Real Estate

Walk me through a NAV calculation for a REIT.

"1.Apply a Cap Rate to each segment of the REIT's 12-month forward NOI. Then you add up all these values and the total represents the value of the REIT's Gross Real Estate Operating Assets. 2. Add up all the other Assets of the REIT, adjusting them where necessary;(i.e. a slight premium for Construction in Progress if it will start contributing revenue soon.) 3. Adjust and subtract the REIT's Liabilities. no major adjustments unless the fair market value of Debt is significantly different from its Book Value. 4. Divide that by the shares outstanding to get NAV Per Share, which you can compare to its current stock price. The underlying idea with the NAV model is that local, private markets are often more efficient and move more quickly with real estate. So if prevailing Cap Rates suddenly rise or fall, you'll see that right away with sales of individual properties, but the share price of the REIT itself may lag that movement, which results in a premium or discount to the NAV Per Share."

JLL Office Insights 3Q21

"Approximately 4.7 million s.f. of leases transacted in Q3, representing the highest volume recorded since Q1 2020 and a 33% increase from the previous quarter. The uptick in velocity despite rising Covid-19 cases was fueled by occupier demand for upgraded space and points to long-term confidence in the value of the office workplace and its role in retaining and attracting top talent. Financial services activity within the sub-25,000-s.f. size segment not only fully recovered to pre-pandemic velocity, but exceeded levels recorded in 2018 and 2019 within the same time period.. Total Office Vacancy 14.8%"

How does a sale of a $100 Asset ($80 BV, NI $2) flow through the statements?

"Asset sale net proceeds are $100, and the Gain on the sale of the Assets is $20. Rental income is $8, and operating expenses and property taxes are $4 and Depreciation was $2, so Income from Discontinued Operations on the Income Statement is $2. Additionally, there is a Gain of $20, so Net Income at the bottom is up by $22 (remember - no corporate taxes for a REIT!). On the CFS, Net Income is up by $22, but we must subtract the Gain of $20 because it is already accounted for under CFI, so CFO is up by $2. Under Cash Flow from Investing, we record the $100 sale of Assets, so cash flow is up by $102 and cash is up by $102 at the bottom. On the BS, cash is up by $102 but Gross Real Estate Assets are down by $80, so overall the Assets side is up by $22. The other side is also up by $22 because Net Income was $22 higher, so both sides balance."

UPREIT and DownREIT

"Created by investment bankers in the early 1990s, these two structures allowed real estate operating companies to place assets into a REIT structure in a tax-free manner. In an UPREIT, the founders of the company contribute assets to the REIT in return for operating partnership (OP) units while public shareholders receive traditional common stock as part of the IPO. From an economic standpoint, OP units and common stock are equivalent as the OP units are convertible into common stock, usually on a 1:1 basis after a certain period of time. Distributions paid are the same on the OP units and the common stock. The major difference is that OP units are not freely tradable, and holders of the OP units face a taxable transaction if and when they sell their OP units. One issue with the UPREIT structure is that the founders of the REIT (the original owners of the assets and now owners of OP units) have a different tax basis for their units or shares than the shareholders. This creates a potential conflict of interest as the OP unit holders (often members of management) would not want the REIT to sell their properties, as a sale would create a taxable event. A DownREIT is similar to an UPREIT, but is generally created when the REIT is already a public company and owns and operates separate properties in addition to the controlled partnership's properties."

Data Centers - Background and demand drivers

"Data center REITs own and operate buildings that house networking, data storage and communications technology infrastructure. This infrastructure includes servers, storage gear, switches, routers and fiber optic communications equipment. The unique design of data centers satisfies the specialized needs of tenants for power, cooling capacity, building security and network connectivity. Data center companies provide the infrastructure, but typically do not own any of the server, storage or networking gear that customers install in the facility. Typical tenants are those that require large amounts of computing capacity, data storage or network connectivity, and include corporations, governments, telecommunications carriers, digital media and content providers, cloud providers, and financial and educational institutions. Secular drivers, including IT outsourcing, IP traffic growth and cloud adoption are driving demand for data center capacity. Enterprise IT outsourcing is still in its early stages with only 30% of capacity in multi-tenant data centers (MTDC). Bandwidth-intensive applications, such as gaming and video, and the shift in content consumption through over-the-top (OTT) platforms are similarly expected to remain positive contributors to demand for the foreseeable future."

Distribution Yields Pros and Cons

"Distribution yield is calculated as the forward four quarters distribution divided by the share price. • Pros: Distribution yields require no assumptions and are easily compared across all companies as well as against indices such as the S&P 500.• Cons: Distributions may be set too high if the supporting free cash flow has declined or the quality of AFFO supporting the distribution is poor. When using distribution yields as a valuation tool, investors need to develop a sense for the safety of the distribution by computing the AFFO coverage ratio and determining the overall quality of cash flows. A good approximation of a REIT's ability to pay its distribution is the AFFO payout ratio (forward distribution divided by AFFO) or the AFFO coverage ratio (AFFO divided by the distribution; the inverse of the payout ratio). Distribution growth is also important and is a function of AFFO growth and the AFFO coverage ratio."

What is FFO?

"FFO should not be compared to Free Cash Flow because they're measuring different things - FFO is intended to be a replacement for Net Income for REITs, and is not necessarily close to the REIT's true cash flow. Remember that the massive Depreciation charges as well as Gains and Losses create a misleading Net Income number, and that is what you are adjusting for when calculating Funds from Operations."

Why do Levered Discounted Cash Flow (DCF) and Dividend Discount Models (DDM) often produce similar valuation ranges for REITs?

