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Real Estate 101 - UCLA



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  • 1. Real Estate 101 Introduction to Basic Real Estate Terms and Concepts
  • 2. Summary of Topics
    • What is real estate “value”?
    • Property Types
    • Real Estate Terminology
    • Basic Legal Topics
    • Basic Finance, Investment Terms and Concepts
  • 3. Summary of Topics (Cont’d)
    • Development Outline
    • Major Players/Sources of Capital
    • Size of Domestic Real Estate Markets
    • Career Opportunities
  • 4. What is Real Estate Value?
    • Present Value of Cash Flows
    • Capital Structure Decisions
    • Definition of Market Value
    • Market Value vs. Price vs. Cost
  • 5. Property Types
    • Office
    • Industrial
    • Retail
    • Multifamily
    • Hospitality
    • Institutional
    • Mixed use
    • Single Family
  • 6. Real Estate Terminology - Leasing
    • In-Place vs. Market Rents
    • Expense structures
      • Triple Net (NNN)
      • Expense Stops
      • Full Service
    • Vacancy
    • Absorption
    • Sublease Space
    • “Phantom Space”
  • 7. Leasing Terminology (Cont’d)
    • Tenant Improvements (“TI allowance”)
    • Leasing Commissions
      • Both in-house and external brokerage fees
    • Concessions
      • Free rent, excess TI over the “building standard allowance” moving expenses, etc.
      • Calculation of “effective rent” – straight line, PV equivalent of the rental stream over the term of the lease
  • 8. “Per Unit” Terminology
    • Real estate is measured, costed, and leased on a “per unit” basis
      • Construction cost per square foot
      • Land price per square foot of building area
      • Leases are quoted per unit as well
    • Unit definition depends on the property type
      • Retail, office, industrial – per square root
      • Multifamily – per apartment
      • Hospitality – per “key” (ie, per room)
  • 9. Office Terminology
    • Gross, rentable and usable area
    • Floor to ceiling heights
    • Floor Area Ratio – “FAR”
    • “ Skin” – external curtain wall/façade materials
    • Property types:
      • Low, mid and high rise; CBD vs. suburban
      • Build to suit
    • Office leases – quoted annually, all structures depending upon market convention
    • Parking ratio zoned as spaces per 1,000 sq.ft. of space
  • 10. Industrial Terminology
    • Gross, rentable and useable area
    • “Clear Height”
    • Dock doors
    • Types:
      • Warehouse/distribution, flex/R&D, hybrid
    • Industrial leases quoted both monthly and annually, NNN
  • 11. Terminology - Retail
    • Types of Shopping Centers
      • Strip, neighborhood, grocery-anchored, power centers, regional and super regional malls
    • Common Area Maintenance Charges
    • 1, 3, and 5 mile “trade areas”
    • Anchor Tenants
      • Anchors are the “draw” for the center
    • In-line Tenants
      • In line tenants subsidize the anchors
    • Leases quoted annually, hybrid with “CAM” charges
  • 12. Terminology - Multifamily
    • Type:
      • Garden, midrise, highrise
      • Condominium, coop
    • Base rent plus additional tenant charges
    • Repositioning
    • Unit Turnover
  • 13. Hospitality – Operating Business Using Real Estate
    • ADR
    • REVPAR
    • Departmental Profitability
    • Gross Operating Profit
    • Flagged vs. Independent
    • Type
      • Limited service, full service, luxury, resort
      • Other subsets exist as well
  • 14. Basic Legal Concepts
    • Ownership = Control over “bundle of rights”
    • Transfers of Ownership
    • Types of Legal Interests
      • Possessory vs. Non-Possessory
      • Fee Simple
      • Leasehold
      • Easements
  • 15. Basic Legal Concepts (Cont’d)
    • Title
    • Purchase and Sale Agreements
      • Escrow
      • “Go Firm”
      • Closing
      • Types of deeds, importance of recording
    • Mortgages
    • Promissory Notes
  • 16. Legal (Cont’d)
    • Deeds of Trust
    • 1 st Lien – Secured vs. Unsecured
    • Guarantees
    • Defaults – Monetary vs. Technical
    • Foreclosures
    • “Deed in Lieu”
    • Deficiency Judgment
  • 17. Finance and Investment Terms: The Operating Statement
    • Revenue
    • Actual vs Gross Potential
    • Vacancy Allowance
    • Gross Effective Income
    • Operating Expenses
    • Replacement Reserves
    • Net Operating Income
    • Debt Service
    • Capital Expenditures
    • TI, Commissions, and other Capex
    • Before Tax Net Cash Flow to Equity
  • 18. Finance and Investment Terms – Debt Financing
    • Loan to Value (LTV)
    • DCR
    • Spread
    • Interest Rate
    • Amortization vs. Maturity
    • Discount Points
    • Prepayment Points
    • Types of Debt
    • Private vs. Public Debt Markets – CMBS
    • Private vs. Public Equity Markets - REITs
  • 19. Finance and Investment Terms: Return Analysis – Three Critical Components
    • Initial Investment Amount
    • Cash Flow “pro forma” over the holding period
    • Exit or Terminal Value
  • 20. Finance and Investment Terms: Return Analysis (Cont’d)
    • Leveraged vs. Unleveraged Returns
    • Yields
      • “ going-in” yield
      • “ free and clear “ yield
      • “ cash on cash” yield
      • in place vs. stabilized yield
    • Capitalization Rates
      • WACC
      • Real rate + risk, inflation, and recapture premiums
    • Discount Rates
  • 21. Finance and Investment Terms: IRR
    • Use DCF analysis to calculate internal rate of return
      • Return to investment over a holding period
    • Also, use DCF to conduct sensitivity analysis
      • Test level of risk in your pro forma assumptions
    • Partitioning the IRR
      • How much of your return comes from cash flow versus “residual” value?
