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REAL ESTATE Flashcards

1
Q

Give 5 reasons to invest in real estate

A 
Current income
Capital appreciation
Inflation hedge
Diversification
Tax
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2
Q

Outline 11 main risks of real-estate investing

A 
Business cycle
Lead time (development) 
Cost (development) 
Availability of capital
Unexpected inflation
Demographics
Liquidity
Environmental
Information
Management
Leverage
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3
Q

What are the three ways of valuing real estate

A

Cost
Income
Sales comparison

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4
Q

Outline the Cost approach for real estate valuation. When is it used? When is it not suitable?

A

It determines the upper limit of investment value

Total cost=land value + adjusted replacement cost - depreciation

Newer, Unique or specialised properties where comparable are difficult to find.

Not good for old or obsolescent properties

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5
Q

What is highest and best use for?

A

Highest and best use maximises implied value of land

Implied value of land = value of building - cost of building

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6
Q

What is the link between effective age and Incurable depreciation?

A

Incurable items increase the effective age

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7
Q

Explain curable deterioration. When is it deducted from replacement cost?

A

Where the cost of repair is fully reflected in building value

It is the first deduction

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8
Q

List the 2 steps and 5 adjustments in the third step for the cost approach to equity valuation

A

Step 1 - Estimate market value of the land

STEP 2 - Estimate building replacement cost

Step 3 - adjustments
Curable Physical depreciation
Incurable depreciation
Functional obsolescence
Location obsolescence
Economic obsolescence
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9
Q

Outline sales comparison approach for real estate and 5 adjustment factors

A

Market SLAC

Comparable prices adjusted up or down for:

Market conditions
Size
Location
Age
Condition of property
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10
Q

NAME 3 methods for THE INCOME Approach to real estate valuation. Which income measures do they use

A
  1. The Gross Income Multipler method - this uses gross income

The two following methods use Net Operating Income (NOI) :

  1. Direct capitalisation approach
  2. DCF approach
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11
Q

Outline 7 line items to obtain NOI for real-estate valuation

A

Gross rental income
+ other income
= potential gross income (PGI)

  • vacancy and collection losses
    = effective gross income (EGI)
  • Opex
    = Net Operating Income (NOI)
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12
Q

Which two expenses are not included in calculation of NOI for real-estate

A

Interest Cost

Income Tax

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13
Q

What is the effect on the Cap rate when value and income grow at the same rate? Why?

A

The Cap rate < Discount rate

Cap rate = Discount rate - Growth rate

As in Equity, if Dividends and earnings grow by the same rate, so does retained earnings (equity).

The growth in property value is the growth in equity.

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14
Q

What is the value of a property using capitalisation rate?

What component is forward looking?

A

Value=NOI(first year after purchase) / (cap rate)

Note Value is t=0, NOI is t=1

NOI is forward looking

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15
Q

Explain the gross income multiplier method.

What is the main disadvantage

A

GIM = (Sales value) / (Gross income)

It does not exicitly include vacancy rates and opex

1/(gross income multiplier) = (Gross income)/(Sales value)
This is similar to All Risks Yield = Rent/(Sales value)

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16
Q

What is the going in cap rate

A

It is the discount rate adjusted for growth used to capitalise the first year NOI
Going in cap rate = year 1 (Re-g)

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17
Q

Explain the terminal cap rate.

What is another name for it?

A

The terminal cap rate is the Cap rate used for the year after the property is expected to be sold

Residual cap rate

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18
Q

Compare going in cap rate with terminal cap rate

A

The terminal cap rate is usually higher than the going in cap rate because

  1. Growth rate declines over time
  2. Interest rate curves usually upward sloping
  3. Long term income streams are more risky

If growth and/or interest rate outlook is reversed terminal cap rate can be lower than going in cap rate

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19
Q

Outline the discounted cash flow method for real estate valuation.

A

The total return is the sum of
(a) capitalised first year income
+ (b) growth in income and value for remaining years

  1. NOI is projected for each year of the holding period
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20
Q

What is the equation for constant growth with the DCF method of real estate valuation.

What are three effects when NOI is constant.

A

Value = NOI / (r-g)

  1. Like GGM
    If NOI is constant, g=0
  2. If g=0, value is perpetuity, V=NOI/r
  3. If g=0, Cap rate = r-0,
    so cap rate = Discount rate
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21
Q

Give two other names for Terminal value in real-estate valuation

Outline the estimate of Terminal Value

A
  1. Reversion
  2. Resale

Terminal value is the capitalisation of future NOI (after sale) at a future cap rate

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22
Q

What does t= for NOI when calculating terminal value for a sale in year 4
What year is it discounted at?

