Lecture One: Real Estate Investment Decisions (MS PowerPoint)


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Lecture One: Real Estate Investment Decisions (MS PowerPoint)

  1. 1. Real Estate Finance and Investments: Lecture 1 Real Estate Investment Decisions
  2. 2. Investment Analysis <ul><li>Immediate sacrifice; possibility of future awards </li></ul><ul><li>More opportunities than resources </li></ul><ul><li>Incomplete information </li></ul><ul><li>Rank in terms of least expected risks </li></ul><ul><li>Real estate earns presence in financial investing world in 1950’s and 1960’s </li></ul><ul><li>Currently, computerized modeling helps make more informed and risk-hedging decisions in real estate investing </li></ul>
  3. 3. Others Who Invest in Real Estate <ul><li>Institutional Investors </li></ul><ul><ul><li>Pension Funds </li></ul></ul><ul><ul><li>Real Estate Investment Trusts (REIT’s) </li></ul></ul><ul><li>Foreign Participation </li></ul><ul><ul><li>Exchange Rates </li></ul></ul><ul><ul><li>Relative Interest Rates </li></ul></ul>
  4. 4. Why Invest in Real Estate? <ul><li>TWO FORMS OF VALUE AND RETURN TO INVESTING IN REAL ESTATE: </li></ul><ul><li>Periodic Cash Flow </li></ul><ul><li>Market Appreciation / Equity Build </li></ul>
  5. 5. Why Invest in Real Estate? <ul><li>Price Determined By: </li></ul><ul><li>Amount and timing of anticipated cash flows </li></ul><ul><li>How much will be received, and when </li></ul><ul><li>Degree of confidence with which expectations are held </li></ul><ul><li>Investors’ tolerance for bearing risk </li></ul><ul><li>Attractiveness of alternative investment opportunities </li></ul>
  6. 6. Basic Types of Real Estate <ul><li>Residential </li></ul><ul><ul><li>Multi-Family, Single-Family </li></ul></ul><ul><li>Commercial </li></ul><ul><ul><li>Land (All Types) </li></ul></ul><ul><ul><li>Retail </li></ul></ul><ul><ul><li>Agricultural / Industrial </li></ul></ul><ul><ul><li>Office </li></ul></ul><ul><ul><li>Special Purpose </li></ul></ul>
  7. 7. Types of Investors <ul><ul><li>Passive </li></ul></ul><ul><ul><ul><li>Can make NO operating decisions </li></ul></ul></ul><ul><ul><li>Active </li></ul></ul><ul><ul><ul><li>Make operating decisions of the underlying assets </li></ul></ul></ul><ul><ul><li>Equity </li></ul></ul><ul><ul><ul><li>Purchasing asset for expected cash flows and market appreciation </li></ul></ul></ul><ul><ul><li>Debt </li></ul></ul><ul><ul><ul><li>Purchasing debt for expected streams of income (interest from debt service) </li></ul></ul></ul>
  8. 8. Types of Investors (examples) Debt (streams of interest) Equity (cash flow & apprec.) Active (makes operating decisions) Passive (makes no operating decisions) Shares in real estate corporation Limited partnership shares Equity REIT Pass-through certificates Mortgage REIT’s MBS’s – Residential and/or Commercial Direct ownership of rental property; purchase or development Loan Origination; Construction Lending Permanent loans Loan purchases on secondary mortgage market
  9. 9. Performance of Real Estate Investments <ul><li>Data sparse and contradictory </li></ul><ul><ul><li>Yield indices computed quarterly by appraisal estimates </li></ul></ul><ul><ul><li>Indicators smoothed; eliminates true measure of volatility </li></ul></ul>
  10. 10. CREF’s and REIT’s <ul><li>Commingled Real Estate Fund (CREF) – “Real Estate Pension Fund of the 1970’s” </li></ul><ul><ul><li>CREF acquires real estate and monitors its operation on behalf of institutional investors </li></ul></ul><ul><ul><li>Brueggeman, Chen, Tibodeau: Real estate outperformed S&P 500 and Ibbotson Assoc between 1972 – 1983. After adjusting for risk, real estate found to be better on yields. </li></ul></ul><ul><ul><li>Gilberto compared 1,200 large REIT’s w/ S&P’s 500 for 1978-1989; found advantage shifted to common stocks </li></ul></ul>
