Fundamental elements of property returns including capital and retail returns, plus how these are generated in practice Flashcards
What is income return?
Return generated from rent
What is capital return?
Return generated from the change in the value of the property
What is total return?
The sum of the capital return + income return
A performance measure that many property investors and funds are benchmarked
How might you enhance the value of a property and its returns?
Via ‘active’ asset management, including:
- Refurbishment / redevelopment
- Renegotiation of leases / new lettings with aim of increasing rent / value of property
What are RETAILERS?
Are business firms engaged in offering goods and services directly to consumers (primarily concerned with selling merchandise)
What are the SEVEN different segments of retail securities?
automotive building supply distributors grocery and food online general specialty retailers
How do retail securities generally fair in the market?
Tend to track market as a whole, but with a degree of greater volatility
Stronger gains during bull runs, but larger losses when the bears roar
Therefore retail stocks tend to be more volatile than thebroader market
When looking to own retail stocks, what are the FOUR Rs investors should focus on?
Return on Revenues (ROR)
Return on Invested Capital (ROIC)
Return on Total Assets (ROA)
Return on Capital Employed (ROCE)
What is ROR?
Return on Revenues
Tells you how much net income = made from top-line revenues
Two basic building blocks;
- Balance sheet
- Cash flow statement
What is a balance sheet?
A summary of all your business assets (what the business owns) and liabilities (what the business owes)
At any moment, shows you how much money you would have left over if you sold all your assets and paid off all your debts (i.e. it also shows ‘owner’s equity’)
Retail stores maintain inventory (finished goods / goods used in production) = assets. Dividing inventory by the previous 12 months = inventory turnover (higher = better)
What is a cash flow statement?
Tells you how much cash is entering and leaving your business within given period and given as net amount of cash
Inflows = ongoing operations and external investment sources
Outflows = pay for business activities and investments
Can still generate profits with negative cash flow. But better to look at companies with positive cash flow.
What are the THREE forms of cash flow?
OPERATING: includes all cash generated by a company’s main business activities
INVESTING: includes all purchases of capital assets and investments in other business ventures
FINANCING: includes all proceeds gained from issuing debt and equity as well as payments made by the company
What is ROIC?
Return on Invested Capital
Ratio used to measure profitability and value-creating potential of companies, relative to amount of capital invested by shareholders and other debtholders
Ratio gives a sense of how well a company is using its money to generate returns
In relation to a store, ROIC can indicate amount of profit generated per store
E.g. a new store from a chain averages $2 million annual sales in first year open
Its ‘four wall cash contribution’ / profit generated is $200,000
Initial $300,000 investment = used to build and open the store
Therefore ROIC = 67%.
What is ROA?
Return on Total Assets
Shows percentage of how profitable a company’s assets are in generating revenue
Defined as a ratio = net income / total average assets
How does a retailer’s ROA compare with competition?
If ROA = 10% and its competitor across street = 20%, this indicates competitor = operating more efficiently
What is ROCE?
Return on Capital Employed
Ratio can help understand how well a company is generating profits from its capital
Ratio =earnings before interest and taxes(EBIT)/ capital employed
Where capital employed = total assets less current liabilities
What is the difference between ROCE and ROIC?
ROCE used EBIT = a pre-tax look at return ondebtandequity
Whereas ROIC = after-tax (dividendspaid) look at its profitability
What are some Risks in Retail Investing?
Economic Conditions (if recession, companies lay off workers and cut budgets, consumer spending slows = immediate negative effect to retail industry)
Regulation (many retailers rely on operating at minimum wages and any increases effect profitability)
Competition and Consolidation (proliferation of e commerce and less need for brick and mortar retailing)
Channel Disruption (disruption to supply chain = big risk to retail)
What are some types of users in the property investment market?
o Occupiers o fund managers o private investors o family office investors o pension funds o insurance funds o property companies o real estate investment trusts (REITS) o Sovereign wealth funds etc
What is unique about each property investment user?
Each have own return requirement / risk profile (e.g. a family office may desire wealth preservation and is a
long-term holder vs. pension fund may require regular secure income to distribute back to the pension fund
for payment to policy holders).
What are the FOUR categories of the commercial property market / corporate finance as an asset class?
- Property Private Equity;
- Property Public Equity;
- Property Private Debt;
- Property Public Debt;
What is Property Private Equity?
Direct investments in:
- tangible property
- privately held property companies
- pension funds that primarily own property
Focus on investments where there’s opportunity to add value to buildings i.e. increasing the rent (via refurbishment / redevelopment)
Some pension funds focus on income stability rather than value creation
What is Property Public Equity?
Indirect investments in:
- REITs
- Listed property companies
Most liquid form of property investing
Buying equities / shares in publicly-traded property companies that can be purchased / sold on a stock exchange
Provides ability for exposure to diversified pool of property assets with both income and capital growth potential that is professionally managed
What is Property Private Debt?
Involves lending to property owners / prospective investors, where debt / loan = secured by property asset / the company that owns the property
Lender looks to generate income from interest payment paid by the borrower
Strong focus on risk profile of the asset / portfolio that provides security over the loan
Area traditionally been dominated by banks but more recently insurance funds and alternative lenders
What is Property Public Debt?
Public debt exposure to property = specialist area
Investments = made in structures with publicly traded preferred stock, unsecured debt, convertible debentures, preferred equity of REITs or mortgage REITs
What are the advantages of indirect property investment (public equity)?
Means of gaining more diverse property exposure and hence lowering risk profile
Capital invested = not solely committed to a single, expensive asset but a portfolio of assets
No management or transaction costs (are already encompassed in the initial investment pricing)
Taxation can sometimes be more beneficial (for example REITs)
What are some examples of indirect property investment vehicles?
o unit trusts o property authorised investment funds (PAIFS) o Jersey property unit trusts (JPUTS) o real estate investment trusts (REITS) o debt o commercial mortgage-backed securities (CMBS) o property securities o property derivatives
What is the difference between Primary and Secondary Market investment?
The PRIMARY market concerns new investments. Companies issue new securities to investors and issue share certification.
The SECONDARY market is where shares and debt securities issued in the primary market are bought and
sold. Another layer of investor buys shares from the primary market investor, and a market of buying and
selling investments develops.
What were some recent policy changes in the BTL scheme?
Landlords effected by policies intended to curb BTL investment – must now adhere to 400 rules and
regulations, with possible fines up to £30k
Additional 3% stamp duty on investment purchases / second homes = hindrance
Borrowing with the latest taxation changes is difficult unless property is let as HMO
The anti-BTL policies = introduced by the government to reduce competition for first-time buyers, boosting homeownership and encouraging investment from large institutions
But didn’t realise knock on effect to tenants in rented properties being sold to first-time buyers. Ignored the fact that tenants don’t only rent because they can’t afford to buy.
What trends have there been in relation to local authorities’ property investment?
LAs are looking to commercial property investment to help plug their funding gap, with aim of generating long-term income streams
The Local Government Association (LGA) voiced concern on drying up of central government funding to councils in September 2018, with cuts of a further £1.3bn from council funding proposed in 2019/20
Strong upward trend in the amount invested in commercial property by UK councils over past 4 years; 0.16% in 2014, but now well above 3% and likely to remain part of many councils’ future strategies
Direct investment can offer councils significant control over their financial sustainability and potentially a
degree of control of local economic regeneration.
Locally-based investment may enable wider community benefits and modest financial returns
