Overview Of Types Of Real Estate Investment Flashcards
What is the difference between residential and non-residential real estate? What’s the difference between commercial real estate and owner occupied real estate?
- residential RE: homes, apartments, etc
- non-residential RE: office space, shopping centers, etc
- commercial RE: for rent RE
- owner occupied RE: not for rent RE
What does capital position mean in RE?
- capital position: describes whether a RE investor is an equity or debt provider
What is the different between real estate operating companies (REOC) and real estate investment trusts (REIT)?
- REOC: corporations that manage commercial RE
- REIT: owning or renting properties and/or purchasing mortgages
What is the difference between equity investor and debt investor for RE?
- equity investors: have ownership in RE investment
- debt investor: provides funding for RE investment
What are 8 unique characteristics of RE that distinguish it from listed equity or fixed income instrument? UHMHDINP
- unique asset: no two RE properties are the same (location, size, price)
- high cost: unit of RE is higher than stocks
- management intensive: requires maintenance, contracting, rent collection
- high transaction costs: buying & selling RE is costly in time & money
- depreciation: RE depreciates every year
- illiquidity: takes time to buy/sell, bid/ask is wider than stocks
- need for debt capital: typically require debt for funding of RE investment
- price determination: hard to determine due to infrequent transactions & unique properties
What are 3 main risks of RE investing?
- property demand & supply (eg. business conditions, demographics, RE cycles)
- valuation (interest rate environment, cost & availability of capital, etc)
- property operations (management, leases, etc)
What is household formation?
- household formation: change in the number of households from year to year.
What is the difference between under supply and over supply for real estate cycles?
- Oversupply: when occupancy and rental rates are low
- Undersupply: when occupancy and rental rates are high
What are 5 benefits of RE? PCIDT
- provides current income
- capital appreciation
- inflation hedge
- diversification
- tax benefits
What is the difference between gross lease and net lease?
- gross lease: requires the owner to pay the operating expenses (eg. owner pays the property tax)
- net lease: requires the tenant to be responsible for paying operating expenses (eg. tenant pays the property taxes)
What is a triple net leases?
- commercial lease where the renter pays rent and utilities as well as three other types of property expenses: insurance, maintenance, and taxes.
What is a sale-leaseback?
- sale-leaseback: arrangement in which the company that sells an asset can lease back that same asset from the purchaser.
What are 6 things you should examine when doing due diligence on a property?
- market review (eg. Population, growth, etc)
- lease & rent review (review history and rental rate compared to market rate)
- cost of re-leasing (cost to lease again, paying broker money to find tenant or benefits for leasing, etc)
- review documentation (review financial statements, utility bills, etc)
- property inspections & service agreements (maintenance, engineering, etc)
- legal documentation & tax compliance (verify title, zoning, property taxes)
What are 2 different types of real estate indexes, describe them.
- appraisal based indexes: indexes based on the appraised value of properties
- transaction based indexes: indexes based on recent transactions of similar properties
What’s the formula for total return of property under the appraisal based indexes?
- return = (NOI - CAPex + (ending market value - beginning market value)) / (beginning market value)
NOI = net operating income
CAPex = capital expenditures
What are 2 types of transaction based indexes, describe them.
- repeat sales index: repeat sales of the same property
- hedonic index: only one sale of the property, but takes into account property, size, location, etc.
What is the main difference between performance for appraisal based indexes and transaction based indexes?
- appraisal index is less volatile and lags a transaction based index
What is rollover risk, step up clauses, indexed rent, and overage rent?
-Rollover risk: potential for lost income while searching for a new tenant after the departure of an old one
- Step up clauses: clause that specify defined incremental rent increases at various point, common for land lords who believe their operating costs will increase over term of the lease
- Indexed rent: periodically adjusted based on an observed market variable, such as an inflation index.
- Overage rent: clause allows a retail tenant to pay a relatively low fixed monthly rental rate plus a percentage of sales in excess of a specified amount.
What are 3 Factors that motivate investors to hold real estate in their portfolios?
-Long-term stable income
- Ability to hedge against inflation
- Low correlations with returns on traditional assets
What is the order of types of real estate investing that go from lowest risk to highest risk?