      • Helps assess the risk in achieving the IRR – or, is your IRR requirement a good match with the level of risk in the property?
  • 22. Finance and Investment Terms: Assumptions
    • General Economic Conditions
    • Rental Rate Growth
    • Occupancy
    • Exit Cap Rates
    • Loan Underwriting Parameters
      • LTV and DCR ratio tests
    • Year of Exit
  • 23. Finance and Investment Terms: Deal Structure
    • Use of Tax Efficient Forms of Ownership
      • Partnerships
      • LLC’s
      • Syndications
      • REITS and UPREITS
    • Preferred Returns
    • Promotes
  • 24. Finance and Investment Terms: Analysis of Tax Benefits
    • “ Interest Expense Deductibility
    • Depreciation
    • Loss Carryforwards
    • Must demonstrate “substantial economic effect” to use tax deductions
  • 25. Development Issues
    • Supply and demand constraints
      • Urban economic analysis
      • Understanding when the market is ripe for new development
      • Understanding what the tenants want - and will pay for - is critical
      • Lag times for bringing property to completion
    • Zoning and Entitlements
    • Financing Issues and capital market constraints
    • Renovation and Repositioning
  • 26. Major Equity Players and Capital Sources
    • Pension Funds
      • Direct Investments
      • “ Core” Funds
      • Opportunity Funds
      • Separate Account Allocations
      • Advisors
    • Equity REITS
    • Life Companies
    • Foreign Investors
    • Individuals, Syndications and Partnerships
  • 27. Major Player/Capital Sources: Equity:
  • 28. Major Player/Capital Sources: Debt
  • 29. Growth of MBS Market
  • 30. Creation of MBS – Fannie Mae MBS Creation
  • 31. Mortgage Pass Through from Pooled – Investment Characteristics
    • Cash Flows
      • Interest
      • Principal
      • Unscheduled principal (PREPAYMENT)
    • Risks
      • Basic FI (bond) risk – time value, reinvestment
        • Mitigate default and payment timing risk through pool insurance issued by Ginnie, Fannie, and Freddie
      • Prepayment – easier to predict prepayment across a pool
        • (think insurance: life, auto, flood, health, etc. – law of large numbers)
    • Additionally, pooled “creature” now divisible into MBS securities
  • 32. Mortgage Pass Through Securities – Benefits created
    • Default and payment timing risk (receiving both P&I timely) mitigated by pool insurance supplied by Ginnie, Fannie, Freddie
    • Prepayment risk still exists (total prepayment risk unchanged) but becomes easier to predict across the entire pool
    • Adds liquidity to the investment through creation of “small pieces”
      • This is different from adding liquidity to primary mortgage market that we’ve been talking about
  • 33. Ginnie Mae (GNMA)
    • Oldest; started making MBS in 1970
    • Ginnie pools contain only government insured mortgages (primarily FHA and VA)
    • Ginnie pass-through securities are fully modified
      • Fully modified means security holder will receive full and timely payment of P&I regardless of payment pattern on underlying mortgage
    • 2002 single family conforming limit up to $300,700 from $203,000
      • Increased to match Fannie and Freddie
  • 34. Fannie Mae (FNMA) : General
    • Quasi-private
      • Not a government department or entity
      • Guarantee does not carry “full faith and credit of U.S. Government”
      • Freddie has ability to request “emergency funding” from the U.S. Treasury
    • Like Ginnie, Fannie guarantees timely payment of P&I fro all securities it issues
    • Unlike Ginnie, Fannie securitizes conventional mortgages (mortgages that do not have government insurance) and seasoned (older) FHA/VA mortgages
    • On the web at
  • 35. Freddie Mac (FHLMC) : General
    • Very similar to Fannie
    • Created to securitize conventional mortgages and seasoned non-conventionals
    • Wide variety of pool types
      • Bi-weekly mortgages
      • High LTV mortgages
    • On the web at
  • 36. Fannie & Freddie loan limits – Definition of Conforming Loans
  • 37. Private MBS issues – NOT Ginnie, Fannie or Freddie
    • Private MBS issues account for about 11% of total market
    • Private MBS market primarily for non-conforming loans, i.e., loans that Fannie, Freddie or Ginnie cannot accept
      • Jumbos (greater than $300,700 (2002))
      • No-docs or limited doc
  • 38. MBS Pass-Through Wrap-up
    • Concept – MBS pass-through is an ownership share of an underlying mortgage pool where each security receives a pro-rata share of both the P&I paid by the underlying mortgages
      • Are there any questions on this?