"First off, note that this statement is only true if you're referring to a Levered DCF analysis, i.e. you take into account Interest Expense and Mandatory Debt Repayments when calculating Free Cash Flow (effectively making it Free Cash Flow to Equity). This happens because the Dividends issued by a REIT are usually very close to its "Free Cash Flow" - after all, the REIT is required to pay out most of its taxable income in the form of Dividends... which means that it's also giving up much of its cash flow in the form of Dividends."

Lodging - Background and demand drivers

"Lodging REITs consist of a portfolio of hotel properties with no unifying brand that are managed by a third party operator. This is the direct result of a legal restriction placed on REITs - in addition to complying with the restrictions placed on other REITs, lodging REITs are neither able to receive income from hotel operations, nor operate owned hotels. Lodging REITs historically have proven to be highly cyclical as the extremely short-term nature of their leases (nightly) can lead to highly volatile room rates and occupancy levels. Many operating expenses cannot be easily pared back, which can lead to volatile earnings cycles. Since lodging REITs are not able to receive income from hotel operations or operate owned hotels, Lodging REITs have set up taxable REIT subsidiaries (TRS) that generate income from the hotels, and the TRS' in turn pay the REIT. When the Lodging REITs report earnings, they show the actual room revenue and food/beverage revenue; however, the income from hotel operations is not received by the REIT directly. For"

How does a REIT's capital structure differ from a normal company's?

"Most of these differences come from the fact that REITs must issue 90% of their taxable income as Dividends. As a result of that, they have little cash available to finance their operations: • They are much more highly leveraged than normal companies; it's not uncommon for Debt to comprise half or more of a REIT's Equity value. • They frequently issue Debt and Equity simply to continue acquiring, developing, and renovating properties. • In addition, Noncontrolling Interests, Equity Interests, and Joint Ventures are extremely common because of capital constraints; REITs often join forces to accomplish their goals."

NOI

"NOI is an assets net operating income. It is equal to total operating income - operating costs 1. Rental income 2. - vacancy = net rental income 3. + ancillary and overage income 4. + expense reimbursement 5. + ancillary income 6. - credit loss = operating income 7. - reimbursable expenses 8. - non reimbursable expenses 9. = NOI 10. - TI's, leasing commissions and capex (all referred to as normal capital reserves) = FCF"

For which type of REIT would you MOST likely see an adjustment for the straight-lining of rent on the Cash Flow Statement: office REITs, apartment REITs, or hotel REITs

"Office REITs, because tenants often sign multi-year leases. When that happens, you may "straight-line" the rent and assume that, for example, $5,000 of owed rent is paid evenly over 5 years. But in reality, rather than getting $1,000 in each year you may receive $800 in year 1, $900 in year 2, $1,000 in year 3, $1,100 in year 4, and $1,200 in year 5 as the rent escalates each year. So you will overestimate cash flow, FFO, and AFFO in early years and underestimate it in later years, which is why the straight-line adjustment for rent will be a negative in early years and a positive in later years. You don't see this as much for apartment REITs since leases are usually 1 year or less, and you don't see it at all for hotel REITs since hotel stays are even shorter-term."

Price/AFFO Pros and Cons

"Pros: AFFO is a more robust proxy for FCF than FFO. This allows for a more meaningful earnings metric across REITs and is especially helpful in capital-intensive property types such as Office. • Cons: AFFO is not widely reported by all REITs. Moreover, analysts can make their own adjustments to AFFO for what they believe is the clearest picture of FCF. Similar FFO, there is variation in how companies calculate AFFO, CAD, or FAD, which can skew what measure is reported. As a result, estimates for AFFO vary among analysts and can skew the P/AFFO metric. Like FFO, AFFO does not adjust for differences in capital structure. This can lead to a company appearing more expensive on a P/AFFO multiple basis simply because they employ more equity or more fixed rate capital."

Price/FFO Pros and Cons

"Pros: As opposed to NAV, which requires many assumptions to calculate, FFO (and the values used to derive FFO) is reported by most REITs. This allows for a more standardized comparison across companies and sectors. • Cons: FFO may not be the most robust proxy for free cash flow, as it contains several non-cash items. Normalized FFO adjusts for one-time charges and impairments, and AFFO adjusts for other non-cash charges to reach a closer approximation of free cash flow (FCF). However, estimates for normalized FFO and AFFO vary among analysts."

Price/NAV Pros and Cons

"Pros: NAV allows an analyst to apply different multiples to different cash flows depending on the risk profile of the cash flows. The NAV concept also adjusts for different capital structures so we can look at where a company is trading on both a levered and unlevered basis. • Cons: The NAV calculation is subjective as it requires many assumptions by analysts, who employ varying assumptions and calculation methodologies. Some argue that NAV is not a REIT's true market value because it ignores the value of the REIT's business enterprise."

Self Storage - Background and demand drivers

"The industry is fragmented, with the top six largest owners (CUBE, EXR, NSA, PSA, LSI, and U-Haul) owning about 16% of the self storage industry's facilities.[1] Self Storage Almanac, an independent research firm, estimates the total number of self-storage facilities in the United States to be over 41,000 (and other estimates range 50,000-60,000). Demand for storage is resilient through good times and bad and sometimes driven by diverse life changes including death, divorce and dislocation. Moderately increasing lengths of stay corroborate the stickiness of the storage customer. Over the long term, we expect industry demand for storage to grow with household formation growth and the economy. That said, there is seasonality to the business with greater demand in 2Q and 3Q due largely to student demand. Peak leasing season typically starts in late April/early May and extends through late August/early September. Self-storage renters fall into four key categories: residential/retail, commercial, student and military."

