Overview Of Types Of Real Estate Investment

Question 1

What is the difference between residential and non-residential real estate? What’s the difference between commercial real estate and owner occupied real estate?

Answer 1

• residential RE: homes, apartments, etc
• non-residential RE: office space, shopping centers, etc
• commercial RE: for rent RE
• owner occupied RE: not for rent RE

Question 2

What does capital position mean in RE?

Answer 2

• capital position: describes whether a RE investor is an equity or debt provider

Question 3

What is the different between real estate operating companies (REOC) and real estate investment trusts (REIT)?

Answer 3

• REOC: corporations that manage commercial RE
• REIT: owning or renting properties and/or purchasing mortgages

Question 4

What is the difference between equity investor and debt investor for RE?

Answer 4

• equity investors: have ownership in RE investment
• debt investor: provides funding for RE investment

Question 5

What are 8 unique characteristics of RE that distinguish it from listed equity or fixed income instrument? UHMHDINP

Answer 5

• unique asset: no two RE properties are the same (location, size, price)
• high cost: unit of RE is higher than stocks
• management intensive: requires maintenance, contracting, rent collection
• high transaction costs: buying & selling RE is costly in time & money
• depreciation: RE depreciates every year
• illiquidity: takes time to buy/sell, bid/ask is wider than stocks
• need for debt capital: typically require debt for funding of RE investment
• price determination: hard to determine due to infrequent transactions & unique properties

Question 6

What are 3 main risks of RE investing?

Answer 6

• property demand & supply (eg. business conditions, demographics, RE cycles)
• valuation (interest rate environment, cost & availability of capital, etc)
• property operations (management, leases, etc)

Question 7

What is household formation?

Answer 7

• household formation: change in the number of households from year to year.

Question 8

What is the difference between under supply and over supply for real estate cycles?

Answer 8

• Oversupply: when occupancy and rental rates are low
• Undersupply: when occupancy and rental rates are high

Question 9

What are 5 benefits of RE? PCIDT

Answer 9

• provides current income
• capital appreciation
• inflation hedge
• diversification
• tax benefits

Question 10

What is the difference between gross lease and net lease?

Answer 10

• gross lease: requires the owner to pay the operating expenses (eg. owner pays the property tax)
• net lease: requires the tenant to be responsible for paying operating expenses (eg. tenant pays the property taxes)

Question 11

What is a triple net leases?

Answer 11

• commercial lease where the renter pays rent and utilities as well as three other types of property expenses: insurance, maintenance, and taxes.

Question 12

What is a sale-leaseback?

Answer 12

• sale-leaseback: arrangement in which the company that sells an asset can lease back that same asset from the purchaser.

Question 13

What are 6 things you should examine when doing due diligence on a property?

Answer 13

• market review (eg. Population, growth, etc)
• lease & rent review (review history and rental rate compared to market rate)
• cost of re-leasing (cost to lease again, paying broker money to find tenant or benefits for leasing, etc)
• review documentation (review financial statements, utility bills, etc)
• property inspections & service agreements (maintenance, engineering, etc)
• legal documentation & tax compliance (verify title, zoning, property taxes)

Question 14

What are 2 different types of real estate indexes, describe them.

Answer 14

• appraisal based indexes: indexes based on the appraised value of properties
• transaction based indexes: indexes based on recent transactions of similar properties

Question 15

What’s the formula for total return of property under the appraisal based indexes?

Answer 15

• return = (NOI - CAPex + (ending market value - beginning market value)) / (beginning market value)

NOI = net operating income
CAPex = capital expenditures

Question 16

What are 2 types of transaction based indexes, describe them.

Answer 16

• repeat sales index: repeat sales of the same property
• hedonic index: only one sale of the property, but takes into account property, size, location, etc.

Question 17

What is the main difference between performance for appraisal based indexes and transaction based indexes?

Answer 17

• appraisal index is less volatile and lags a transaction based index

Question 18

What is rollover risk, step up clauses, indexed rent, and overage rent?

Answer 18

-Rollover risk: potential for lost income while searching for a new tenant after the departure of an old one

• Step up clauses: clause that specify defined incremental rent increases at various point, common for land lords who believe their operating costs will increase over term of the lease
• Indexed rent: periodically adjusted based on an observed market variable, such as an inflation index.
• Overage rent: clause allows a retail tenant to pay a relatively low fixed monthly rental rate plus a percentage of sales in excess of a specified amount.

Question 19

What are 3 Factors that motivate investors to hold real estate in their portfolios?

Answer 19

-Long-term stable income
- Ability to hedge against inflation
- Low correlations with returns on traditional assets

Question 20

What is the order of types of real estate investing that go from lowest risk to highest risk?