- Senior Debt (debt like returns & least risky)
- Core (debt like returns & a little more riskier than senior debt)
- Core Plus (equity like returns & a little more riskier than core)
- Value Add (equity like returns & a little more riskier than core plus)
- Opportunistic (equity like returns & a little more riskier than value added)
What are the 4 phases in the real estate cycle?
- recovery: economy at lowest, consumer confidence is low, and employment uncertainty is high.
- expansion: rising economic activity and easing credit conditions.
- oversupply: after business cycle has peaked occupancy rates fall, and RE prices & rents level off and may start to decline.
- recession: occupant rate continues to fall, construction slows until interest rates fall.
What are 3 property specific risk? MOE
- Management issues: Failure to perform routine preventative maintenance and repair work
- Obsolescence (outdated): Changes in zoning laws and user preferences can cause buildings to become obsolete, requiring owners to undertake significant renovations
- Environmental factors: Geographic and climate-related risks include exposure to floods, earthquakes, and hurricanes.
What is gross potential rental income & formula?
gross potential rental income (GPRI): potential gross income that could be generated at current market rents assuming full occupancy.
GPRI = market rent * rentable space
What is loss to leases?
- difference between the market rent for a property and the actual rent that’s collected
What is gross rental income formula?
GPRI - loss to leases = gross rental income
What is net rental income from gross rental income?
Gross rental income - vacancy & collection losses - concessions & other adjustments = net rental income
concession & other adjustments: adjustments landlords make to attract tenants
What is effective gross income from net rental income?
Net rental income + other income + operating expense recovery = effective gross income
other income (eg. parking revenue)
operating expense recovery (operating expenses passed to the tenant)
What is formula for net operating income from effective gross income?
Effective gross income - operating expenses - property maintenance allowance = net operating income
property maintenance allowance (budget for repairs & upkeep of property)
What is pre tax cash flow and formula?
- difference between NOI & debt service charge
Net operating income property- debt service charge = pre-tax cash flow
debt service charge (both the principal and interest components of mortgage payments made during the period.)
What is the after tax cash flow and formula?
Pre tax cash flow - taxes paid = after tax cash flow
What is formula for taxes owed/paid or tax obligation?
tax rate * (NOI - depreciation expense - interest expense) = tax obligation
What is the equity dividend rate or cash on cash return?
equity dividend rate = pre-tax cash flow / (property purchase price-debt financing)
property purchase price - debt financing = equity invested
What is loan to value and formula?
LTV = debt outstanding/ current property value
higher LTV means higher chance of default
lower LTV mean lower chance of default
What is debt service coverage ratio and formula?
DSC = NOI /Debt service charges
DSC = ability to pay/cover its debt with income
higher debt service coverage ratio is better
lower debt service coverage ratio is bad (could signal it owes creditors more money than it can generate)
What are 2 ways to value real estate under the income approach?
- discount cash flow method
- direct capitalization method
What is the discounted cash flow method in real estate valuation & formula?
Property Value = (NOI / (1+r)^i) + (terminal value/ (1+r)^n)
What is the terminal value formula under the discount cash flow valuation method?
Terminal value = NOI (1+g) / r-g
capitalization rate (cap rate) = r-g
What is formula for the direct capitalization method for real estate valuation under the income approach?
Property Value = expected NOI / capitalization rate
Capitalization rate (cap rate) = r -g
What is the cost approach for real estate valuation?
- cost approach: based on premise that an investor should not pay more for a property than its replacement cost,
replacement cost is defined as the costs that would be incurred to acquire vacant land and produce a building that provides the same utility to users as the current version
What is the sales comparison approach of valuation real estate?
- sales comparison approach (aka market approach): estimates a property’s value based on the current selling price of comparable properties
What happens to interest rates during recovery, expansion, oversupply, & recessions?
recovery: bottom out, begin to rise
expansion: rising
oversupply: peak & begin to fall
recession: lowest
What happens to NOI during recovery, expansion, oversupply, & recessions?
recovery: bottom out, begin to rise
expansion: rising
oversupply: peak & begin to fall
recession: falling
What happens to DSC (debt service charge) during recovery, expansion, oversupply, & recessions?
recovery: bottom out, begin to rise
expansion: rising
oversupply: peak & begin to fall
recession: falling
What happens to LTV during recovery, expansion, oversupply, & recessions?
recovery: peaks & begins to fall
expansion: falling
oversupply: bottoms out and begins to rise
recession: rising
