Flashcards in week 4 Deck (17)

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1

## difference between ex ante and post ante returns

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Ex Post Returns = historic returns used to measure past performance.

Ex Ante Returns = forecast returns used to make investment decisions.

2

## 2 types of return measures

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Holding Period or Periodic Return

Multi-period Return

3

## what is holding period return

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The actual total return earned during the period the asset was held.

Total holding period return (HPR) for real estate consists of two components:

Capital Appreciation

Change in property value

Can be negative

Income

Net rental income

Can be negative

4

##
iii) Why is there a difference in the returns calculated?

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Geometric mean return captures the relationship between each return. Arithmetic mean return calculation does not. Arithmetic return assumes the returns are all independent of each other.

Another way of looking at it is, if you lose 100% of your capital in one year, you don't have any hope of making a return on it during the next year. Therefore investment returns are not independent of each other, so we should use geometric average to calculate the return.

5

## Advantage IRR over TWRR

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With IRR a return can be calculated without having to know the capital value of the investment at intermediate points in time. TWRR needs this information!

More convenient for real estate investments where reappraisal may not be frequent, and can capture timing of returns.

IRR measures the return an investment is generating given the initial outlay

Alternatively: IRR is the discount rate applied to all future cash flows, that when added up exactly equal the initial outlay, i.e. where NPV = 0

6

## disadvantages of irr

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Can be difficult to calculate (need excel or financial calculator)

Has difficulties if cash-flows change from positive to negative to positive during the project life

7

## what is the profability index

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Used as a measure of the return that takes into account scale of the investment (initial outlay)

Ratio of the present value of the future cash-flows to the initial outlay

Also called “benefit-cost ratio”

8

## difference between real and nominal returns

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Inflation – loss of purchasing power over time.

When comparing returns there may be times we need to be looking at REAL returns (adjusted for inflation), rather than NOMINAL (current dollar) returns.

Returns usually quoted nominally (including inflation).

9

## explain capatalisation of revisionary income streams

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Applying a straight cap rate can be unreliable when there are differences between passing & market rents

To account for this we capitalise the income with reversions

Reversions = changes in rental income that are expected when the current lease(s) permit

This is achieved by capitalising the passing rent until the next market review and then capitalised todays market rent from the next review.

10

## explain ranking of investments

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Both NPV and IRR give the same accept/reject decision

However, sometimes they may give conflicting rankings when considering mutually exclusive investments or there is capital rationing

If the investments are of similar risk, 2 factors to consider:

Objectives of the investor (e.g. investment timeframe)

Other uses of the investor’s money

PI:

It is a ratio measure, calculating the returns in proportion to the initial outlay.

Works on assumption smaller outlay project can earn the same IRR

In this example, E is preferred over C due to higher PI

11

## sources of risk

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1. market risk = Drop in demand

Oversupply

Unexpected inflation

2. financial risk = Interest rates

Renewal terms

Insolvency

3 property risk = location, tennants, building

Ratios can give us insight into the performance of property investments.

Enable comparisons with similar (benchmark) properties or historical performance of the actual property

12

## what is WALE

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A major property risk is tenants may not renew their leases

WALE is a risk measure for a multi-tenanted property or a portfolio of portfolios

It gives us a weighted average of the time remaining of all the leases

Longer WALE = lower risk

13

## what is a sensitivity analysis

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Considers the effect of changing one variable at a time

Aims at checking how sensitive the decision measure (IRR & NPV) is to changes in key assumptions

Helps understand how sensitive investment NPV is to changes in a particular key variable.

It is a technique used to determine the impact that changes in a certain variable have on the bottom line, i.e. NPV

Sensitivity analysis answers questions such as:

What impact does a 1% increase in loan interest rates have on NPV?

What impact does a 2% increase in rent have on NPV

14

## 2 probablity distribution approaches

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Discrete distributions

Distributions based on past data

15

## explain discrete returns

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Here we consider a range of possible values and then estimate the probability of 3 to 6 values in that range

E.G. We might set the range for loan interest rates to fall between 5% and 11%. We can then assign a probability of occurrence at say 5%, 7%, 9% and 11% (every two % points)

Assigning the probability is subjective and thus is reliant on intuition and experience from past occurrences

16

## what is the sharpe ratio

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The Sharpe ratio is a risk-adjusted measure of return that is often used to evaluate the performance of an investment.

The ratio helps to compare the performance of one investment against another by making an adjustment for risk.

The higher the Sharpe ratio is, the more return the investor is getting per unit of risk

list formula variables

17