Answer 20

• Senior Debt (debt like returns & least risky)
• Core (debt like returns & a little more riskier than senior debt)
• Core Plus (equity like returns & a little more riskier than core)
• Value Add (equity like returns & a little more riskier than core plus)
• Opportunistic (equity like returns & a little more riskier than value added)

Question 21

What are the 4 phases in the real estate cycle?

Answer 21

• recovery: economy at lowest, consumer confidence is low, and employment uncertainty is high.
• expansion: rising economic activity and easing credit conditions.
• oversupply: after business cycle has peaked occupancy rates fall, and RE prices & rents level off and may start to decline.
• recession: occupant rate continues to fall, construction slows until interest rates fall.

Question 22

What are 3 property specific risk? MOE

Answer 22

• Management issues: Failure to perform routine preventative maintenance and repair work
• Obsolescence (outdated): Changes in zoning laws and user preferences can cause buildings to become obsolete, requiring owners to undertake significant renovations
• Environmental factors: Geographic and climate-related risks include exposure to floods, earthquakes, and hurricanes.

Question 23

What is gross potential rental income & formula?

Answer 23

gross potential rental income (GPRI): potential gross income that could be generated at current market rents assuming full occupancy.

GPRI = market rent * rentable space

Question 24

What is loss to leases?

Answer 24

• difference between the market rent for a property and the actual rent that’s collected

Question 25

What is gross rental income formula?

Answer 25

GPRI - loss to leases = gross rental income

Question 26

What is net rental income from gross rental income?

Answer 26

Gross rental income - vacancy & collection losses - concessions & other adjustments = net rental income concession & other adjustments: adjustments landlords make to attract tenants

Question 27

What is effective gross income from net rental income?

Answer 27

Net rental income + other income + operating expense recovery = effective gross income other income (eg. parking revenue) operating expense recovery (operating expenses passed to the tenant)

Question 28

What is formula for net operating income from effective gross income?

Answer 28

Effective gross income - operating expenses - property maintenance allowance = net operating income property maintenance allowance (budget for repairs & upkeep of property)

Question 29

What is pre tax cash flow and formula?

Answer 29

- difference between NOI & debt service charge Net operating income property- debt service charge = pre-tax cash flow debt service charge (both the principal and interest components of mortgage payments made during the period.)

Question 30

What is the after tax cash flow and formula?

Answer 30

Pre tax cash flow - taxes paid = after tax cash flow

Question 31

What is formula for taxes owed/paid or tax obligation?

Answer 31

tax rate * (NOI - depreciation expense - interest expense) = tax obligation

Question 32

What is the equity dividend rate or cash on cash return?

Answer 32

equity dividend rate = pre-tax cash flow / (property purchase price-debt financing) property purchase price - debt financing = equity invested

Question 33

What is loan to value and formula?

Answer 33

LTV = debt outstanding/ current property value higher LTV means higher chance of default lower LTV mean lower chance of default

Question 34

What is debt service coverage ratio and formula?

Answer 34

DSC = NOI /Debt service charges DSC = ability to pay/cover its debt with income higher debt service coverage ratio is better lower debt service coverage ratio is bad (could signal it owes creditors more money than it can generate)

Question 35

What are 2 ways to value real estate under the income approach?

Answer 35

- discount cash flow method - direct capitalization method

Question 36

What is the discounted cash flow method in real estate valuation & formula?

Answer 36

Property Value = (NOI / (1+r)^i) + (terminal value/ (1+r)^n)

Question 37

What is the terminal value formula under the discount cash flow valuation method?

Answer 37

Terminal value = NOI (1+g) / r-g capitalization rate (cap rate) = r-g

Question 38

What is formula for the direct capitalization method for real estate valuation under the income approach?

Answer 38

Property Value = expected NOI / capitalization rate Capitalization rate (cap rate) = r -g

Question 39

What is the cost approach for real estate valuation?

Answer 39

- cost approach: based on premise that an investor should not pay more for a property than its replacement cost, replacement cost is defined as the costs that would be incurred to acquire vacant land and produce a building that provides the same utility to users as the current version

Question 40

What is the sales comparison approach of valuation real estate?

Answer 40

- sales comparison approach (aka market approach): estimates a property’s value based on the current selling price of comparable properties

Question 41

What happens to interest rates during recovery, expansion, oversupply, & recessions?

Answer 41

recovery: bottom out, begin to rise expansion: rising oversupply: peak & begin to fall recession: lowest

Question 42

What happens to NOI during recovery, expansion, oversupply, & recessions?

Answer 42

recovery: bottom out, begin to rise expansion: rising oversupply: peak & begin to fall recession: falling

Question 43

What happens to DSC (debt service charge) during recovery, expansion, oversupply, & recessions?

Answer 43

recovery: bottom out, begin to rise expansion: rising oversupply: peak & begin to fall recession: falling

Question 44

What happens to LTV during recovery, expansion, oversupply, & recessions?

Answer 44

recovery: peaks & begins to fall expansion: falling oversupply: bottoms out and begins to rise recession: rising