Re 420 unit 1 test

Real Estate: Two Markets

Space Market (AKA "usage market", or "rental market") For the usage (or right to use) "real property". (e.g., tenants & landlords exchange money for leases.) Asset Market . . . For the ownership of "real property". AKA "property market". (e.g., Pension funds exchange $ for an office bldg.)

What does financial theory predict for the cap rate in London given an increase in bond yields :

The cap rate will increase

In the previous questions, what if wages and prices do not fully adjust? There is unemployment in DI There is unemployment in CI There is unemployment in both DI and CI Nothing changes

There is unemployment in both DI and CI

cap rate

= risk free rate+ risk factor Libor (for floating rate) and 10 yr T-Bill rate (for fixed rate) will make: borrowing costs go up, demand for CRE down, CRE prices go down, and cap rates go up.

impact on cap rates of Lehman bankruptcy & the subprime crisis (2008-2012)?

Decrease in price, increase in cap rates

impact on cap rates of The Feb 4 1994 interest rate increase?

Interest rate increase > price goes up, you need a lot of debt to buy commercial real estate. Debt is more expensive. Once commercial real estate goes down, cap rates go up.

The subprime conduit mortgage market can also collapse because

Land use regulations prevent subprime borrowers with small loans from buying houses with lot size below a minimum threshold

Remember The Big Short movie?

The ratings agencies, coached by the investment banks, rated the CDOs as if they were truly diversified—giving the impression that these derivatives were based on a bundle of different kinds of mortgages with geographic diversification that would not all topple together.

The liquidity trap occurs when

When the nominal interest rate is zero

Enumerate and explain four government policies in the United States that encourage low densities in large metropolitan areas.

Four potential causes of sprawl (low density) are: Underpricing of roads ("congestion" externalities) Mortgage subsidy: makes housing and land cheaper than other consumption goods financed with consumer debt Underpricing of fringe infrastructure Zoning (minimum lot size)

what is the impact on cap rates of The oil crisis in the 1970s?

Inflation and expect cap rates going down b/c interest going up.

If the required rate of return decreases for real estate investments, do prices increase or decrease, all else being equal?

Prices increase, all else being equal; Price = NOI / Cap Rate

The real interest rate is equal to

nominal interest rate minus inflation

Adverse selection in the primary mortgage market occurs when the lender has more information about the borrower's characteristics (e.g., default risk, etc.) than the borrower the borrower has more information about his characteristics (e.g., default risk, etc.) than the lender the lender has more information about the borrower's characteristics (e.g., default risk, etc.) than the secondary market investor the secondary market investor has more information about the borrower's characteristics (e.g., default risk, etc.) than the lender

the borrower has more information about his characteristics (e.g., default risk, etc.) than the lender

The term "real property" refers to: (a) Financial capital as opposed to physical capital. (b) Long-lived personal property, such as automobiles, musical instruments, works of art. (c) Land or built space. (d) Property valued net of inflation.

(c) Land or built space.

What would be the 'short-term' effect of an increase in demand for space usage on the following factors?

1) Rent goes up 2) Price of real estate assets goes up 3) New development increases

Which period better captures the rise of the subprime conduit mortgage market? < 1995 1995 - early 2000s Early 2000s - Middle 2000s 2006 - 2015

1995 - early 2000s

The EUR/USD cross-currency basis (β in terms of our notation) ) reflects the premium that owners of dollars demand for lending their dollars to international banks. When β>0, we say that the Covered Interest-rate Parity (CIP) formula does not hold. This was the case, for example, of the large deviation of the EUR/USD cross-currency basis in October 2008. As we discussed in class, this departure from the CIP was due to

European banks' difficulties to roll over their US dollar denominated loans, which grew to more than $800 billion by mid-2007

Which of the following is an example of the private equity market? (a) The commercial real estate property asset market. (b) The stock market. (c) The commercial mortgage market. (d) The money market.

The commercial real estate property asset market.

impact on cap rates of The Fed decreased interest rates at record low levels after Lehman. Did cap rates increase or decrease?

Interest rate down > prrices are low> cap rates increase

1. the 'replacement cost' level of rent

The level of rent that is just sufficient to stimulate profitable new development in the market

The basic geographic unit in real estate space markets is typically: (a) The country (b) The state (c) The county (d) The metropolitan area (MSA)

The metropolitan area (MSA)

Which of the following is true?