What are the advantages of a Net Asset Value (NAV) model over a DCF or DDM for a REIT? What are the disadvantages?

"The main advantage is that it's not as dependent on far-in-the-future predictions; it's grounded in what's on the REIT's Balance Sheet. The disadvantage is that assigning Cap Rates is very, very difficult and can be close to impossible to do accurately if you don't have good data. Just like using FFO or AFFO multiples to value a REIT, the NAV model is very dependent on the data you have available... but unlike with FFO or AFFO multiples, this data is much more difficult to locate."

What are the advantages of AFFO over FFO? What are the disadvantages?

"The main advantage of AFFO is that it's closer to the company's true "cash flow" because it reflects the impact of Maintenance CapEx. Many analysts believe that AFFO more accurately represents how much cash flow a REIT generates on a recurring basis. The main disadvantage is that definitions for AFFO tend to be inconsistent, and different REITs may include very different items in the AFFO number. So you really have to scrutinize the AFFO number closely when you see it listed in a company's filings. Another disadvantage is that AFFO still does not truly represent recurring cash flow, because it excludes CapEx related to acquisitions, development/redevelopment, and dispositions."

What's the difference between REITs and homebuilders?

"The main business for REITs is generally to own and operate real estate, while homebuilders tend to develop and sell real estate. The revenue stream of these two businesses is different, as REITs derive most of their revenue from rental income, which is a generally stable and visible income stream. Homebuilders, on the other hand, generally develop on a speculative basis, meaning there is limited pre-commitment from buyers, which can make income streams more variable. Additionally, there is generally some level of pre-commitment from future REIT tenants before a REIT begins to build an asset, while homebuilders often develop without any pre-commitment from buyers and therefore undertake additional risk by developing the property on their own balance sheet."

REITs during recessions

"These analyses show the most defensive REIT sectors during prior recessions were Apartments and Retail and least defensive were Office and Industrial. On average, cap rates rise +113bps during a recession Our analysis of the last three recessions found that cap rates expanded approximately +113 bps from trough to peak. Given REITs payout ~75% of their cash flow, tightening credit markets will have a profound impact on the group. The lowest leverage and highest level of liquidity best position these REITs to weather a storm, but also to invest opportunistically should opportunities arise. Many REIT consolidations over the years came together after periods of fundamental market disruption such as AMB/PLD, CUZ/PKY and SPG/TCO to name a few. Self-storage, Industrial and Data Centers have the lowest average sector leverage."

Question (in most basic form): (Please note that an interviewer can interchange these numbers). If I buy something at a 5 cap, put 50% debt on the property at a 4% interest rate, what is my cash on cash yield?

"To make this easier, assume that you purchased the building for $100. That means that you bought the property with $5 of current income (5 cap). That also means that you only spent $50 in equity and borrowed the other $50 from the bank (50% debt). If your debt cost 4%, you are paying $2 of interest (.04*$50). This means that your levered income is $3 (your $5 of current income, less your $2 of debt). Your equity investment in $50. That means your cash on cash yield is 6% ($3/$50) i. Please note that your unlevered yield is 5% ii. If they ask if you hold it for a year and sell at a 5 cap, your unlevered IRR is 5% and your levered IRR is 6% (assuming interim cash flows are reinvested at the IRR rate) iii. Please know this question front and back, the interviewer can give you any 3 of the 4 variables and ask for the forth. iv. Without getting into numbers, if they sell it for a 4 cap in 1 year, your levered IRR will be greater than 6% (because your exit cap > entry cap)"

Type of REIT structure

"Traditional is easy: the REIT owns all existing Assets when the company is formed and all future Assets as well when they get acquired or developed. But, any contributing property owners must pay taxes immediately when transferring property to the REIT. With an UPREIT structure, the property owners contribute property but get Operating Partnership Units (OP Units) that represent ownership in the REIT rather than cash, so they don't get taxed immediately. The disadvantage is that the REIT management may also own OP Units, which can create conflicts of interest (e.g. one group wants to agree to an acquisition but the other does not). A DownREIT is similar, but the Partnership behind the DownREIT only owns new Assets they acquired rather than all existing Assets as well. And the management team cannot own OP Units, which prevents conflicts of interest."

Walk me through how $10 of Earnings Attributable to Noncontrolling Interests flows through the 3 statements. Assume that the statements have ALREADY been consolidated, and that we only need to record these Earnings

"You subtract it on the IS because it's not attributable to the company, so Net Income is $10 lower. On the CFS, you add it back in the CFO section because if you own over 50% of a company, you do receive those earnings in cash. So cash flow and cash at the bottom are unchanged. On the BS, there are no changes to the Assets side. On the other side, Noncontrolling Interests under Shareholders' Equity is up by $10 due to these earnings, but Retained Earnings is down by $10 because Net Income was $10 lower, so the Balance Sheet balances."

Walk me through Replacement Cost

"You would start by calculating the Asking Price per Square Foot or Square Meter for a property you're considering buying - let's say the asking price is $100 million and it has 100,000 square feet, so it's $1,000 / square foot. Then, you would call a developer or someone else in the market to look at the property and estimate how much it would cost to build it yourself - the Land Acquisition Costs, Hard Costs, Soft Costs, and so on. Let's say you call several developers and they estimate that they could construct it for $95 million, which comes to $950 / square foot. In this case, the asking price is above the Replacement Cost so you're buying the building at a premium. ADV: it's grounded in fundamental construction costs as opposed to the prevailing Cap Rates in the market - so it's also less subject to fluctuations in the real estate prices DIS: determining accurate values is close to impossible - ask 10 different developers and they'll give you 10 different answers. Especially for large and complex properties, estimates vary widely and are still highly dependent on assumptions."

