3.5 Real Estate Equity Flashcards
(50 cards)
Steps in the RE development process
1) Purchasing land/building
2) Estimating projects expected profits and potential interests from buyers/renters
3) Designing the building structure/improvements
4) Getting public approvals/permits
5) Acquiring financing
6) Building/remodeling the structure
7) leasing/selling the property
Real option is what type of option? 3 types of real options?
An option on a real asset.
3 types: option to buy and asset, option to sell a real asset, option to exchange non-cash assets
What is a fair investment?
Investment with an expected value of zero
What is a decision node?
Point in a decision tree when a decision is made
What is an information node
Point when new information is revealed that may affect future decisions
Backward induction?
Start from the final nodes and go to the earlier nodes one step at a time and decide to accept or not accept the project at the first node
5 common approaches to valuing private commercial real estate equity
1) comparable sale price approach
2) profit approach
3) cost approach
4) income (discounted cash flow) approach
5) Multi-factor transaction based approach
When and how is comparable sales price approach used?
Non income producing real estate properties are compared to comparable recently sold properties
When using the comparable sales approach is not viable due to limited recent, comparable real estate transactions, alternative approaches may be used based on one or both of two components:
- The structure’s replacement costs.
- The site’s estimated market value for its most profitable use.
When is cost approach used?
Typically used to value new structures and in market with substantial new construction
CAP Rate formula, description of inputs
NOI / Property Value
NOI = normalized, annual cash flow IGNORING financing cost
Property value = market value
When were CAP rates higher and lower?
Higher: mid 90s & 2002
Lower: pre 2007 GFC and 2021
Pros / cons of income approach valuation?
Pros: value property’s unique characteristics
Cons: needing to estimate a discount rate and exposures to errors in forecasting cash flows
Description of transaction based real estate valuation methods?
Use large data sets of property transaction prices in a specific time period to determine value based on MULTIPLE factors
When transaction-based valuation methods may serve as a reliable basis for real estate valuation?
As long as the following holds:
- They are applied using adequate data and rigorous econometric methods.
- Differences among the properties are modeled well.
- Statistical noise in the data is minimized.
The two main transaction-based valuation methods are
1) repeat-sales
2) hedonic pricing methods
Pros / cons of appraisal over transaction based models?
Pros:
1. They do not suffer from a small sample size bias.
2. All properties can be appraised frequently and by several experts (although this would be costly)
Cons:
1) Appraisals are subjective and backward-looking
2) Properties in appraisal-based real estate price indices are not reappraised as often as the index is reported (appraisals performed annually).
3) Values of appraisal-based indices are smoothed
4) Quality of the appraisal depends on the relevance and quality of available data.
What is stale appraisal effect?
Errors due to using dated appraisals, which contributes to the lagged price changes in appraisal-based indices.
NCREIF Property index (NPI) characteristics?
Popular, large, value weighted index published QUARTERLY based on UNLEVERAGED commercial property appraisals
7500 properties, total value $600 billion
1977 started
How is NPI calculated?
Each quarter the price of property is calculated AS IF it was sold at begging of quarter appraised value and then sold at the end of quarter appraised value
If property is sold, its price is used.
Calculated as if bought for 100% equity and on a PRE-TAX basis
How is NPI total return calculated?
NPI return = income return + capital value return
Income return = NOI / Property value (beginning appraised value adjusted for improvements, reinvestments and sale)
Capital value = change of property value
UK alternative to NPI
Investment Property Databank (IPD) available monthly and annually
NCREIF’s hedonic index that uses transaction data from NCREIF database?
Transaction based index (TBI)
Net operating income formula
NOI= Effective gross income - Operating expenses
OR
[Potential gross income X (1-Vacancy loss rate) ] - (fixed + variable expenses)