The post "Great Recession" recovery has been long and shallow, with growth rates roughly half of that normally observed in expansions.

Months supply calculation

Vacant space+ New Space/ Sqft per month

Is the collapse of Lehman Brothers the linchpin of the Great Recession? -Yes, it is. The collapse in residential investment was in full swing in 2006, a full two years before the collapse of Lehman Brothers -Yes, it is. The collapse in residential investment was in full swing in 2010, a full two years after the collapse of Lehman Brothers -No, it is not. The collapse in residential investment was in full swing in 2010, a full two years after the collapse of Lehman Brothers -No, it is not. The collapse in residential investment was in full swing in 2006, a full two years before the collapse of Lehman Brothers

No, it is not. The collapse in residential investment was in full swing in 2006, a full two years before the collapse of Lehman Brothers

If the cap rates prevailing in a given market are 10.5%, then how much would you expect a property to sell for in that market if its annual net income were $50,000? (a) $5,250. (b) $50,000. (c) $476,190. (d) $525,000.

P= NOI/Cap Rate =50,000/ .105= $476,190

PBTCF

PGI- Vacancy= EGI EGI- operating expenses- property taxes= NOI NOI- capital expenditures- DS= BTCF

Perpetuity equation

PV=R/i R=revenue i= opportunity cost of interest.

impact on cap rates of Early 2000s: Tech crash, 9/11,

People have fear so they put money in RE or gold. Demand goes up, prices go up, Cap rates go down.

impact on cap rates of A booming stock market as in the late 1990s?

People put money in stock market (commerical RE market), lower prices, Cap rate go up

The main differences between traditional portfolio lenders and conduit lenders are:

Portfolio lenders originate-to-own and have access to soft information, whereas conduit lenders originate-to-distribute and don't rely on soft information

impact of cap rates on The stock market crash of the late 1980s?

Price would go up, b/c more demand and seeking differenent asset classes people have money and they will put money in safe assets like real estate, more demand for RE, more demand= higher price, Higher price means lower cap rates.

In a real estate market. "constrained supply", or rising real Long-Run Marginal Cost (upward-sloping supply curve), is generally caused by: (a) Inflation. (b) Technological improvements in the construction industry. (c) Scarcity of buildable land due to geographic or regulatory constraints. (d) Tenant requirements for more lavish accommodations.

Scarcity of buildable land due to geographic or regulatory constraints.

Consider a city that has vacant land (6,000 square feet of space) ready for development in a neighborhood that is desirable because of its superior schools. There are two types of households, low income (L) and high income (H). Each L-type household is willing to pay $40,000 to live in the neighborhood, and each H-type household is willing to pay $60,000. The preferred lot size is 1,000 square feet for type L, compared to 3,000 square feet for type H. Suppose the city sets a minimum lot size. The vacant land will be allocated to type H if the minimum lot size is at least ......... square feet because ......

Suppose the city sets a minimum lot size. Then, land will be allocated to H types if the minimum lot size is at least 2,000 square feet because (if L must consume 2,000 square feet, the willingness to pay per square foot will be $20, the same as H). Mathematically, (40,000/x)<(60,000/3,000), where x denotes the minimum lot size. Solving the inequality we get x>2000sf.

How can the US pay its debt?

Taxes Printing money. Doesn't this inflate debt even more? TIPS (Treasury Inflation-Protected Securities) US nominal bonds Creating new bonds to pay down debt

What does financial theory predict for the cap rate in London given an increase in bond yields : The cap rate will increase The cap rate will decrease The cap rate is not affected There is no financial theory that relates cap rates with bond yields

The cap rate will increase

The "kink point" in the real estate space supply function occurs at: (a) The current quantity of built space and the "replacement cost" rent. (b) The maximum quantity of built space allowed by zoning laws and geographical constraints. (c) The current quantity of built space and the current rent. (d) The rent that provides a cap rate equal to the mortgage interest rate.

The current quantity of built space and the "replacement cost" rent.

Which statement below is true? (a) The supply side of the space market consists of investors. (b) The demand side of the space market consists of investors. (c) The supply side of the space market consists of potential tenants. (d) The demand side of the space market consists of potential tenants.