A

NOI t=5

Discounted at year 4

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23
Q

What cap rate uses rent instead of NOI?

How is it calculated?

A

The ARY, “All Risks Yield”

ARY= Rent / (comparable sales price)

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24
Q

Give two other names for contract rent

A
  1. Passing rent

2. Term rent

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25
Q

Outline the “term and reversion” approach.

A

The contract rent value and reversion value are evaluated separately with different capitalisation rates

The term rent cap rate < reversion cap rate

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26
Q

Compare discount rates for contract and reversion

A

Discount rate for reversion will be higher than for contract rent because reversion is in the future and more risky

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27
Q

Describe the reversion cap rate

A

The reversion cap rate is derived from future estimates of comparable, fully let properties, discounted to present value

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28
Q

What is reversionary potential

A

The adjustment of contract rent upwards to market rent

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29
Q

What does t= for reversionary value

A

For term t=3
t =4 for ERV

Like Terminal value, ERV is discounted by t=3 to PV

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30
Q

Describe the layer approach

A

Two values:

  1. Value of contract rent as perpetuity, growth=0, Contract Cap rate = ARY
  2. Value of incremental rent after reviews, Incremental Cap rate> Contract cap rate
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31
Q

What is the equivalent yield for Term and Reversion and Layer methods

A

It is a single cap rate applied to the total cash flow that is equivalent to the individual cap rates applied to the two separate cash flows.

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32
Q

What are the 7 steps in DCF analysis for real-estate

A

Estimate:

  1. Future income for existing leases
  2. Probability of lease renewals, rental rates and costs
  3. OpEx: Fixed, variable (related to occupancy) or hybrid
  4. CapEx
  5. Vacancy absorption
  6. Resale value(reversion)
  7. Discount rate to determine PV of all future cashflows
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33
Q

Give three ways the Direct Capitalisation approve with DCF for real estate valuation

A
  1. Growth (expected) is implicit in cap rate but is explicit in DCF approach.
  2. DCF is more complex since it includes the complete pattern of NOI over the whole period e. g. Lease by lease analysis.
  3. DCF does not rely on comparable sales prices.
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34
Q

Give 5 common errors in the DCF approach to real-estate valuation

A
  1. Discount rate does not include all risks
  2. Income growth > expense growth
  3. Going-in cap rate is inconsistent with Terminal Cap Rate
  4. Atypical (unrepresentative) NOI is used for Terminal value calculation.
  5. Cyclical nature of real estate markets is not included.
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35
Q

Describe 10 due diligence areas in private equity real estate investment.
What risks are lowered?

A

Private debt and equity investors review:

  1. Lease and rental history
  2. OpEx
  3. Cash flow statements
  4. Environmental inspection
  5. Engineering / structural
  6. Ownership history
  7. Service & Maintenance agreements
  8. Property survey, boundaries, easements
  9. Compliance etc.
  10. Property taxes, insurance etc.

Unexpected legal and physical risks.

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36
Q

Give one example of an appraisal based index. How is it calculated?

A

NCREIF Property Index is:
value weighted,
includes quarterly appraisal data (not sales data) as follows:
1. Appraisal value (beg and end of quarter)
2. NOI
3. CapEx
4. Return (HPR, IRR) = (NOI - Capex + change in value) / beginning value of quarter

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37
Q

Give the two return components of an appraisal based index

A
  1. Income return = NOI/(beg market value)

2. Capital return = (change in market value - CapEx) /(beg market value)

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38
Q

Give three uses of appraisal based indices

A
  1. Compare performance with other asset classes
  2. Measure risk
  3. Benchmark portfolios
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39
Q

Give three disadvantages of appraisal based indices

A
  1. Appraisal lag - appraisal values lag transaction prices
  2. Appraisal lag smooths returns and under estimates volatility
  3. Appraisal lag artificially lowers correlation of returns with other asset classes leading to overweight in portfolio diversification construction
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40
Q

Outline a repeat sales index

A
  1. A transaction based index
  2. When a specific property is sold twice in a given period the change in value is a proxy for the market
  3. Regression allocates the price changes for each quarter
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41
Q

Outline a hedonic index

A
  1. Requires only one sale.
  2. Independent variables are included in the regression to account for different types of properties.
  3. Unexplained variation shows the change in market conditions
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42
Q

Compare transaction based indices v appraisal based indices

A
  1. Transaction based indices better than appraisal based.

