chapter 9: property finance: equity Flashcards
what are the two aspects of equity that serve to define it as an investment vehicle?
First, equity holders own the residual risk (the benefits or losses) from an asset
Second, equity holders are generally given the right to participate in making the critical decisions regarding the operation and disposition of an investment
when do equity holders own the residual risk of an asset?
when the more senior classes of security holders have been paid
what do equity holders expect in return of their higher risk?
higher returns than debt holders
the chance to earn the highest returns of any class of investor
what can be distributed to the equity holders?
the residual cash (if any)
current cash returns
investment’s terminal or liquidation value
current cash returns
Periodic distributions from the operating income of a property
so distributions from ongoing cash flow if any
investment’s terminal or liquidation value
when the property is sold and converted into cash.
when all of the liabilities have been paid, any residual cash is distributed to the equity investors
what if the cash flow is negative and senior creditors dont get their money first,
what do equity holder have to do?
what is their risk?
they have to invest more money if they want the property to keep functioning
they risk losing their entire investment
why do creditors charge lower interest rates for higher levels of equity?
From a senior lender’s perspective, equity capital absorbs economic risk
It provides capital that can increase the entity’s economic activity, generating more cash flow, and building asset value
lowers the probability that the entity will default on its debt
the equity plays a valuable role in absorbing risk for the enterprise
lower debt-to-equity ratio
does an equity investment have a fixed term like debt?
nah bruv
debt holders can force a sale to get their money back
the equity holder cannot directly demand a sale or liquidation
what can equity holders do if property management bugging?
equity holders can act as a group to take over the management of the entity
are equity investors obliged to invest more cash if property is bugging?
in the vast majority of cases, nah
In certain circumstances, equity investors may agree in advance to invest further funds if required to support the initial investment
equity investors are subject to assessment
when equity investors agree in advance to invest further funds if required to support the initial investment
Private direct investments in real estate or public real estate companies are most liquid?
public real estate companies are most liquid
Private direct investments in real estate or public real estate companies can be traded in stock exchange?
public real estate companies can be traded on the world’s major stock exchanges
which are expected to liquidate, corporations or partnerships?
why?
partnerships are expected to liquidate
Partnerships have a fixed life
Corporations are of infinite life
single proprietorship
simplest form of organization
business is owned directly by a single person
owner receives all the profits and is responsible for all of the legal and financial obligations of the entity
liability of a single proprietorship
The liability of a proprietor for the actions of a proprietorship is unlimited
extends to the owner’s assets outside of the business
partnership
agreement among a group of people who desire to share ownership of an enterprise
Each general partner is responsible for all of the legal and financial obligations of the entity
general partnership
partners are all equal
owners are known as general partners
liability of a partnership
each general partner is individually responsible for the entire amount of the liability
how do single proprietors and partnerships show the income of their business?
show the income directly on their personal financial statements
they do not pay a separate corporate tax
capital call
A request for additional funding from existing partners in a partnership
Typically, each partner is asked to invest their pro rata share of the required capital
Cram Down Provisions
getting new partners that are willing to invest instead of those not willing to do so in a capital call
the former take massive W with disproportionate share of investment
the latter takes the L
when does a partnership end?
when the investment’s value is realized through a liquidation of the partnership’s assets
or when more than 50 percent of the ownership changes hands within a 12-month period
join ventures
agreements between financially sophisticated entities to pursue specific goals over a limited period of time
n real estate, joint ventures may be focused on a development project or the ownership of a particular property
how are joint ventures structured as?
typically structured as partnerships, with each institution retaining a vote in the affairs of the partnership
who uses joint venture structures usually?
used by financial institutions that invest capital with real estate operating companies to acquire properties
Limited Partnerships
arrangement between operating and financial partners to share ownership of an enterprise
general partner of limited partnerships
operating partner of a limited partnership
has unlimited liability for the operations and liabilities of the partnership
responsible for making all operating decisions
responsible for any decisions that affect the tax position of the partnership
financial partner of limited partnerships
those who contribute cash rather than expertise to the venture
limited partners
not allowed to participate in the day-to-day operation of the partnership
may have a say in major decisions
liability of financial partner of limited partnerships
at risk for only the amount of their investment
a waterfall
The allocation of the economic benefits in a limited partnership
economic benefits of the partnership to be reallocated in favor of those partners that contribute additional capital if the partnership requires it
how is a limited partnership taxed?
the same way as a general partnership
how to limit the risk of a limited partnership?
create a corporation or limited liability company to serve as the general partner
corporations
legal entities, owned by their shareholders, that are set up to conduct a business
entities apart from their owners and have unlimited lives
who elects a corporation’s board of directors?