Explain the bottom up analysis of a market? Top down?

"a. Bottom up is starting with a specific asset and looking at its drivers, then is submarket, then the market, then further on up into how it fits into its marco environment b. Top down is the reverse. Start with marco factors and work your way down to the asset level"

Do you think a hotel REIT or an office REIT would trade at a higher FFO multiple?

"generally, office REITs have superior business models because clients sign multi-year leases in advance, which locks in recurring, predictable revenue for years to come, so they are valued more highly. Remember that higher valuation = higher FFO or AFFO multiple, but lower Cap Rate."

What are the three major determinants of cap rates?

"i. Investor sentiment / opportunity cost of capital ii. Specific risk of property iii. Opportunity for growth in cashflow iv. Interest rates"

Implied Cap Rate Pros and Cons

"implied cap rates are calculated by dividing the forward NOI estimate by the sum of equity market cap based on today's stock price, plus NAV liabilities minus NAV assets. • Pros: Implied cap rates reveal the real estate returns required by the capital market (investors). As this measure provides an aggregate view of many investors' assumptions, it helps smooth differences among investor assumptions and provides a consensus view for the value of a REIT stock or sector. • Cons: There can be some variations in calculating implied cap rates, eg, whether to include capex reserve or management fee, which may also vary by sector. Implied cap rates are also impacted by the amount of construction-in-progress included as well as the expected development pipeline. There is therefore no one way to calculate an implied cap rate, which can generate differences among investors and analysts."

Structure of a REIT

"• Be structured as a taxable corporation • Be managed by a board of directors or trustees• Distribute at least 90% of taxable net income as distributions to shareholders • Have at least 75% of assets in real estate (real property or loans secured by property) • Derive at least 75% of gross income from real estate income (rents or interest from mortgages) • Have a minimum of 100 shareholders • Have no more than 50% of shares held by five or fewer individuals • Have no more than 25% of assets invested in stocks of taxable REIT subsidiaries (TRS) Although REITs must generate 75% of their income from real estate or rental income, they can generate additional revenue through a taxable REIT subsidiary (TRS). These business activities, which are fully taxed, allow REITs to potentially boost their earnings stream by providing services that their tenants need and/or want. This can include merchant development (developing with intention of selling to third parties), property management, and funds management."

What are some of the major differences in a REIT's 3 financial statements as a result of its special requirements?

"• Income Statement: Revenue is primarily rental income; Expenses are split into property-level costs and corporate overhead; Net Interest Expense and Depreciation are extremely high; Discontinued Operations, Earnings in Equity Interests, Earnings Attributable to Noncontrolling Interests, Gains / (Losses) on Asset Sales, and Impairment Charges are all common. • Balance Sheet: 75% of Assets must be real estate-related; Real Estate Assets split into Operating Real Estate vs. Other Real Estate vs. Accumulated Depreciation; high Debt balances and negative Retained Earnings are common.• Cash Flow Statement: The overall structure is similar to normal companies, but it can be "messier" due to all the different Assets and segments they have; CapEx is split into Maintenance CapEx vs. Growth CapEx (i.e. acquiring or developing new properties); there are high Dividends and Debt and Equity issuances."

Property Type and Lease Length

1) Hotels - Daily 2) Self Storage - Monthly 3) Apartments, MFG Housing, Single Family Rental - Annual 4)Retail - Inline (Strips), Industrial - 3-5 years 5)Office Suburban - 5-7 years 6)Retail Anchor - 10+ years 7) Triple net leases HC and Retail 15+

Largest REIT Sectors by Market Cap

1) Infastructure 19.1% 2) Industrial 10.8% 3) Data Center 10.6% 4) Apartments 10.1%

REIT Valuation Methods

1) Multiples -FFO/AFFO, 2) DCF (typically levered) 3) NAV - assign a Cap Rate to the REIT's 12-month forward NOI to determine the true value of their Real Estate Assets, then you adjust and add in all their other Assets, subtract their Liabilities, and divide by the share count to get NAV per Share 4) Replacement Cost - estimate how much it would cost to re-construct a portfolio at the property level

Differences in REIT statements and normal company?

1) No corporate Tax rates 2) Balance Sheet separated by RE and Non-RE Assets 3) Acquiring/Disposing assets is a major CF item 4) typically low on cash - need to raise debt/equity often

Cap Rates in NYC (according to 1H21 CBRE)

1) Office CBD Class A: 4.5-4.75 2) Multi-family Class A - 4.5-5.0 3) Industrial - 2.9-3.25 4) Retail 5.5-6 5) Hotels - 6-8.0 CBRE overall insights: Industrial seeing Cap Rate compression. Logisitics and Multifamily seeing upward pricing pressure, Hotels and Shopping malls downward pressure

Revenue by Property

1) Office/Retail/Industrial - $/Sq.ft 2) Apartments: $/unit 3) Hotels: Avg.Dailty Rate, # Rooms, Occupancy Rate Potential Ancillary Revenue - parking, concessions. Use Potential Rental Income and net against Vacancy

What are major property-level expenses?

1) Property Tax: determined by local zoning regulations and calculated using SQ.FT 2) Operating Expenses: Categories - Repairs/Maintence, Insurance, G&A - modeled with SQ.FT or # rooms/units

How can a REIT grow?

