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Real estate value


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Real estate is "property consisting of land and the buildings on it, along with its natural resources such as crops, minerals, or water; immovable property of this nature; an interest vested in this; (also) an item of real property; (more generally) buildings or housing in general. Also: the business of real estate; the profession of buying, selling, or renting land, buildings or housing

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Real estate value

  1. 1.  Real Estate Value  Real Estate Principles: A Value Approach
  2. 2. Outline ● Investment risk ● Time­value­of­money ● Internal rate of return ● Determining the discount rate ● Appraisal
  3. 3. Investment and risk: A classical view ● Investment is about involving costs (cash outflows)  now for the sake of future benefits (cash inflows). ● Investment risk is about uncertainty.  This  uncertainty comes from two possible sources: (1)  costs can be uncertain, and (2) benefits can be  uncertain. ● Examples of uncertain costs: (1) renovating an aged  house frequently leads to cost overrun, and (2)  developing a subdivision may be surprised by soil  contamination. ● Question: should high costs, in equilibrium, lead to  high benefits (returns)?
  4. 4. The spectrum of risk (Exhibit 14-10)
  5. 5. Calpers loses big on land deal ● “Calpers, a $244 billion fund, did its first  undeveloped land deal in 1994 and today has 7  partners for such deals and investments in more  than 12 states.” ● Some deals filed for bankruptcy. ● “Land can loss value quickly because there are fewer  other ways to generate income form it.” ● Source: WSJ, May 01, 2008.
  6. 6. The spectrum of cost uncertainty
  7. 7. The spectrum of CF uncertainty
  8. 8. Risky hotels ● “Heading into an economic downturn, hotels are  often among the first industries to suffer as travel  slows and room rates weaken.” ● “Lodging analyst Smedes Rose estimates Marriott is  trading at 17 times its expected earnings per share  this year.  It traded as high as 30 times a year ago.” ● Source: WSJ, Apr. 30, 2008.
  9. 9. Definitions ● Investment­grade (vs. speculative­grade) properties:  commercial properties that are large (values  generally well over $10 million), relatively new,  located in major metropolitan areas, and fully  leased. ● Alternatively, properties can be grouped into class A  (new to newer quality construction in prime to good  locations), class B (aging properties in good to  average locations), and class C (older properties  with functional inadequacies and/or marginal  locations)
  10. 10. 2 notions of RE values ● Investment value:  value to a particular individual  (e.g., NPV): Chapters 18 & 19. ● Appraised value:  value to a “typical” investor, or  probable selling price: Chapters 7 & 8.
  11. 11. Investment cash flows Cash Flow at Sale Cash Flow From Operations Initial Cost
  12. 12. Discounting cash flows ● The fundamental, economic value of a real  investment is the sum of discounted future cash  flows. ● A dollar in the future is worth less than a dollar  today.  One of the main reasons for this is inflation. ● Net present value (NPV): the difference between  fundamental value and initial costs. ● If a real estate investment has a positive NPV, the  investment project should be accepted.
  13. 13. Internal rate of return ● In addition to fundamental value, practitioners often  obtain estimates of the internal rate of return (IRR).   The IRR is also known as the “investment yield” or  the “total yield” in the RE industry.  ● If the IRR is higher than the required IRR (the  benchmark), the investment project is accepted.
  14. 14. Cost of equity ● For publicly traded stocks, the cost of equity is  estimated by using an asset pricing model, say the  CAPM.   ● For private RE investment, it is harder to infer the  cost of equity from public market data.   ● One possible way to estimate this required rate of  return is to identify the return investors could  typically earn on real estate investments of similar  risk via a survey.
  15. 15. Going-in IRR ● An investor’s required going­in IRR = risk­free rate  + required risk premium. ● The required risk premium is higher when the  investment has higher risk (risk­return tradeoff).   Investment­grade properties usually require a risk  premium of 4­8%. ● Note that the notion of going­IRR is usually stated as  “before­tax.”  The reason for being before­tax  because before­tax cash flows are used for  appraisals. ● See Exhibit 18­5, p. 493 for range and average  going­in cap rates.
  16. 16. Going-in IRR example ● Suppose that Hill Inc. is thinking about investing in  an investment­grade office building in Manhattan.   The investment horizon is 10 years.  The return for  investing in T­bonds with a maturity of 10 years is  5%.  Given the perceived investment risk, Hill Inc.  estimates that the required risk premium for  investing in this building is 6%.  What is the going­ in IRR? ● Going­in IRR = risk­free rate + required risk  premium = 5% + 6% = 11%. 
  17. 17. Appraisal ● Appraisal provides an estimate of the most  probable selling price of a property.  This  estimation provides valuable information to the  seller and potential buyers of the property.   ● The ask price and bid prices are often established  around the appraisal value.
  18. 18. Thank You... Michael S Robinson Utah(CEO and President) Phone No: 1-916-473-4155 Fax : 877-866-1906 Email : Address : 8880 Cal Center Dr Suite 1000 Sacramento, CA 95824 Contact Me