2. However use of statistical processes (regression) can lead to noisy observations with random elements.

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43
Q

Outline 4 forms of real estate investment

A

Private equity (direct ownership)
Private debt (direct lending)
Publicly traded equity (indirect ownership)
Publicly traded debt (mortgage backed securities)

44
Q

Give 8 characteristics of real estate investment

A 
Heterogenous
High unit value
Active management
High transaction costs
Depreciation and desirability
Cost and availability of debt capital
Lack of liquidity
Difficulty in determining price
45
Q

Give 3 classifications of real estate

A

Residential
Non residential
Income producing

46
Q

Name 4 types of commercial property

A

Office
Industrial
Retail
Multi-family

47
Q

What drives the demand for office space

A

Employment, jobs

48
Q

What drives the demand for industrial space

A

Overall economy

49
Q

What drives demand for retail space

A

Consumer spending

50
Q

What drives demand for multi-family

A

Population growth

51
Q

What is the debt service coverage ratio

A

DSCR= (First Year NOI) / (debt service)

Debt service = interest plus principal

52
Q

What is LTV

A

LTV=(Loan amount) /(appraisal value)

53
Q

What is another name for the equity dividend rate? How is it calculated? What is the period?

A

Cash on cash return = (First year cash flow) / equity

Only the First One year period

54
Q

What is leveraged IRR? How is it calculated?

A

IRR with Leverage includes cashflows over all years in the holding period.

The end of period sales proceeds are reduced by the mortgage balance.

55
Q

Compare the cost, income and sales approach

A

Cost = value of land + adjusted replacement cost

Sales comparison = comparable properties are adjusted for differences with the subject property

Income approach = the present value of the future cash flows over the holding period

56
Q

Compare the direct capitalisation and DCF methods

A

Direct capitalisation: a cap rate applied to first-year NOI, increase in growth is implicit in the Cap rate.

DCF: future cashflows, Capex and terminal value are projected and discounted back over the holding period. Growth rate of NOI is explicit.

57
Q

Explain Leverage in real estate investment

A

Leveraged IRR. As long as investment return is greater than cost of debt capital.

58
Q

Give two examples of publicly traded equity securities for real estate

A

Equity REIT’s

REOC’s

59
Q

Give three examples of publicly traded debt securities in real estate

A

Mortgage REIT’s
Residential MBS
Commercial MBS

60
Q

Give 7 advantages of investing in real estate through publicly traded securities

A

Liquidity - much higher than private investment

Lower minimum investment - fractional ownership, shares with smaller dollar values

Limited liability - unlike general partnership liability

Premium properties - access to prestigious high value properties

Active management - professional management, no investor management required

Investor protections - as for the rules for other publicly traded securities

Easier to achieve Diversification - through holdings in different property types and geographies

61
Q

Give 3 advantages of investing in REITs

A

Exemption from tax
Predictable earning
High dividend yield

62
Q

Give 7 disadvantages of investing in publicly traded real estate securities

A

Lower tax efficiency compared to direct ownership

Lack of control

Costs of operating a public corporate structure

Volatility due to market pricing

Limited growth potential of income

Forced equity issuance (REIT’s have low amount of retained earnings so have to issue equity to purchase new opportunities)

Structural conflicts of interest

63
Q

Give 9 due diligence factors for REIT’s

A

Remaining lease

Inflation protection

Contract rents vs market rents

Costs of re-leasing

Tenant concentration

Tenant financials

Competition

Balance sheet

Management quality

64
Q

Give 4 characteristics for Shopping/Retail REITs

A

Retail sales growth / job creation
Stable revenue stream
Dependant on consumer spending
Due diligence - sales & rental rates

65
Q

Give 4 characteristics of office REITs

A

Job creation. Supply of new space vs demand

Long (5-25 year) lease terms

Changes in vacancy and rental rates

New space and its quality

66
Q

Give the 10 characteristics of Residential REIT’s across the 4 classes

A
  1. Population growth and job creation
  2. Competition, inducements, regional economy, inflating operating costs
  3. Demographics, income trends. Age and appeal of properties.
  4. Costs of home ownership, rent controls
67
Q

Give 14 factors of Health Care REITs

A 
Population growth
New supply vs demand
Leases to health care providers are usually net leases
Demographics
Government funding
Construction cycles
Financial condition of operators
Tenant litigation
Operating trends
Government funding
Litigation settlements
Insurance costs
Competitors new facilities vs demand
68
Q