1) Raise Rents 2) Acquire new properties 3) Develop New Properties 4) Redevelop/renovate properties 5) Sell properties

Real Estate Cycle

1) Recovery - Occupancy: low, Demand: Improving, Rents: Flat/Decreasing, Construction: None 2) Expansion - Occupancy: Rising, Demand: Improving, Rents: Rising, Construction: Limted 3) Peak - Occupancy: Peaking, Demand: flattening, Rents: flattening, Construction: Increasing 4) Oversupply - Occupancy: Flat/decreasing, Demand: falling, Rents: falling, Construction: Significant 5) Recession - Occupancy: low, Demand: flat/decreasing, Rents: flat/decreasing, Construction: decreasing

What are the AFFO adjustmetns?

1) Recurring CAPEX -> Capitalized Maintence, Tenant Improvements, Leasing Costs 2) Straight Line Adjustment - Non-cash revenue, known as straight-line rent, occurs when a landlord enters into a long-term lease with a tenant and the lease contains contractual rent increases over the life of the lease. Based on GAAP accounting, the company must "straight-line" the entire revenue stream over the term of the lease rather than recognize revenue as the cash is collected each period. 3) FAS 141 - above/below rents

Walk Through and Office Property

1) Revenue ( Rents or Parking, etc.) - vacancy allowance = Total Revenue 2) Operating Expenses and Property Taxes = NOI 3) After NOI, Interest Expense/Income and Depreciation

Development Modeling

1) Total Sq. Meters - Lost Size * Max Lot Coverage 2) Floor Area Ratio 3) Gross Area (total building SQ.FT) vs. Rental (typically 70%-90% of Gross Area)

Real Estate Evaluation Methods

1). Sales Approach: Look at comparables of similar properties on a price per square foot basis (more applicable for residential, but can work for commercial buildings) - must make adjustments since no two buildings are exactly the same 2) Cost Approach: First look at cost of replacing the building, then subtract the cost of any improvements that are necessary (i.e. minus estimated depreciation), then add on the cost of the land. Only used for unique properties like churches or schools 3) Income/Direct Capitalization Approach: Calculate the annual NOI of a property, and use the market cap rate for similar properties to back out the value: Value = NOI / CAP rate. 4) DCF: Or, for a longer period of time, you take a discounted cash flow of NOIs for 10 years plus the discounted residual value in year 10. You can calculate the residual value by taking the assumed Y11 cash flow, and dividing it by assumed cap rate in Y11. Or you could use a growing perpetuity formula [i.e. NOI / (r - g) or NOI / going-out-Cap-rate] NOI is gross income produced minus the operating expenses (e.g. taxes, utilities, insurance, maintenance, property management). 5) IRR: The most widely used approach. Often firms have a hurdle they must meet before they chose to invest. Higher IRR is better given two assets with similar risk characteristics. IRR is the discount rate which makes the NPV of a property's future cash flows equal to zero. You include the purchase price in the model. i. Unlevered IRR: Measures the return on an investment at the asset level ignoring capital structure ii. Levered IRR: Represents returns to equity investors"

How to model a development?

1. Determine the size (square feet or square meters), parameters, and Construction Timeline. 2. Estimate the eventual financial profile - revenue, expenses, and Net Operating Income (NOI). 3. Estimate the development costs for the building. 4. Create a Sources & Uses schedule and determine the amount of Debt and Equity to use. 5. Construct the Income Statement down to Net Operating Income, and bring in revenue and expenses over time as tenants move in. 6. Distribute the development costs over the Construction Timeline, drawing on Equity and Debt as required. 7. Assume an exit price (based on the Cap Rate - see below) and calculate the net sale proceeds and IRR. This part is similar to an LBO model.

What is one pro and one con about a building that has a ground lease (if you are going to buy the leasehold fee interest for the building only)?

A pro is that you don't need as much capital to purchase the asset since you aren't buying/paying for the land. Some cons are that it can be difficult to obtain a loan if the ground lease will expire in the near future, that the ground lease rent can roll to market at lease expiration and substantially increase the ground rent expense, that the use and alterations to the property can be restrictive based on the ground lease covenants, and that the value of the asset continuously diminishes as the expiration of the ground lease approaches.

Rules for a REIT

A real estate investment trust (REIT) is a company that buys, sells, develops, and operates properties and/or real estate-related assets. REITs pay no corporate taxes if they distribute 90% of their taxable income as dividends, earn 75% of their gross income from real estate, have 75% of their total assets related to real estate, and have more than 100 shareholders (they also can't have fewer than 5 investors that own over 50% of the company).

Calculating NAV

Approximation of liquidation value of underlying RE, before taxes 1) Find Property Level Core NOI (typically annualize current Quarter (Revenue - expenses + Pro rata JV + adj. for dispositions and development remove straight line rent and FAS 141 - mgmt fee & capex reserve) 2) Divide by cap rate - choose using market observations or running investor IRR hurdles 3) Gross up ancillary/3rd Party Cash flows (higher cap rate - less certain) 4) add all other assets 5) subtract liabilities (Debt, liabilities, Pro Rate JV and Pref stock)