    • Particulars – modeling the cash flow is essentially modeling N mortgages with the prepayment option explicitly included in the cash flows
      • Are there any questions on the MBS cash flow spreadsheet everyone now has?
  • 39. Problems with MBS Pass-Throughs
    • Unknown maturity
        • Difficult to hedge, difficult to include in a traditional FI portfolio
    • Negative Convexity
      • Convexity (as you know) is the curvature in the price/yield relationship for a FI instrument
        • Convexity means that a drop in rates leads to a more than linear increase in price, and an increase in rates leads to a less than linear decrease in price : convexity is a good thing
        • Negative convexity is not a good thing for a FI instrument
          • Rate declines lead to PP and reinvestment problems, market knows this and value suffers on rate declines
          • Rate increases don’t lead to PP, but they then hurt the FI component (fixed future cash flows)
    • Both problems stem mainly from prepayment
  • 40. Source of MBS problems
    • Primarily Prepayment
    • Related issue is the fact that every pass-through share gets both principal and interest
      • Early prepayment
        • good thing in terms of getting money back sooner (good in terms of principal),
        • bad in that interest flow stops (bad in terms of interest)
      • Late prepayment
        • bad because you wait longer for money to return (bad in terms of principal)
        • good in that interest flow continues longer (good in terms of interest)
  • 41. Financial Innovation in the MBS Market Lecture Map
    • IOs and POs (basic strips)
      • Break apart the payment stream into interest and principal – increase predictability of price reaction to rate changes
    • CMOs
      • Increase maturity certainty (tranche creation)
      • Parcel out or concentrate prepayment risk and interest rate risk
        • Freddie Mac Multiclass Certificates, Series 2468
  • 42. OAS – Calculating PV for a Path
  • 43. What is a REIT?
    • Owns, and in most cases operates, income-producing property (Equity REITs)
      • Office
      • Apartment
      • Retail (shopping centers)
      • Hotels
      • Warehouses (storage)
    • Some REITs also finance real estate (Mortgage REITs)
    • REIT shares trade on major exchanges
      • Debt (bonds) are also publicly traded
  • 44. Where did REITs come from?
    • Created in 1960 (act of Congress) as a way to make property investment available to individual investors
      • Offer expert management and familiar corporate governance structures (BOD)
        • REIT trivia – original REIT act was an amendment to an Act regarding excise taxes on cigars
    • REITs make equity interest in commercial property:
        • Divisible into shares that can be purchased by small investors
        • LIQUID – the shares trade on major exchanges
  • 45. How Many REITs are there?
    • About 300, ≈ 2/3 of which are publicly traded
      • 149 on NYSE
      • 27 on American
      • 12 on NASDAQ
    • Total REIT assets ≈ $300 billion
  • 46. Types of REITs
    • Equity REITs
      • Own and operate income-producing real estate
      • Perform leasing, development, and construction activities
        • 151 publicly traded equity REITs
    • Mortgage REITs
      • Hold mortgages on real property
        • Make mortgages (lend money), usually on existing property
        • Buy mortgages
        • 22 publicly traded mortgage REITs
    • Hybrid REITs
      • Both own properties and make loans
        • 9 publicly traded Hybrid REITs
  • 47. Types of REITs – more detail (source: NAREIT)
  • 48. REIT Structures – UPREITs and Traditional REITs
    • UPREIT (Umbrella Partnership REIT)
      • First UPREIT was Taubman Realty IPO in 1992
      • UPREIT structure created to shield owners contributing real estate assets to the REIT from capital gains taxes on contributed property
        • Transfer is then partnership shares for partnership shares, and this is not a taxable event for the owners
      • UPREIT owns a controlling interest in a limited partnership that owns the real estate, as opposed to a traditional REIT structure in which the REIT owns the real estate
      • The Umbrella Partnership “shares” – known as operating partnership units, or OP units – are convertible into REIT shares and enjoy voting rights and dividends just like REIT shares
        • Convertibility allowed after one year, and triggers taxes
  • 49. REITs and Taxes
    • REITs do not have to pay federal taxes at the corporate level
      • More specifically, REITs are allowed to deduct dividends paid to shareholders from taxable income, and thus have the ability to shield 100% of taxable income through distributions to shareholders
        • No other firm in the economy can deduct dividends
      • REIT shareholders still have to pay taxes on dividends and capital gains
      • Most states honor the REIT status and don’t require REITs to pay state taxes
  • 50. Career Opportunities
    • Construction
    • Development
    • Property Management
    • Leasing Brokerage/Tenant Rep
    • Asset Management
    • Consulting
    • City Planning/Economic Community Dev.
  • 51. Career Opportunities (Cont’d)
    • Investment Management (institutional and family office)
    • Equity Funds
    • Commercial Banking
    • Mortgage Brokerage and Placement
    • Institutional Brokerage
    • Investment Banking