Study Session 13 - Alternative Investment and Commodities Flashcards
what is the value of an equity investir’s interest
value of the property less the outstanding debt
what are the dimensions in real estate investment
1st dimension: debt or equity investment
2nd dimension: private or public market
debt/private: mortgage
debt/public: MBS
equity/private: direct investment
equity/publuc: REIT and REOC
advantage of public real estate investment
more liquid and enable investors to diversify by participating in more properties
Real Estate Characteriatics
Heyerogeneity High unit value Active management High transaction costs Depreciation and desirability Cost and availability of capital Lack of liquidity Difficulties in determining price
Differences between residential and non-residential
Residential: single-family (owner-occupied) homes and multi-family properties, such as apartment. Residential real estate purchased with the intent to produce income is usually considered commercial real estate property
Non-residential real estate incluses commercial properties, other than multi-family properties, and other properties such as farmland and timberland
Reasons to invest in real estate
Current income Capital appreciation Inflation hedge Diversification Tax benefits
Principal risks in real estate
Business conditions New property lead time Cost and availability of capital Unexpected inflation Demographic factors Lack of liquidity Environmental issues Availability of information Management expertise Leverage
variables that influence Office property
and
differences between gross and net lease
Demand is heavily dependent on job growth, especially in industries that are heavy users of office space like finance and insurance
In a gross lease, the owner is responsible for the operating expense, and in a net lease the tenant is responsible
variables that influence industrial properties
demand is heavily dependant on the overall economy. demand is also affected by import/export activity of economy
variables that influence retail properties
and
what is percentage lease
Demand is heavily dependent on consumer spending
Retail tenant are often required to pay additional rent once sales reach a certain level
Valuation approches in real estate
Cost approach
sales comparison approach
income approach
Premise of the cost approach
buyer would not pay more for a property than it would cost to purchase land and construct a comparable building
Because of the difficulty in measuring depreciation and obsolescence, the cost approach is most useful when the subject property is relatively new
Premise of the sales comparison approach
buyer would pay no more for a property than others are paying for similar properties
Most useful when there are a number of properties similar to the subject that have recently sold, as is usually the case with single-family homes
Premise of the income approach
value is based on the expected rate of return required by a buyer to invest in the subject property
Implied land value
Value when completed
- construction cost
____________________
Implied land value
valuation methods in the income approach
Direct capitalization: value is based on capitalizing the FIRST YEAR NOI of the property using a capitalization rate
Discounted cash flow method: value is based on the present value of the property’s future cash flow using an appropriate discount rate
NOI Calculation
Rental income if fully occupied \+ Other income = Potential Gross income - Vacancy and collection lost = Effective gross income - Operating expense = NOI
Cap rate
Discount rate - Growth rate
or
NOI1 / Value
if the cap rate is unknown, it can be derived from recent comparable transactions as follows:
NOI1 / Comparable sales price
What is all risks yield (ARY)
Rent divided by comparable sales
Then we can use the rate to calculate the value: Rent1 / ARY
When tenant are required to pay all expenses, the cap rate can be applied to rent instead of NOI
Gross Income Multiplier
Sales price / Gross income
Value = Gross income * Gross income multiplier
Using the DCF method requires the following estimates and assumptions:
Project income fron existing lease lease renewal assumptions Operating expenses assumptions Capex assumptions Cacancy assumptions Estimated resale assumptions Appropriate discount rate (>mortgage rate)
Steps involved in applying the cost approach
1- Estimate the market value of the land
2- Estimate the building’s replacement cost
3- Deduct depreciation including physical deterioration, functional obsolescence, locational obsolescence, and economic obsolescence (also: effective age/economic life)
Appraisal-Based Indices return calculation
(NOI-Capital expenditire+(end value - beg market value))/ beg market value
Appraisal-based indices vs actual transactions
Appraisal-based indices tend to lag actual transactions because actual transactions occur before appraisals are performed. The lag tends to smooth the index; reduce its volatility and correlation with other assets
Transaction-based indices
Repeat-sales index: relies on repeat sales of same property
Hedonic index: requires only one sale then a regression is developed
Debt service coverage ratio
first year/NOI
Loan-to-value
loan amount/ appraisal value
Equity dividend rate
first year cash flow / equity
Convenience yield
the monetary benefit from holding a physical commodity versus being long the equivalent contract
effect of commodities that are expected to be in short supply in the future on the convenience yield
higher convenience yield
the theory of storage page 120
there is a inverse relationship between inventory levels and convenience yield: the higher the level of inventories, the lower the convenience yield will be
Backwardation
Futures price will be lower than the current spot price
Contango
futures price is above the spot price
current futures price of the commodity contract
””””””” with storage cost (U)
”””””””””””””””””””” and convenience yield (Y)
S0 * e^(r*T)
S0 * e^((r+U)*T)
S0 * e^((r+U-Y)*T)
Total return on commodity investment
spot return + roll return + collateral return + rebalancing return
page 126
Roll return calculation
(Ft-1,T - Ft,T) / Ft-1,T
=
(St - Ft,T) / St
When the commidity’s term structure is in backwardination (contango), roll return will be…
positive (negative)