Industrial - Background and demand drivers

Assets owned by industrial REITs typically include: distribution centers, bulk warehouse space, light manufacturing facilities, research and development facilities, and "flex" office space for sales or administrative functions. Industrial assets may be freestanding, but are often located within industrial or warehouse parks. These buildings range in size from 25-50K square feet at the low end to over 1M sf at the high end. While the properties are often leased to a single user, landlords can easily subdivide them for multiple tenant use. This cycle saw a sharp increase in demand for infill assets close to population centers as warehouse tenants have been laser focused on reducing delivery times to both business and consumer customers. We expect this key trend to continue, especially as e-commerce adoption accelerates. We also expect tenants keeping higher levels of inventory on hand to mitigate future supply chain shocks and the re-shoring of manufacturing to North America to add incremental space demand in the coming years. Taking a bird's eye view, the biggest driver of demand for space is consumer spending on goods (Table 2). Construction and trade are also key drivers of warehouse demand according to our analysis. Consumer spending on goods has the highest correlation to net absorption (correlation: 0.59) and is a strong driver of effective rent growth (correlation: 0.54). The high correlation between warehouse demand and consumer spending on goods makes sense given that higher consumer spending will translate into a larger volume of goods flowing through the economy. In addition, firms need a greater cushion of inventory to keep up with sales when times are good. The bottom line is that warehouse demand benefits from inventory storage, or the flow of goods through the supply chain either in the manufacturing process or during distribution. The growth in e-commerce sales reflects a shift in demand rather than a pickup in total consumer demand, which is captured by the total consumer spending data. That said, Prologis (PLD) estimates that e-commerce requires more than 2.5 times more warehouse space than the traditional distribution model. E-commerce requires more logistics space since as retail activities are consolidated from stores due to online retailers 1) carrying more stock keeping units (SKUs), 2) carrying greater levels of inventory buffers, 3) requiring more space and employees to pick, pack and ship to customers (also individual boxes take up more space than pallets) and 4) accommodating space for returns.

Cap Rate

Cap rate is the difference between your discount rate and your NOI growth per the Gordon model. It is the same as your going in yield. NOI / value

Retail - Background and demand drivers

Demographics are a key variable when examining retail assets (eg, median household income and number of households within a trade area) as they provide an important measure of portfolio quality. If a company's portfolio has strong demographics, there is a greater probability it will withstand the ups and downs of the economy and changes within the local market. there are a few factors that affect the success of a mall. These include tenant mix, which should be tailored by market to meet the needs of the local consumer, and location, as landlords can create synergies within the mall layout (ie, placing a toy store next to the food court). Also of significant importance are breadth of retailers (to drive traffic and achieve critical mass) and site location (the asset should be visible and accessible from major roadways).

What would you consider to be the most relevant part of the due diligence process?

Every part of the process is relevant; however, three critical issues in due diligence are environmental, legal and pro-forma analysis. Also, if relevant, DD on your operating partner

Calculate FFO and AFFO

FFO = Net Income to Common + Real Estate-Related Depreciation & Amortization - Gain / (Loss) on Sale of Depreciable Real Estate. You use FFO because Depreciation is exceptionally high for REITs, but most property actually appreciates over time - so Depreciation creates a very misleading Net Income number. G/L on sales don't represent recurring revenue AFFO = FFO - Maintenance CapEx - Straight line Rent Adjustment - Gain / (Loss) on Sale of Land + Other Non-Cash Charges. Closer to cash earnings - maintenice Capex is requied to keep the business running.

Multiples Historically

FWD FFO:long-term (10-year) average of 17.3x and five-year average of 17.7x.

Real estate and inflation

From a broader perspective, real estate is most often thought of as an asset class that provides inflationary protection. Rents can be re-set higher to reflect higher growth as long as the inflation is tied to an improving economy. Real estate investors prefer short-lease term sectors in a rising rate environment, as leases can be adjusted more quickly. These sectors would be lodging (daily lease reset), self storage (monthly), and apartments (annual). Longer duration leases offer some degree of inflationary protection in the short term as most include annual lease bumps. Lease bumps can be a fixed rate or tied to the CPI with a maximum ceiling. Upon expiration, lease rates are typically reset at the market rate.

Do you think a hotel would be valued at a higher or lower Cap Rate than an apartment complex?

Generally, hotels will be valued at higher Cap Rates, meaning they're less valuable, and apartment and office complexes will be valued at lower Cap Rates. That happens because revenue is much more stable and predictable with offices and apartments since they use 1-year or multi-year leases. Yes, some hotels make a lot of money and are very profitable, but on the whole they are also more susceptible to economic downturns and client turnover.

Gross,Single, Double, Triple Net Leases?

Gross: Base Rent, Single Net (N): Rent + Property Taxes, Double Net(NN): Rent + Property Taxes + Insurance, Triple Net(NNN): Rent + Property Taxes + Insurance + Maintenance -> Common for Office and retail

Reits and Rates

In the last three tightening cycles, REITs underperformed in two and outperformed in one. We ran a simple correlation on REIT returns vs. changes in the US 10-year Treasury yield since 1986 and found the correlation was +0.20, indicating that REITs do not necessarily sell off when long-term rates rise. If higher interest rates are driven by rising growth, we would expect better fundamentals to mitigate higher funding costs.

I am buying a vacant multifamily property that is fully completed. I can either condo out the property at no further cost at a $1,000 PSF sellout or lease it up at $50 PSF. Assume that a fully leased residential property across the street just sold at a 4 cap. Should I condo the property or should I lease it up as rental?

It depends on the numbers they give you but given the numbers above, you should move forward as a rental. You must compare the total value of condo vs. the total value of residential. The total value as a condo is $1,000 PSF. The total value as residential is $1,250 ($50 / .04).

Let's say that the implied Cap Rate of a REIT (based on the assumption that Equity Value = Assets - Liabilities and working backward to get the implied Gross Real Estate Operating Asset Value) is higher than its actual Cap Rate (based on the Balance Sheet value of Gross Real Estate Operating Assets). What does that mean?

