Chapter10-Equity and property markets

Question 1

Framework

Answer 1

1 Ordinary Shares*
2 Investment and risk characteristics of ordinary shares
3 Cash Flows of an ordinary share
4 Advantages of listed shares over unlisted shares
5 Practical reason for analysing shares by industry
6 Correlation of performance of shares within the same industry
7 Why market movements are the biggest influence on a share’s price
8 Investment and risk characteristics of direct property
9 Prime property (CALL ST)
10 Freehold property ownership
11 Leasehold property ownership
12 Indirect property investment
13 Advantages of direct property over property company shares
14 Advantages of property company shares over direct property
*Preference shares

Question 2

Investment and risk characteristics of ordinary shares (11)

Answer 2

1. Income = dividends = share in company profits
2. Capital gain may arise on sale of shares
3. Default (of income) risk depends on security of issuing company
4. Security of capital depends on NAV, level of gearing and risk profile of the issuing company
5. Higher long-term expected return than government bonds
6. Expected to provide a real return over the long term
7. Potential for volatile market values (and dividends)
8. Term: no fixed redemption date, generally considered long term
9. Dealing costs higher than on conventional government bonds
10. Marketability depends on issuing company and whether listed or not – marketability generally worse than for government bonds
11. Tax treatment depends on the territory

Question 3

Investment and risk characteristics of direct property (14)

Answer 3

1. Risk of voids (periods where property not let) and tenant default
2. Risk of political interference
3. Risk of obsolescence and need for refurbishment
4. Real return, broad inflation hedge
5. Higher expected return than government issued bonds
6. Income forms a ‘stepped’ pattern over time
7. Running (rental) yield varies by the type of property
8. Volatile capital values in long term, stable capital values in short term
9. Subjective, infrequent valuations, lack of information
10. High dealing costs and management costs
11. Very unmarketable
12. Large unit size, indivisibility
13. Uniqueness
14. Characteristics can be changed by owner, eg redevelopment

Question 4

Prime property

Answer 4

Comparable properties for rent reviews and valuations
Age, condition and flexibility of use
Location
Lease structure

Size
Tenant quality

(The acronym is CALL STreet.)

Question 5

Indirect property investment

Answer 5

1. Open-ended schemes, such as property unit trusts
2. Closed-ended schemes, such as property investment trust companies
3. Shares in property (development / investment) companies

Question 6

Advantages of direct property over property company shares (9)

Answer 6

Control

Diversification away from the stock exchange

Forced selling and the associated loss is less of an issue

Management fees to property share company advisors avoided

Not exposed to high risk types of property (eg development sites)

Not exposed to extra volatility caused by gearing or the discount to NAV changing

Tax advantages (possibly)

Utility value

Volatility of prices lower in the short term as valuations infrequent

Question 7

Advantages of property company shares over direct property (11)

Answer 7

Access to larger / more unusual properties (eg development sites)

Discount to NAV may exist – property shares may represent a ‘cheap’ way of buying property assets

Diversification within the property market

Divisibility

Economies of scale in the case of large property share companies

Expected return may be higher due to the extra volatility associated with gearing and the possibility of any discount to NAV narrowing

Expenses associated with direct property investment avoided

Expertise of property company managers

Marketability better

Quoted prices making valuation easier

Tax advantages (possibly)