and commercial.

B is not correct because residential real estate is the largest sector, making up some 75% of the market globally.

Question 13

Which of the following is least likely a distinguishing feature of real estate compared to other asset classes?

A Diversification across different types of real estate investment alternatives is easy.
B Unique characteristics.
C Indexes replicating the performance of real estate are not directly investable.

Answer 13

A is correct. It may be difficult to diversify across different types of real estate investment alternatives.

Question 15

Variations within Debt-Based Real Estate Investments:

Answer 15

1. Direct Real Estate Investing:
   
   • Direct ownership of real estate assets.
   • Example: Owning residential or commercial properties.
2. Indirect Real Estate Investing:
   
   • Investing in real estate through intermediary vehicles.
   • Example: Real estate funds or private REITs.
3. Mortgages:
   
   • Providing loans secured by real estate assets.
   • Example: Issuing mortgage loans to property buyers.
4. Private Fund Investing Styles:
   
   • Various strategies employed by private real estate funds.
   • Example: Opportunistic investing, value-add strategies.
5. REITs (Real Estate Investment Trusts):
   
   • Publicly traded entities investing in real estate assets.
   • Example: Investing in shares of a REIT focused on commercial properties.

These variations offer different ways to participate in real estate investment through debt instruments, each with its own risk-return profile and investment strategy.

Question 16

DIRECT REAL ESTATE INVESTING

Answer 16

Direct real estate investing:
* Involves purchasing a property and originating debt for one’s own account.
* The major advantages are:
control, and
tax benefits.
* The major disadvantages are:
- extensive time and expertise required to manage the property,
- the large capital requirements, and
- highly concentrated portfolios.

Question 17

Indirect real estate investing:

Answer 17

• Pooled investment vehicles are used to access the underlying real estate assets.
• The vehicles can be public or private, such as limited partnerships, mutual funds,
  corporate shares, REITs, and ETFs.

Question 18

Mortgages:

Answer 18

Represent passive investments in which the lender can expect to receive a predefined stream of payments over the life of the mortgage.

Question 19

Private fund investing styles:

Answer 19

Most real estate private equity funds are structured as infinite-life open-end funds, which allow investors to contribute or redeem capital throughout the life of the fund.

Question 20

REITs:

Answer 20

REITs combine the features of mutual funds and real estate.

An REIT is a company that owns income-producing real estate assets.

In REITs, average investors pool their capital to invest (take ownership) in several large-scale, diversified income-generating real estate properties.

The REIT issues shares, where each share represents a percentage ownership in the
underlying property.

The income generated is paid as a dividend to the shareholders.

Question 21

The main advantage of the REIT structure is that it avoids double corporate taxation.

Answer 21

1. Normal corporations pay taxes on income, and then the dividend paid from the after-tax earnings are taxed again at the shareholder’s personal tax rate.
2. REITs can avoid corporate income taxes by distributing 90% - 100% of their rental
   income as dividends.
3. Another advantage is that REITs are more transparent than private real estate markets.

Question 22

The value of the REIT shares is based on the dividend.

Answer 22

1. REIT shares often trade publicly on exchanges. Highly correlated to equity stocks.
2. It is a way for individual investors to earn a share of the income from commercial properties (office buildings, warehouses, and shopping malls) without buying them.
3. Risk and return of REITs vary based on the types of properties they invest in.

Question 23

EQUITY REITs

Answer 23

Equity REITs invest in properties outright or through partnerships and joint
ventures.

The business strategy for equity REITs is simple:

Maximize property occupancy rates and rents while minimizing ongoing operating and maintenance expenses to maximize cash income and dividends.

Question 24

MORTGAGE REITs

Answer 24

Mortgage REITs invest in real estate debt, typically MBS. Hybrid REITs invest in both
real estate debt and equity.

Question 25

The key reasons for investing in real estate are:

Answer 25

1. Potential for competitive long-term returns (income and capital appreciation).
2. Rent from long-term leases will lessen the impact of economic shocks.
3. Diversification because of low correlation with other asset classes such as stocks, bonds.
4. Inflation hedge.

Question 26

SOURCE OF RETURNS

Answer 26

The return on real estate investments comes from income or asset appreciation or a combination of both.

More than half the returns earned by commercial real estate investors comes from income, and it is a more consistent source of return throughout an economic cycle, as compared to capital appreciation.

Real estate investments can be similar to bond investments in that they generate stable, predictable, lower-risk cash flows from leases that are comparable to bond coupon payments.

Real estate investments are similar to equity investments in that they provide speculative returns based on the price appreciation of the real estate asset.

Question 27

Real Estate Investment Diversification Benefits

Answer 27

Many investors prefer real estate for its ability to provide high, steady current income.

Real estate also has low correlation with other asset classes and thus provides diversification benefits.

However, there are periods when equity REIT correlations with other securities are high, and their correlations are highest during steep market downturns.

Question 28

Infrastructure Investment Features

Answer 28

The assets underlying infrastructure investments are real, capital intensive, and
long-lived.

These assets are intended for public use, and they provide essential services e.g.,
airports, health care facilities, and power plants.