It means that the REIT is trading at a higher value than what its properties are worth according to its Balance Sheet - usually there is some reason for that, such as better-than-average earnings growth, more predictable revenue, a more appealing geography or tenant base than other REITs, and so on.

Office - Background and demand drivers

Job growth remains the key driver of office space demand. The average lease duration for office REITs is 5-7 years for suburban leases and 10-12 years for CBD. Some large CBD leases may last up to 20 years. Office REITs have the widest gap between FFO and AFFO of any REIT sector due to the heavy capital expenditure load required to maintain their buildings and lease space to tenants. Office capital expenditures take the form of leasing costs (broker commissions and tenant improvements on new leases and renewals) and property maintenance expenses. We expect the COVID-19 pandemic and resulting focus on personal space concerns to lead to de-densification and more space per employee. We also expect an increased focus on wellness and hygiene as tenants and landlords design personal workspaces, gathering spaces and amenities in their buildings. We believe newer buildings will be best positioned. A key question going forward will be just how much incremental shifts to work from home arrangements for employees will weigh on overall space demand. Additionally, the growth of co-working and flexible leases could shrink lease length -> higher office cap rates

Total Development Costs in relation to the Construction Timeline. When do you pay for each expense category?

Land Acquisition Costs: Pre-Construction (straight-line) • Hard Costs: Construction (straight-line or bell curve distribution) • Soft Costs: Distributed throughout all phases - no clear pattern • FF&E: Post-Construction (right before tenants move in) • TIs: Post-Construction (right before tenants move in)

DSCR

NOI / debt service. Debt service is equal to interest and principal payments

Calculate NOI

NOI = Revenue - Operating Expenses - Property Taxes, so it excludes Interest, Corporate-Level Taxes, and D&A, just like EBITDA for normal companies. It approximates how much in cash earnings the property is generating each month or each year.

Apartments - Background and demand drivers

One of the main drivers for apartment demand is job growth. An industry rule of thumb is that every five new jobs produce one unit of apartment rental demand. In a growing economy, job growth in the 20-35 year-old age range (Millennials) is more beneficial to apartment rentals as this is the prime renter age cohort. That said, there has been a a trend of baby boomers and "empty nesters" returning to urban centers as they downsize and look for a more amenitized life style. In a downturn, when unemployment is high, tenants tend to trade down, double or triple up, or even decide to move in with parents or other family in order to save money on rent. As a result, effective rents may decline significantly as landlords offer concessions in order to drive occupancy. As a result of the residential mortgage crisis that began in 2007, a significant shift occurred in the US from owning to renting. US home ownership peaked in 2004 at about 69% and troughed in 2016 at about 64%. Every one percentage point decline represents approximately 1.1 million households that enter the renting pool. Recently there has been a slight uptick in homeownership levels with 2019 ending at 65.1%.

REIT Leverage Over Time

REIT leverage has, for the most part, ranged from 25-52% when looking at REITs' total debt as a percent of total capitalization (Chart 10). Since 1989, total debt as a percent of total capitalization has averaged 36%. Since 2000, total debt as a percent of total cap has averaged a modestly higher 38%. When looking at leverage using net debt as a percent of EBITDA (Chart 11), leverage rose from 3.4x in 1989 to a high of 7.4x in 2008. Since 2009, the net debt / EBITDA ratio has trended lower. As of year-end 2019, the average net debt to EBITDA ratio is 6.1x

What is a REIT?

REIT, or real estate investment trust, is a company that owns and, in most cases, operates income-producing real estate such as apartments, office buildings, warehouses, shopping centers, regional malls, or hotels. A small percentage of REITs (mortgage REITs) lend money to owners of real estate and therefore do not have direct ownership of the asset.

Direct RE Pricing

REITs only make up about 15% of institutionally owned commercial real estate. Therefore, much of the transactional activity that occurs in the overall commercial real estate market can influence REIT returns and performance. Direct property values can be derived by examining their: 1) cap rates, or initial yield on a property; 2) replacement value, which represents the cost to replace an asset; and 3) repositioning potential, which signifies the value the property could obtain if it were converted to a more productive use.

How would you select a set of public comps or precedent transactions when valuing a REIT?

Rather than selecting the set based on metrics like revenue or EBITDA, you would select them based on Real Estate Assets, NOI, FFO, AFFO, or something else real estate-specific. Geographical focus is also important, as are the property types; it wouldn't make much sense to compare a UK healthcare REIT to an office REIT on the west coast of the US.

Calculating Implied Cap Rate

The implied cap rate is calculated by dividing the forward NOI estimate by the implied gross property value, which is the sum of equity market cap based on today's stock price, plus NAV liabilities, and minus NAV (other) assets.

Healthcare - Background and demand drivers

The key types of healthcare facilities that REITs invest in include: senior housing communities (independent living, assisted living, and CCRCs), skilled nursing facilities (SNFs), hospitals, medical office buildings (MOBs), and life science properties. Unlike other REIT sectors that typically only have one type of business, the healthcare REITs are able to diversify their investments by business and payor mix. For example, the four types of healthcare facilities have varying pay mechanisms: senior housing (private pay), skilled nursing (public pay), hospitals (public pay), and medical office buildings/life science (private pay). The key drivers of healthcare REIT property fundamentals include aging demographics, proximity to the oldest daughter (often the caregiver for aging parents), and proximity to the nearest hospital. Healthcare REITs are generally thought of as relatively defensive, given that the industry is necessity based (there are always people getting older who need care) and the predominance of the triple net lease structure, assuming current rent levels are sustainable. Several REITs have also focused on increasing their exposure to life science assets and MOBs, which offer a relatively attractive risk/reward given their private-pay focus and steady long-term rent growth.