Shareholders
what taxes do corporations pay?
required to pay corporate taxes because of their status as separate legal entities
when are shareholders taxed?
taxed only when they receive dividends or the proceeds of a liquidation event
Limited Liability Company
has the limitations on personal liability of a corporation as well as the pass-through tax attributes of a partnership
owners of a Limited Liability Company
members
One of the members is selected as the managing member
target return
the expected level of return on an investment expected by a financial partner
annual cash on cash return
target return stated as an annual return from operating cash flow
the amount distributed to the investor each year as a percentage of the amount invested
what does the target return over the life on an investment typically include’?
combination of annual cash distributions and the proceeds realized on the sale of the asset
preferred return
first claim on profits until a target return has been achieved
why do preferred returns exist?
when the operating partner wants a financial partner to enter into the partnership
NPV (net present value)
metric used to evaluate the performance or return on an investment over its life
the sum of the discounted cash flows returned from an investment less the amount of the initial investment
Internal Rate of Return
discount factor that equates the NPV of the cash flows returned from an investment to the amount of the investment itself
can be compared to the investor’s desired rate of return
what does a high Internal Rate of Return mean?
the investment exceeds the investor’s expectation
what does a low Internal Rate of Return mean?
the investment decision must be reconsidered
unlevered figure of merit
figure of merit calculated prior to taking into account debt
unlevered returns
look at how well an asset is performing without regard to how it is financed
may be an indicator of astute property acquisition and management skills
levered returns
take into account how well an investor has accessed the capital markets and can be an indicator of financial acumen
promoted interest
disproportionate share of profits given to operating partner after financial partners have achieved a given internal rate of return on their capital accounts
clawback provision
agreement to give up a certain portion of operating manager’s share of return to the financial partner if agreed-upon return thresholds have not been achieved
why use clawback provisions?
To further incentivize a financial partner to reach
cumulative preferred equity
when the preferred equity holders havent gotten their dividends yet and it accumulates to the next period
make whole distributions
Distributions to fulfill prior year deficiencies
who makes major decisions in corporations and partnerships?
what are thya?
the equity holders
strategic decisions
tax matters partner
one partner is typically given the discretion to represent the partnership on tax matters
who manages tax matters in corporations?
the CFO
Right of First Offer
a departing partner may trigger the sale of an asset, but it must offer the remaining partners the right to make an offer to purchase the asset before it is offered for sale to the public
also known as a first look
Right of First Refusal
less advantageous to the departing partner than the right of first offer
must offer the remaining partner the opportunity to buy the asset at any price agreed to by a bonafide third party
Sale by Appraisal
common method for price setting between a departing and remaining partner is to have a price set by appraisal
partners are willing to transact
Each party to the transaction hires an appraisal firm to determine fair value
If the two appraisers cannot agree on a value, they choose a third independent appraiser, who sets the price
acquisition fee
a fee for acquiring properties
covers the manager’s cost of sourcing the asset and processing the acquisition
disposition fee
fee paid for disposition
typically a stated percentage of the sales proceeds
types of fees
acquisition fee
disposition fee
financing fee
asset management fee
property management fee
development fee
construction management fees
fees in joint ventures
syndicates
are groups of banks that come together to place an issue of securities with investors
securities offering
Syndicates placing an issue of securities with investors
Underwriting
reviewing an investment for suitability on behalf of prospective investors
Best Efforts Offering
a banker agrees to place an issue of securities but makes no guarantee that the securities will actually be sold
accepts no market risk
which is longer, underwritten offering or a best efforts offering?
a best efforts offering is a longer process and involves a considerable marketing and sales effort
Real Estate Investment Trusts (REITs)
entities whose primary business is the ownership of debt and equity interests in real property
limit their investments to real property
operate within certain parameters
how are REITs structured as?
as corporations
Real Estate Operating Companies (REOCs)
corporations whose primary business is the ownership of equity interests in real property
also provide of services to the real estate industry
Master Limited Partnerships (MLPs)
invest in real estate and other asset classes
partnerships that issue interests known as units
are Master Limited Partnerships (MLPs)’s units traded on public securities exchange?
yeeee boyyyy
public real estate companies that issue equity securities in public markets
Real Estate Investment Trusts (REITs)
Real Estate Operating Companies (REOCs)
Master Limited Partnerships (MLPs)
private equity investment vehicles in private markets
Entrepreneurial Limited Partnerships
Pension Funds and Insurance Companies
Private Equity
Private REITs
Tenancy in Common (TIC)
direct investors
Investors that invest directly in property and own an interest in an asset
indirect investors
Investors that purchase interests in entities that own assets
private equity firms
Investment firms that raise opportunistic capital from high-net-worth individuals and financial institutions
make investments in real property either directly or through joint ventures with property companies
interested in taking greater risk in order to achieve higher returns
Private REITs
invest in property with the goals of creating significant appreciation prior to finding an exit in the public markets or through liquidation
known as non-traded REITs
why are Private REITs known as non-traded REITs?
Shares in these REITS are typically sold to individual investors through networks of financial planners
their shares are not listed on public stock exchanges and have limited liquidity
Tenancy in Common (TIC)
ownership structure in which group of investors each own fractional interests in an investment property
each owner has a direct interest in real property
benefits of having an institutional equity partner’
can accelerate the growth of any entrepreneurial real estate business
can lend credibility to the entrepreneur and bolster its financial position in the eyes of business partners, property sellers, and debt sources
buy-sell agreement
in the event that either partner decides to exit the investment, the other partner is often given the initial right to purchase the seller’s interest
when is a buy-sell agreement typically triggered?
when there is a disagreement regarding the future of the investment between the institutional partner and the entrepreneur