  11. 11. Real Estate Finance and Investments: Lecture 1 Key Definitions and Concepts
  12. 12. Market Value <ul><li>Most probable price at which a property would sell for in a competitive market as of a specific date , had it been exposed to the market for a reasonable time prior to that date. </li></ul><ul><li>--The Appraisal Institute </li></ul><ul><li>--Informed Buyers/Sellers </li></ul><ul><li>--No Duress Situation </li></ul>
  13. 13. Most Probable Selling Price <ul><li>Most likely price at which a property will sell, given the market conditions then prevailing and the financing arrangements available </li></ul><ul><li>--Used in determining Transaction Range </li></ul>
  14. 14. Transaction Range <ul><li>Price range within which a transaction can occur and leave both the buyer and the seller better off than before (win-win situation) </li></ul><ul><li>Lower End: Present owner’s investment value </li></ul><ul><li>Higher End: Prospective Buyer </li></ul>
  15. 15. SELLER Perspective V p V s $490,000 $475,000 Most Probable Selling Price > Minimal acceptable price to Seller Most Probable Selling Price (market set) Minimum Acceptable Price to Seller
  16. 16. BUYER Perspective V b V p $510,000 $490,000 Maximum acceptable price to Buyer > Most Probable Selling Price Maximum Buyer will Pay Most Probable Selling Price (market set)
  17. 17. Transaction Range V b V s $510,000 $475,000 Maximum Buyer will Pay Minimum Acceptable Price to Seller
  18. 18. Investment Value <ul><li>Worth to a present or specific prospective owner; unique to the individual and need not be closely related to most probable selling price </li></ul><ul><li>Reflects an investor’s assumptions about the asset’s future ability to produce revenue, about the likely holding period, selling price, tax consequences, available financing, etc. </li></ul>
  19. 19. Real Estate Finance and Investments: Lecture 1 Investment Decision Process
  20. 20. <ul><li>EQUITY INVESTOR </li></ul><ul><li>DEBT INVESTOR </li></ul>
  21. 21. Steps in Investment Decision Process <ul><li>Estimate the stream of expected benefits </li></ul><ul><li>Adjust for timing differences among expected streams of benefits flowing from investment alternatives </li></ul><ul><li>Adjust for differences in perceived risk associated with the alternatives </li></ul><ul><li>Rank alternatives to the relative desirability of perceived risk-return combinations they embody </li></ul>
  22. 22. Value of Expected Benefits Stream <ul><li>Benefits expected to be received in the far distant future add less to a property’s investment value than do those whose anticipated receipt is more imminent. </li></ul><ul><ul><li>Time Value of Money </li></ul></ul><ul><ul><li>Expected benefits: Periodic Cash Flow, Future Sale (market appreciation recognized) </li></ul></ul><ul><li>Investment Value = Present Value of Equity Position PLUS Present Value of the Debt Position </li></ul>
  23. 23. Investment Decisions <ul><li>Purchaser’s investment value > acquisition cost = Increase in Purchaser’s net worth </li></ul><ul><li>Market Value > Seller’s investment value = Increase in Seller’s wealth position </li></ul>
  24. 24. Real Estate Finance and Investments: Lecture 1 Investor Objectives and Risk
  25. 25. Investor Objectives and Risk <ul><li>Minimize Risk and Maximize Return Potential </li></ul><ul><li>Investors seek financial return as a reward for committing resources and as compensation for risk </li></ul><ul><li>Emotion: Risk takers vs. Risk avoiders </li></ul>
  26. 26. Attitudes Towards Risk Risk Return Risk Neutral Risk Averting Risk Seeking