Like real estate, investment in infrastructure involves acquiring unique, illiquid assets with distinct locations, features, and uses.

The returns can come from income and capital appreciation.

Question 29

Infrastructure Investments

Answer 29

Rather than rentals, infrastructure cash flows arise from contractual payments such
as:

1. Availability payments: Payments received to make the facility available.
2. Usage-based payments: Tolls and fees for using the facility.
3. “Take-or-pay” arrangements: This obligates buyers to pay a minimum purchase price to sellers for a pre-agreed volume.

Question 30

Infrastructure assets were primarily owned, financed, and operated by the government.

PPP: Public-Pvt Partnerships

Answer 30

Of late, they are financed privately through the use of public-private partnerships (PPPs).

A public–private partnership is typically defined as a long-term contractual relationship between the public and private sectors for the purpose of having the private sector deliver a project or service traditionally provided by the public sector.

Question 31

Which of the following is least likely an advantage of direct real estate investing?

A Control
B Tax benefits
C Diversified portfolio

Answer 31

C is correct.

It is not possible for owners, particularly smaller investors, to create a well-diversified real estate portfolio through direct investment. Direct investment generally results in highly concentrated portfolios.

The major advantages of direct investment are control and tax benefits.

Question 32

Investment in existing infrastructure facilities or fully operational assets that do not need further expansion and investments will be termed as:

A Greenfield investment.
B Secondary stage investment.
C Brownfield investment.

Answer 32

B is correct.

Secondary-stage investments focus on existing infrastructure facilities or fully operational assets that do not need further expansion and investments. They generate immediate cash flows.

Question 33

Infrastructure debt when compared with similar fixed-income instruments has:

A lower recovery rates.
B volatile cash flows.
C lower default rates.

Answer 33

C is correct.

Because of the stable underlying nature of cash flows, infrastructure debt has lower default rates and higher recovery rates than comparable fixed-income instruments, and it is less volatile over the economic cycle.

Question 34

Infrastructure investments may be categorized based on:

Answer 34

1. underlying assets
2. stage of development of the underlying assets.

Question 35

Categories of Infrastructure Investments

Answer 35

1. Infrastructure investments based on underlying assets:
   * They can be classified into economic and social infrastructure assets.

(a) Economic infrastructure assets:
(b) Social infrastructure assets:

Question 36

1(a) Economic infrastructure assets:

Answer 36

1(a) Economic infrastructure assets:

• These include transportation, communication, and social utility assets that are
  needed to support economic activity.
• Examples of transportation assets are roads, airports, bridges, tunnels, ports, etc.
• Examples of utility assets are assets used to transmit and distribute gas,
  electricity, generate power, etc.
• Examples of communication assets are assets that are used to broadcast
  information.

Question 37

1(b) Social infrastructure assets:

Answer 37

1(b) Social infrastructure assets:

These are assets required for the benefit of the society such as educational and
healthcare facilities.

Question 38

2. Infrastructure investments based on the stage of development of the underlying assets:

They can be classified into greenfield, brownfield and secondary-stage investments.

Answer 38

• Greenfield investments develop new assets and new infrastructure. The objective may be to construct and sell the assets to the government, or to hold and operate the assets.
• Brownfield investments expand existing facilities and may involve privatization of public assets. They have a shorter investment period and immediate cash flows. The assets may also have a financial and operating history.
• Secondary-stage investments invest in existing infrastructure facilities or fully operational assets that do not need further expansion and investments. They generate immediate cash flows.

RISK (x) vs RETURN (y) graph
On Diagonal:
Secondary-Brownfield-Greenfield
Increasing order of risk & return

Question 39

Forms of Infrastructure Investments

Answer 39

Investors may invest either directly or indirectly in infrastructure investments.

The investment form affects the liquidity and the income and cash flows to the investor.

The advantages of investing directly in infrastructure are that investors have a
control over the asset and can capture the full value of the asset.

But the downside of a large investment is that it results in concentration and liquidity risks.

Question 40

Most investors invest indirectly. Some forms of indirect investments include:

Answer 40

• investment in an infrastructure fund
• infrastructure ETFs
• shares of companies

Question 41

Forms of Infrastructure Investments

Answer 41

Investing in publicly traded infrastructure companies offer the benefit of liquidity.

Publicly traded infrastructure securities also have a reasonable fee structure, transparent governance, and provide the benefit of diversification.

Master limited partnerships (MLPs) are pass-through entities similar to REITs and are listed on exchanges.

Question 42

Infrastructure debt financing can take the form of both private and publicly traded debt.

Answer 42

• The terms are typically flexible to accommodate periods of zero cash flow and long development or investment horizons.
• Because of the stable underlying nature of cash flows, infrastructure debt has lower default rates and higher recovery rates than comparable fixed income instruments, and it is less volatile over the economic cycle.

Question 43

Greenfield infrastructure investments

Answer 43

Greenfield infrastructure investments have the highest expected return and the highest expected risk, while secondary stage investments have the lowest expected return and the lowest expected risk.

