Reading 3.1 Flashcards
Split estates are?
When different parties can own the surface and subsurface
What is an MLP?
1) publicly traded limited liability partnership
2) has to have 90% of income from natural resources or RE
3) have general partners and limited partners
How is effective economic ownership of NR is achieved?
1) leasing ownership rights from the owner of the NR
2) buying land that and that gives rights for some NR
3) Exchange traded securities
What is pure play?
Pure play company is a public company that focuses only on one revenue stream.
Limits the exposure to only one risk
What is a stochastic price?
Price that is not fixed, and is dependent on some variable
What is the exchange option for NR?
You exchange one risky asset (input) for another risky asset (output) at a STOCHASTIC STRIKE PRICE
On what is the value of an EXCHANGE OPTION dependent?
1) volatility of the delivered asset (output)
2) volatility of the received asset (input)
3) correlation between the 2 prices
Volatility of an exchange option is comparable to?
Volatility of a 2 asset portfolio
When is the exchange option value high? I.e when is it good to invest in NR development
When development cost and commodity prices are not positively correlated (i.e do not move in the same direction)
What kind of option (american/european) is the option to develop NR?
Perpetual option (American option)
Low hanging fruit principal?
Firstly develop the most attractive options = that have the potential to create the most value
What factors determine when to exercise an option (i.e. develop the NR)?
1) volatility of the commodity price
2) volatility of the development cost
3) correlation between the two
Option value formula
Intrinsic option value + Time value of option
What is time value of option?
Excess above option’s intrinsic value
What is the intrinsic value of an option?
Value of the option, if you exercise it immediately. But NEVER below zero, it cant be negative.
Why some options should not be exercised immediately?
To benefit from:
1) convexity = price increases at an increasing rate, but cant go below 0
2) possible future price increase
Risks for in the money and out of the money developments?
In the money: Driven by the commodity price.
Out of the money: longer the time horizon, the greater risk of changes in development cost, interest rates and other factors
What is land banking
Investing in land expecting that it will increase in price or for development
What determines the value of land?
Ability to generate value
Type of land lots:
1) paper lots - vacant lots. Legal permission to develop are in place.
2) blue top lots - infrastructure (water, sewage, electricity) is being developed.
3) finished lots - infrastructure is ready, development fees (except building permits) have been paid
On what factors does the value of land depend on? In terms of options
1) underlying asset - land
2) strike price - development cost
3) time to expiration - unlimited
4) pay off - spread between value of competed dev, and cost to dev.
5) volatility in the spread between the value of completed development and cost to develop
6) risk free rate
7) dividend yield - income of completed project
8) cost of holding undev land (taxes, maintenance)
When is land more valuable?
When it can serve multiple purposes, as long as the values from these purposes are not perfectly correlated
What is negative survivorship bias in undeveloped land returns? What are its consequences?
The databases of returns usually exclude high returns of successfully developed land.
=>
The returns are understated
What is a Rotation period?
Time needed to grow the tree from planting to harvest
What are vertically integrated companies?
Companies what are involved in all stages of the product developing process
Pros of investing in timberwood:
1) flexibility - can postpone harvest of trees to wait for a better market
2) Stable demand - because a multipurpose commodity
3) inflation hedge
4) diversification (due to low correlation with stocks/bonds)
Cons of investing in timberwood
1) prone to high risks of natural disasters because of long rotation period
2) long rotation period
3) timber values tied to cyclical industries
How to gain exposure to timberwood:
1) ETFs
2) REITs
3) futures contracts
4) shares in timber companies
Value of farmland property formula:
Annual operating income / Cap rate
Operating income formula:
Income - Expenses (except financing)
Net income formula
Operating income - Financing costs
ROA formula:
Operating income / Total Assets
ROE Formula
Net income / Total Equity
Total equity formula for farmland
Purchase price - financing costs
What is the capitalization rate (cap rate)?
Expected rate of return on RE property
=
ROA
2 types of farmland ownership
1) row cropland - crops that are replenished each year
2) Permanent cropland - long replenishment cycle
2 types of farmland investment risk
1) agency risk - the lessee harms the land
2) political risk - decrease in subsidies
Demand factors for agricultural products
1) global population growth
2) rising incomes
3) increased use of agricultural products in non-food based uses (biofuel)
Future supply of agricultural products is dependent on:
1) changing agricultural yields
2) changing agricultural infrastructure
3) quality of cultivated land
Reasons for growth in agricultural yields?
1) technology
2) improved agronomy (science of soil management, etc)
3) increase use of inputs (fertilizer)
4) increased use of machinery
Pros of farmland investment
1) inflation hedge
2) diversification
3) constrained supply
Cons of farmland investment
1) illiquidity
2) high transaction costs
3) Agency risk (the cost of that)
4 main sectors of the agribusiness
1) agricultural products
2) seed & fertilizer
3) farm & machinery
4) packaged foods
When is multiple use farmland most valuable?
1) When the value of different uses are not correlated
Even better if there is a agricultural and non-agricultural use
2) when profitability of the each crop is uncertain = very volatile
How does smoothing impact risk? Why does it do so?
Smoothing decreases the perceived risk because STDEV is lower.
What is anchoring?
Relying heavily on prior beliefs, not acknowledging new information
Impact of smoothing on true returns?
Impact = True returns - Smoothed returns
Stale data is?
No longer up to date data
Causes of return smoothing / stale data
1) Time gap between deal and transaction
2) not appropriate indicators of valuation changes
3) managing data appraisal
4) data delays
What problem does smoothing create?
1) reduces volatility
2) because reduces volatility reduces correlation estimates
Main ways that returns can be “managed” (aka manipulated)
1) favorable mark - favorable price quote
2) selective appraisal - selected time and asset to be appraised
3) model manipulation - changing inputs/assumptions
4) Market manipulation - trading in such a way to move markets
Difference between market and smoothed returns?
Smoothed returns decline on a delayed basis
What is contagion?
Tendency of major market moves to be passed from one financial market to the other
Timber return observations compared to General Market (volatility, sharpe ratio, skewness, excess kurtosis, max drawdown, partial autocorrelation, clustering around the mean)
GE - global equity
1) volatility: much less than GE
2) sharpe ratio: attractive, more than GE
3) skewness: modestly positive (vs negative for GE)
4) excess kurtosis: markedly positive (much more than GE)
5) maximum drawdown: very mild (much smaller than GE
6) Partial autocorrelation: markedly 4th order = there is a one year lag in recognizing value change
7) clustering around the mean: very tight
Farmland return observations (volatility, sharpe ratio, skewness, excess kurtosis, max drawdown, partial autocorrelation, clustering around the mean)
GE - global equity
1) volatility: less than GE
2) sharpe ratio: very attractive, much more than GE
3) skewness: markedly positive (vs negative for GE)
4) excess kurtosis: markedly positive (much more than GE)
5) maximum drawdown: very small
6) Partial autocorrelation: markedly 4th order = there is a one year lag in recognizing value change
7) clustering around the mean: very tight
A NR should be developed when which value is zero?
When TIME VALUE of the development option is ZERO
Volatility used in the value of an exchange option is driven by which 3 factors?
1) volatility of delivered asset
2) volatility of a received asset
3) correlation between volatilities of delivered and received asset
Pairwise correlation is
Two variable correlation