Would a REIT focused on offices in major metropolitan areas or one focused on offices in rural areas to have higher FFO and AFFO multiples and Cap Rates?

The one with properties in major metropolitan areas - everything is more expensive in big cities, including properties. Cap Rates tend to be the lowest (meaning the most expensive properties) in places like Manhattan and tend to be higher (less expensive properties) in rural areas because there are fewer buyers, fewer transactions taking place, and lower potential revenue from the properties.

Loosening or rolling back financial regulations

Tightening of financial regulations has been a contributing factor in the more muted supply response this cycle, in our view. Basel 3 has made it less profitable and more capital intensive for banks to provide construction loans. Merchant builders need to provide substantially more equity, raising their costs and concentrating their equity in fewer projects. A large-scale rollback in regulations could mean changing rules that would make it easier for banks to provide development financing. While this would likely be a tall order, we cannot rule out the possibility.

Triple Net Lease - Background and demand drivers

Typically, triple net leases have relatively long lease terms, low embedded rent bumps and renewal options at the end of the lease. As a result, the cash flow of a triple net lease is fairly predictable and stable. The downside of a steady and stable income stream is that net lease REITs produce modest internal growth. Triple net REITs supplement their modest internal growth with acquisition-fueled external growth. Over the last few years, external growth has contributed 50-75% of each triple net's annual FFO/AFFO growth. With no development platforms and limited internal growth, the investment spread on an acquisition is the key to driving earnings growth. Two factors drive the investment spread: (1) the initial cap rate on an acquisition and (2) the REIT's cost of capital. The initial cap rate is a function of the asset and the overall risk of the investment. The cost of capital is determined by the relative mix of debt and equity it uses in its capital structure as well as each component's cost.

You have two buildings that are located at the same intersection, across the street from each other, that are the same size, asset class (office), age, and occupancy rate. However, one is valued twice as much as the other. Why could that be?

Variety of answers, but some reasons include: one building has higher (at or above market) paying leases, better credit tenants, a better lease expiration plan (so all tenants don't roll at once), substantial deferred maintenance that needs to be completed, higher expenses (due to an ineffective operator). Basically look for quantitative things that would produce a different NOI or qualitative things that make the building more attractive to investors.

Impact of Fiscal Stimulus

We see any large scale infrastructure plan on the federal or state level as a positive as it may temper real estate supply growth. President Donald Trump in February 2018 released his plan for increased infrastructure spending. The plan calls for a potential $1.5 trillion in spending, of which $200 billion would be federal spending. For real estate owners such as REITs, this would be welcome news since it would drive up construction costs, slowing supply growth. Our economists note support for core PCE inflation, and believe inflation should advance to 0.6% by year end 2020, further pressuring construction costs. All else equal, this would put a damper on supply growth and over time help drive rent growth.

Do you think NOI accurately describes the cash flow that a property can generate?

Yes and no - it's better than Net Income since it excludes Depreciation, but it also excludes Interest and possibly CapEx, so it doesn't represent a property's true cash flow. NOI tends to be more accurate for established properties where there's no Debt and where CapEx is minimal.

How do you calculate NOI for the entire REIT on its Income Statement?

You add up the Rental Income and Operating Expenses and Property Taxes for Same-Store Properties, Development & Redevelopment Properties, and Acquired Properties, and then subtract Rental Income and Expenses from Dispositions (since those are reflected under Discontinued Operations on the IS now). NOTE: If you've been tracking the Assets properly for all these segments and assuming that Disposed Properties directly reduce the Assets for one or more segments, you may not need to subtract Rental Income and Expenses from Dispositions; the Asset reduction already accounts for that.

If a property has a low cap rate (say 3.0%), why could that be?

cap rate is simply NOI / Value. Two major reasons ways the cap rate is very low: (1) The property is either a very safe, core, stabilized asset so a new investor buying the asset would require a lower return because it is "safer", or (2) the asset is not stabilized with very low NOI. In this case, an investor looking to buy the asset is going to evaluate the cap rate versus the stabilized yield and mark-to-market cap rate (the cap rate a property would have today if the property was stabilized at today's market rents).

Let's say that a REIT has NOI from non-rental-income sources such as property management fees. Would you value that NOI at a higher lower Cap Rate (Yield) than its normal rental NOI?

higher Cap Rate for these non-rental-income sources, meaning that they are less highly valued. The rationale is that this type of revenue is easily cancellable and is not as stable or predictable as rental income from 1-year or multi-year leases.

Why Real Estate?

• Real estate is a reliable asset class that isn't going anywhere - unlike a field like technology that's constantly changing, buildings will exist and produce income as long as humans live in them. • Real estate affects your everyday life - everyone lives in some form of real estate asset, and most people work in them as well. No other investments are like that. • There are many ways to invest in real estate - you can buy properties, develop properties, renovate properties, invest in REITs, mortgages, loans, and so on. • Accounting and valuation differ significantly, which makes it more interesting than standard companies as you have to think about corporate structure and even basic concepts like Depreciation differently.

Income Statement for Hotel

• Revenue: RevPAR = Occupancy Rate* ADR, There are categories of revenue such as Rooms, Food & Beverage, Telecom & Other, and Parking. • Cost of Sales & Labor and Gross Profit: You include the costs directly associated with all those revenue categories here. • Operating Expenses: G&A, S&M, Energy, Insurance, Property Taxes, Maintenance, Management Fees. • There may be a Management Incentive if NOI hits a certain target.