Question 44

Infrastructure Investment Characteristics

Answer 44

Also, investments in basic social services infrastructure (e.g., hospitals) or existing regulated industries (e.g., Power grids) typically involves lower risk and lower expected return.

Whereas, demand-based infrastructure (e.g., new toll roads) are built on projections of future economic growth and are riskier.

Question 45

Some of the advantages to investors from investing in infrastructure are as follows:

Answer 45

a steady income stream
potential for capital appreciation
diversification because of low correlation of infrastructure assets to traditional investments
protection against inflation
match the long-term liability structure of some investors such as pension funds

Question 46

LO. Explain features and characteristics of real estate.

Answer 46

Real estate includes two major sectors: residential and commercial.

Unique features of real estate are: heterogeneity, fragmentation, challenges in price discovery, costly and time-consuming transactions.

Question 47

LO. Explain the investment characteristics of real estate investments.

Answer 47

Real estate investing can be categorized along two dimensions: public/private markets and debt/equity based.

The return on real estate investments comes from income or asset appreciation or a combination of both.

Real estate investments can be similar to bond investments in that they generate stable, predictable, lower-risk cash flows from leases that are comparable to bond coupon payments.

Real estate investments are similar to equity investments in that they provide speculative returns based on the price appreciation of the real estate asset.

Real estate provides diversification benefits because of their low correlation with other asset classes.

However, during steep market downturns, equity REIT correlations with market benchmarks can increase.

Question 48

LO. Explain features and characteristics of infrastructure.

Answer 48

The assets underlying infrastructure investments are real, capital intensive, and long-lived. These assets are intended for public use, and they provide essential services.

Infrastructure investments can be categorized based on:

• underlying assets as either economic or social
• stage of development of underlying assets as greenfield, brownfield, or secondary stage.
• Infrastructure assets were primarily owned, financed, and operated by the government. Of late, they are financed privately through the use of public-private partnerships (PPPs).

Question 49

LO. Explain the investment characteristics of infrastructure investments.

Answer 49

Greenfield infrastructure investments have the highest expected return and the highest expected risk, while secondary stage investments have the lowest expected return and the lowest expected risk.

• Some of the advantages to investors from investing in infrastructure are as follows:

a steady income stream

potential for capital appreciation

diversification because of low correlation of infrastructure assets to traditional investments

protection against inflation

match the long-term liability structure of some investors such as pension funds

Question 50

Which of the following is a common source of direct revenue from raw land, farmland and timberland investments?

A Lease revenue
B Sale of agricultural products
C Sale of trees and wood products

Answer 50

A is correct. Lease revenue and price appreciation are common sources of direct revenue from raw land, farmland and timberland investments.

B is also a source of direct revenue from farmland investments while C is another value driver applicable to timberland investments.

Question 51

Which of the following types of investment is most suited to family ownership?

A Farmland
B Timberland
C Both A) and B)

Answer 51

A is correct. Farmland is more suited to family ownership, whereas timberland is more commonly owned by institutions.

This is because timberland tracts are typically thousands (or more) of acres in size, whereas farmland is frequently owned in smaller tracts of tens or hundreds of acres.

Question 52

Which of the following is most likely an advantage of institutional ownership of physical farmland as opposed to buying exposure to crops through futures contracts?

A No requirement for sector specialists
B Exposure to broader universe of agricultural products
C Transparent pricing of farmland

Answer 52

B is correct.

Futures contracts are only available on a few common crops (such as wheat and corn).

Ownership of physical farmland allows for the cultivation of crops that are not traded on futures exchanges, resulting in a broader universe of agricultural product price exposures.

A and C are not correct because assistance from sector specialists is required due to limited price transparency or information to guide investment decisions.

Question 53

Which of the following is least likely to be a key reason for investing in real estate?

A Potential to avoid government regulations.
B Potential for competitive long term total returns.
C Potential to provide an inflation hedge.

Answer 53

A is correct. A concern for real estate is that it is subject to government regulations affecting what can be done to modify the existing property and how it can be transferred.

Both B and C are the reasons for investing in real estate.

Question 54

Which of the following is an example of a social infrastructure asset?

A Transportation assets
B Communication assets
C Educational and healthcare facilities

Answer 54

C is correct. Educational and healthcare facilities are examples of social infrastructure assets which are required for the benefit of the society.

A and B are examples of economic infrastructure assets which include transportation, communication, and social utility assets that are needed to support economic activity.

Question 55

Which of the following infrastructure investments has the highest expected return and the highest expected risk?

A Brownfield investment
B Secondary stage investment
C Greenfield investment

Answer 55

C is correct.

Greenfield infrastructure investments have the highest expected return and the highest expected risk, while secondary stage investments have the lowest expected return and the lowest expected risk.

Question 56

Which of the following statements is not correct about infrastructure investments?

A They may be categorized based on underlying assets and stage of development.
B They match the short-term liability structure of some investors such as pension funds.
C Investors may invest either directly or indirectly in infrastructure investments.

Answer 56

B is correct. Infrastructure investments match the long-term liability structure of some investors such as large pension funds.

These funds are frequent direct investors being better positioned to manage concentration and liquidity risks and the typical long-term horizon associated with infrastructure investments.