Give 11 factors for Industrial REITs

A 
Retail sales growth
Population growth
Less cyclical than other REITs
5-25 year net leases
Slow change in income and value
Shifts in composition of local and national industrial base and trade
Trends in tenant requirements
Obsolescence of existing space
Need for new types of space
Proximity to transportation
Trends in local supply and demand
69
Q

What are the main factors in Hotel REITs

A 
Job creation
Supply of new space vs demand
Variable income
Not protected by long-term leases
Cyclical sector
Exposed to business cycle
Changes in business and leisure travel
Exposure to travel disruptions
Occupancy, room rates
Operating Profit margins vs industry averages
RevPAR
Trends in forward bookings
Maintenance expenditures
New construction in local markets
Financial leverage
70
Q

Give 9 factors in Storage REITs

A 
Population growth
Job creation
Space rented in gross leases
Ease of market entry leads to oversupply
Competition
Trends in housing sales
Demographic trends
New business startup
Seasonal demand trends
71
Q

What is an UPREIT

A

Controlling interest (GP) in a partnership that
Owns and operates properties
Upreits are most common

72
Q

What is a downreit

A

An ownership interest in more than one reit partnership

73
Q

Give the 5 most important factors affecting the types of REITs

A 
National GDP growth
Job creation
Retail sales growth
Population growth
New space supply vs demand
74
Q

What is the difference between a gross lease and a net lease

A

Fill later

75
Q

Describe NAVPS

A

Estimated cash NOI
÷ Assumed cash rate
= estimated value of operating real estate

+ other Tangible assets (cash, receivables, development land)
- debts and liabilities
= NAV

76
Q

Describe FFO

A

A measure of continuing operating income

Adjusts reported earnings as follow:
FFO =

Accounting Net earning
+ Depreciation expense
- Gains (+losses) from property sales
= Funds From Operations (FFO)

77
Q

Describe relative value approaches

A

Market based multiples:

  1. Price to FFO
  2. Price to AFFO
78
Q

Describe 4 advantages if ROECs over REIT

A
  1. Free to invest in:
    (a) any kind of real estate
    (b) related activity
  2. More resources can be used for development.
  3. Can retain more earnings for future opportunities.
  4. Increased leverage.
79
Q

Describe characteristics of shopping center REITs

A
  1. Regional shopping malls -
    (a) enclosed space,
    (b) high priced goods,
    (c) lease terms 3-10 years
    (d) plus percentage of sales (participatory leases)
    (e) anchor retailers - long term fixed rents or own
  2. Community shopping centers -
    (a) stores linked by open air walkways
    (b) basic goods & services
    (c) similar lease terms for all
    (d) non participatory
    (e) periodic increases
80
Q

Describe Office REITs

A
  1. Usually multi-tenanted properties
  2. Tenants pay proportionate share of OpEx, communal costs and property tax
  3. Rental income is stable
  4. Can be supply demand mismatch over lifecycle
  5. Location, transportation, quality
81
Q

Describe Industrial REITs

A
  1. Single or multi-tenant
  2. Warehouse, distribution, light manufacturing
  3. Less cyclical:
    (a) longer lease terms
    (b) shorter construction times
    (c) build and pre-lease
  4. Location and availability of transport
82
Q

Describe multi-family residential REITs

A
  1. Rental apartments leased to individual tenancies
  2. Competition of supply
  3. Economic sensitivity, inflation, OpEx, maintenance
  4. Local demographics
  5. Government controls
  6. Energy costs
83
Q

Describe Storage REITs

A
  1. Own and operate self-storage places
  2. Gross leases
  3. Typically monthly rents
  4. Low barriers to entry
  5. Risks excess supply
  6. Local demographics and seasonal trends
84
Q

Describe Health Care REITs

A
  1. Nursing homes, assisted living, hospitals, medical and rehab
  2. Tax exemptions for leasing to health care providers
  3. Net leases
  4. Relatively less sensitive to economy
  5. Sensitive to Demographic changes
  6. Operating trends
  7. Government funding
  8. New constructions
85
Q

Describe Hotel REITs

A
  1. Similar to healthcare REIT’s, cannot self operate and have tax advantages
  2. Rent is major part of a hotels operating cash flow, this part enjoys the tax related discount
  3. Exposed to business cycle and global macro trends
  4. Occupancy rates, location, trends, margins
  5. RevPAR - revenue per available room
86
Q

