What is the main value or usefulness of real estate in the

Question

What is the main value or usefulness of real estate in the portfolio on the asset side of the balance sheet, and what is its main value or usefulness in dealing with the liability side of the balance sheet, for a typical pension fund?

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Q: A certain property market is characterized by 100,000 SF spaces that are expected to rent in 8-year fixed-rent leases, successively in perpetuity (annual payments at the ends of the years). Properties are typically sold just after a lease is signed (1 year prior to first rent payment). There is no vacancy down-time between the successive leases. The rent in each lease is constant, but between new lease signings the rent is expected to grow at a rate of 2% per year. The current market rent is $10/SF per year. In general, the rents are uncertain prior to lease signings. The opportunity cost of capital (OCC) for investments providing contractually-fixed cash flows is 6% per year, and the typical prevailing cap rate in this property market is 7%. (a) What is the market value of space per square foot? (b) What is the implied inter-lease discount rate applicable to risky cash flows that depend on the real estate market?

Q: Suppose market rate apartments produce net cash flow of $10,000/yr in perpetuity, while affordable units provide only $5,000. However, if the developer commits that 25% of the units will be forever affordable, then she will qualify for a perpetual loan $4,375,000 at an interest rate 50 basis points (0.5%) below the market interest rate. (However, this is not a tax-exempt loan " its interest is taxable.) Also, the developer can receive perpetual (and transferable) annual LIHTC equal to $1,000/yr per low-income unit. If property yields (total returns, opportunity cost of capital) are 10% at the PBT level (assume same for market and affordable apartments), loan market interest rates before-tax are 5%, yields on otherwise similar municipal bonds (tax-exempt loans) are 4%, and the developer faces an income tax rate on investment returns of 20%, then should the developer make her 100-unit apartment complex a mixed-income affordable development or a 100% market development? Tell why, and how much difference it makes (i.e., evaluate the two alternatives). Answer this question from a market value (MV) perspective (but be careful: the LIHTCs are after-tax cash flows).

Q: The table below shows the projected net cash flows (including reversion) for Property A and Property B. If both properties sell at fair market value for a cap rate (initial and terminal net cash yields) of 7%, then which statement below correctly describes the relative investment risk in the two properties?Annual net cash flow projections for two properties ($1,000,000s):Year:12345678910A$1.0000$1.0000$1.0000$1.0000$1.0000$1.0000$1.0000$1.0000$1.0000$15.2857B$1.0000$1.0200$1.0404$1.0612$1.0824$1.1041$1.1262$1.1487$1.1717$18.6093(a) Property A is more risky.(b) Property B is more risky. (c) They both are equally risky.(d) Insufficient information to determine the answer.

Q: Projected Year 1 NOI: $100,000.Projected Year 11 NOI: $121,899.Projected Year 10 resale (reversion) value: $1,523,738.Current (going-in) market cap rate for similar properties: 7%.What is the current market value of the property?(a) $7,000.(b) $1,000,000.(c) $1,428,571.(d) $1,741,414.(e) Insufficient information to determine answer.

Q: All of the following are typical "GIGO" mistakes in common application of the DCF method to real estate investment analysis except:(a) The growth rate in the rents is projected too high.(b) The level of required capital improvement expenditures, or the going-out cap rate, are projected too low.(c) The discount rate or going-in IRR is too high.(d) The going-in cap rate is projected too low.

Q: a) Consider the following fully-amortizing 5-year ARM (contract interest rate can change once every 60 months) with 15-year maturity, monthly payments. The ARM has initial interest rate 6.5% with 2 points, caps are 2% per jump, 5% lifetime, margin is 300 basis points, index is Treasury Bonds that are currently yielding 6.0%. The loan amount is $100,000. Under the "straight line" assumption about future interest rates (i.e., assuming the market rate on the index remains constant), what is the yield to maturity? (Show your work if you want to possibly get partial credit.)b) Consider a $4,000,000, 7%, 25-year mortgage with monthly payments and a 7-year maturity with balloon. If the market yield is 7.5% (BEY), how many disbursement discount points must the lender charge to avoid doing a negative NPV deal from a market value perspective?

Q: (a) Fully explain and clarify the following statement: "There are two types of tax shields available to investors in property equity: deprecation tax shields (DTS) and interest tax shields (ITS), but only one of these types of tax shields generally adds to the investment value of the investment no matter what the investor's marginal tax rate." (b) As part of your answer, quantify the NPV to two different borrowers, from an after-tax investment value perspective, of a perpetual loan of $1,000,000 at 6% interest when the market yield on corporate bonds is 6% and on otherwise identical municipal bonds is 4%, and Borrower A faces a marginal tax rate of 30% while Borrower B faces a marginal tax rate of 35%. (c) Also, compare the NPV to Borrower B to the PV of that borrower's interest tax shields (the PV of the borrower's tax deductions associated with the loan).

Q: Suppose the riskfree (i.e., Government Bond) interest rate is 5%, the current cash yield payout rate on newly built property is 7.5%, and the annual volatility of individual property total returns is 25% for built properties that are leased up and operational. Use the Samuelson-McKean formula to answer the following questions concerning a vacant but developable land parcel. (a) If built property has a 4% risk premium in its expected total return (9% total return), then what is the risk premium and expected total return for the land parcel? (hint: use the elasticity formula 8.11a and the risk premium formula 8.11c) (b) What is the value of the land parcel if a building currently worth $2,500,000 new could be built on the land for a construction cost of $2,200,000? (c) What is the "hurdle benefit/cost ratio" above which the land should be immediately developed? (d) What value of newly built property does this suggest is required before the land should be developed? (e) Under these conditions should the land be developed immediately or is it better to wait?

Q: The "option premium" is: a) The excess of the option value over its immediate exercise value. b) The risk premium in the required investment return to option investment. c) The excess of the option value over the current value of the underlying asset. d) Difficult to quantify using the Samuelson-McKean Formula.

Q: Alex and Kay are two retail property investment managers hired one year ago by two different investors. In both cases the managers were free to use their own judgment regarding geographical allocation between properties in the East versus West of the country. Kay allocated her capital equally between the two regions, while Alex placed 65% of his capital in the Western region. After one year their respective total returns were as depicted in the table below. As you can see, Kay beat Alex by 60 basis-points in her total portfolio performance for the year.Alex & Kay's returns realized for clients:Weights:AlexKayEast35%50%West65%50%Returns:AlexKayTotal Portfolio6.65%7.25%East6.00%6.50%West7.00%8.00%How would you attribute this 60 basis-point differential between pure allocation performance, pure selection performance, and a combined interaction effect, if you wanted to compute an unconditional performance attribution that was independent of the order of computation? (Note: This is equivalent to taking Alex as the benchmark against which Kay's performance is being compared.)

Q: Suppose the riskfree rate is 3% and the market risk premium is 6% and a certain asset has a beta of 0.5. The asset in question is expected to produce a perpetuity of net cash flow to its investors equal to $1,000,000 per year. Suppose the CAPM is "true", and disequilibrium in asset market prices does not endure beyond (i.e., "gets corrected" within) one year. Should you buy this asset if you can get it for a current price of $15,000,000? What would be the NPV of such an acquisition, and what would be the minimum expected return on a one-year investment in this asset at that price, and how much of that return (if any) would be considered "super-normal" (i.e., more than what is warranted by the amount of risk in the investment)?

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