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REE 5305 FSU Exam 2 - Liang (1
REE 5305 FSU Exam 2 - Liang (1
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REE 5305 FSU Exam 2 - LiangDo income producing properties provide competitive returns? - ANS-- Determined by alternative
real estate investments and other alternative investments.
- Look at returns on alternatives, and risk differences.
What are some investment concerns? - ANS-1. Total Return
2. Price Growth
3. Income Yield
4. Risk
5. Inflation Hedge
Types of Investments: - ANS-1. Stocks
2. Real Estate
3. Bonds
4. Short-term Treasuries
Stocks: - ANS-TR: High
PG: High
IY: Low
Risk: High
Inflation Hedge: Moderate
Real Estate: - ANS-TR: Moderate
PG: Low
IY: High
Risk: Moderate
Inflation Hedge: Good
Risk Return Relationship Increasing: - ANS-Safe - Risky (Return low to return high)
- T-blils
- Municipal Bonds
- Mortgage-backed Securities
- Corporate bonds
- Real Estate
- Common Stock
8 Types of Risk: - ANS-1. Business Risk
- Economic conditions, tenant mix, lease provisions
2. Financial Risk
- Use of debt, cost and structure of debt
3. Liquidity Risk
,- Challenges in selling property
4. Inflation Risk
- Unexpected Inflation
- Does income increase enough to offset inflation?
5. Management Risk
- Ability to respond to conditions.
6. Interest Rate Risk
- Impact on variable rate of debt
- Impact of higher rates on property value
7. Legislative Risk
- Regulatory Changes
8. Environmental Risk
What is due diligence? - ANS-The investigation that an investor should undertake when
considering the acquisition of a property.
What are some areas that should be investigated in due diligence? - ANS-1. Lease agreement
review.
2. Pending or threatened matters review.
3. Review of title/deed documents to determine nature and extent of easements.
4. Property Survey
5. Government compliance
6. Physical Inspection
7. Tax matters
8. Insurance policies
9. Market Studies
10. List of personal property
Sensitivity Analysis Rundown: - ANS-1. Create the base case; which is the frame of reference
for the analysis
2. Change a single assumption and then see the effects on the NPV or IRR
3. Then you do a Scenario Analysis
What is a Scenario Analysis? - ANS-- In a sensitivity analysis when you identify the most likely,
pessimistic, and optimistic scenarios
Partitioning the IRR - ANS-- Separating the IRR cash flows to see what the PV is from the
resale and the rent.
- "How is the total IRR distributed between operating cash flow and property sale cash flow?"
- IRR on equity Investment in RE comprises two sources of cash flow: (1) cash flow from
operations and (2) cash flow from the sale of the investment.
Steps in Partitioning the IRR: - ANS-1. Compute the IRR
2. Discount cash flows from operations using the IRR
, 3. Discount cash flows from property sale using the IRR
4. Compute the %'s.
Partitioning Example: - ANS-- Equity Invested = $600,000
- Before Tax Operatin CF 1 = $40,000
- BTOCF 2 = $42,000
- BTOCF 3 = $45,000 + 800,000 from sale
- IRR = 16.48%
PV of BTOCF, =npv(.1648, 40k 42k 45k)= A
PV of BTCF(sale) =npv(.1648, 0, 0, 800,000)= B
- % of Opeartions = A / 600,000
- % from Sale = B / 600,000
Why is partitioning the IRR useful? - ANS-- Comparing alternative similar investments.
- An alternative property may have the same IRR, but if the % of return from operations is 5%
and sale 95%, there might be significant risk differences.
Which is riskier in Partitioning the IRR, sale or operating cash flows? - ANS-- The portion of
return based on the sale of the property versus the cash flows. I.e. the higher the portion in the
sale, the riskier the investment.
Variation in Risk & Return: - ANS-- Measure risk with the variance of returns.
- STDEV: the lower the stdev, the more likely an actual return is closer to the expected return.
- STDEV formula: sqrt(summation((value - mean)^2 * probability))
Coefficient of Variation formula and interpretation: - ANS-- CV = sigma / E(IRR)
- Risk per unit of expected return
- Standardized measure of stand-alone risk
Portfolio Considerations: - ANS-1. Reduce risk by combining assets into a portfolio
2. Diversification
Why use economic scenarios (scenario analysis)? - ANS-1. Used to compute the cash flows
from operations and property sale of each potential scenario.
2. Compute the IRR in each scenario.
3. Multiply the IRR by the probability of the scenario to compute the expected return
4. Need to consider risk
5. Go to Excel to see example.
What is Lease Rollover Risk? - ANS-- The uncertainty of renewal by existing tenants.
- No renewal
- Possible lengthy vacancy
- New tenant may require money for tenant improvements
- Pay commissions to a leasing agent.
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