Describe diversified REITs

A
  1. Own and operate more than one type of property
  2. Lower risk due to Diversification
  3. Management experience
  4. Property type
  5. Local market PRESENCE
87
Q

Which type of REIT is most sensitive to Retail Sales Growth

A
  1. Shopping/Retail

2. Industrial

88
Q

Which type of REIT is most sensitive to Job Creation

A
  1. Office

2. Hotel

89
Q

Which type of REIT is most sensitive to Population Growth

A
  1. Residential
  2. Health care
  3. Storage
90
Q

Which type of REIT is also sensitive to Job Creation

A
  1. Shopping / Retail
  2. Residential
  3. Storage
91
Q

Which type of REIT is also sensitive to New Space Supply vs Demand(H2O)

A
  1. Health care
  2. Hotel
  3. Office
92
Q

Which type of REIT is also sensitive to Population Growth

A
  1. Industrial
93
Q

Which type of REIT has 5-25 year lease terms

A
  1. Office

2. Industrial

94
Q

Describe NAVPS of a REIT

A

Market based values

  1. The per share excess value of the assets over liabilities.
  2. Based on current market values not book value.
  3. Difference between NAVPS and REIT.
95
Q

How to use forecasted cash net operating income to estimate NAVPS

A
  1. Obtain NOI by adding G&A to REIT EBITDA
  2. Determine a cap rate
  3. Calculate property value
  4. Add other Tangible assets
  5. Subtract liabilities

= NAV REIT

NAVPS = NAV / (shares outstanding)

96
Q

Describe Funds From Operations

A
  1. FFO Adjusts reported earnings.
  2. Measures continuing operating income.

Accounting Net Earnings
+ Depreciation & Amortization
- Gains from sales
+ Losses from sales

= Funds from Operations

(similar to CFO)

97
Q

Describe Adjusted Funds from Operations

A

Extends FFO to represent current economic income

  1. Also known as cash available for distribution.
  2. Also known as funds available for distribution.

FFO (funds from Operations)
- Non cash (straight line) rent adjustment
- Recurring maintenance type Capex and leasing commissions
= AFFO (adjusted funds from Operations)

AFFO is considered a better measure of economic income than FFO because it consider CapEx

AFFO relies on estimates, considered more subjective than FFO

98
Q

Name 3 ways to value REITs

A
  1. Net Asset Value
  2. Relative, Price to FFO, Price to AFFO
  3. DCF
99
Q

Explain the private and public view of REIT NAV

A

Public price for NAV tends to be higher than value to private investors

REIT’s tend to trade at Premium to NAVPS

Value investors buy REIT at lowest price premium to NAV

100
Q

Give 3 factors that impact Price to FFO and Price to AFFO

A
  1. Growth expectations
  2. Risks inherent in the underlying
  3. Risks related to firm Leverage and access to capital
101
Q

Explain why DCF and DDM is appropriate for REITs

A
  1. REIT’s and REOCs pay dividends
  2. DCF and DDM used in the same way as for stock valuation
  3. Two or three stage DDM models
  4. For DCF use intermediate cash flows and forecast Terminal value
102
Q

Give the value of a REIT share using DCF and DDM type model

A

Value of REIT share = PV (dividends for years 1 to n) + PV (Term Value n)

103
Q

Describe AFFO

A 
Adjusted Funds From Operations =
FFO
- Non-cash (straight line) rent adjustment
- Recurring maintenance and commissions
= AFFO (adjusted funds from Operations)
104
Q

Describe Price to FFO to value NAV per share

A
  1. FFO per share = FUNDS FROM OPERATION ÷ Shares outstanding
  2. Obtain NAV per share from FFO per share using sector Price to FFO ratio

NAV per share = FFO per share x (sector multiple) Price to FFO

105
Q

Describe how to obtain NAV per share from Price to AFFO

A
  1. AFFO per share =

[FUNDS FROM OPERATION

  • Non cash rents
  • Recurring MAINTENANCE]

÷ Shares outstanding
= AFFO per share

  1. Obtain NAV per share from AFFO per share using sector Price to AFFO ratio

NAV per share = AFFO per share x (sector multiple) Price to AFFO

106
Q

Give 5 adjustments in the sales comparison approach to real estate valuation

A

Compare CLAMS

Condition
Location
Age
Market regime
Size
107
Q

Give 4 items to include / exclude from Operating Expense in NOI calcs

A

Exclude Income TAX & finance:

  1. Finance costs
  2. Income tax
  3. Personal expenses

Include Property TAX

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