The demand side of the space market consists of potential tenants.

The basic demand curve for real estate suggests that as rents decline, the amount of space leased increases. How does this differ from the demand growth that occurs in an office market when there is significant job growth in a market?

The former is moving along the demand curve, reflecting the trade-off between quantity and rent at any given level of demand (# of employees) The latter reflects a shift in the overall demand curve to the right, that is, higher quantity occupied at any given level of rents, or, higher rents at any given quantity of supply.

Which of the following is true? The post "Great Recession" recovery has been short and shallow, with growth rates roughly half of that normally observed in expansions. The post "Great Recession" recovery has been long and shallow, with growth rates roughly the double of that normally observed in expansions. The post "Great Recession" recovery has been long and strong, with growth rates roughly the double of that normally observed in expansions. The post "Great Recession" recovery has been long and shallow, with growth rates roughly half of that normally observed in expansions.

The post "Great Recession" recovery has been long and shallow, with growth rates roughly half of that normally observed in expansions.

Long-run equilibrium in a DiPasquale-Wheaton "Four-Quadrant Model" (4QM) is found by: (a) The triangle connecting the current quantity of built space, the current price of property per square foot, and the current rent per square foot. (b) The square that equates supply and demand. (c) The rectangle with vertical sides and horizontal top & bottom whose four corners just touch the four binary relationship lines in each quadrant. (d) The diamond whose four corners are on the four axes at the current prices and quantities.

The rectangle with vertical sides and horizontal top & bottom whose four corners just touch the four binary relationship lines in each quadrant.

Rentable area

tenant usable area (1+load factor) 1.) floorplate= 20,000 Vertical penetrations=800 Rentable area= 20,000-800= 19,200 2.) rentable area- common area= property useable area load factor= rentable/ useable

Use the following information to answer the next 2 questions. Suppose demand for apartments in a metropolitan area is: #Apt.units=60,000 +(0.30)(# households)-(80)*($Rent/unit/mo.) If developers increase the number of apartment units from 88,000 to 100,000, over a period of several years, to what level will real rent fall in the market below the original $400/mo level if the population remains stable at 200,000 households? (a) $350 (b) $300 (c) $250 (d) $200 (e) Cannot be determined from the information given.

$250 Rent= -100,000+ 60,000+.3+200,000/80= $250

In the absence of foresight among asset market participants, a growth in demand for real estate assets in the capital market, holding demand in the space usage market constant, will produce which of the following short-run and long-run effects? (a) A short-run increase in property asset prices followed by a subsequent drop (SEE NEXT SLIDE) (b) A short-run decrease in property asset prices followed by a subsequent rise. (c) A short-run increase in rents followed by a subsequent drop. (d) A short-run decrease in rents followed by a subsequent increase.

(a) A short-run increase in property asset prices followed by a subsequent drop (SEE NEXT SLIDE)

Equilibrium between current supply and demand in the space market is reflected by: (a) The prices (rents) and occupancy observed in the market. (b) The amount of new construction in process in the market. (c) The volume of properties bought and sold during the year. (d) A constant long-run marginal cost function.

(a) The prices (rents) and occupancy observed in the market.

The "real estate system" consists of the following three major components: (a) The space market, the capital market, and the mortgage industry. (b) The space market, the asset market, and the development industry. (c) The public equity market, the private equity market, and the debt market. (d) The capital market, the government, and land.

(b) The space market, the asset market, and the development industry.

Back door DSCR approach

1.) find PGI (rentable area* Rent)- Vacancy= EGI 2.) EGI- operating expenses= NOI 3.) Take NOI and DSCR to find the DS. Side 1: Debt service amount/ mortgage constant 1.) -Mortgage constant: plug in rate, amortization*12, FV=0, PV=1 or any number to get your PMT. -Take PMT multiply by 12 to get DS -Mortgage constant= DS/Loan amount (PV=1) 2.) Debt service/ Mortgage constant= Loan amount. (add to total project cost) Side 2: Equity dividend= NOI-DS (from side 1) 1.) Required equity= Equity dividend/ equity dividend rate (required return equity return to investor) Plug side 1 and 2 in to get total project cost. 1.) total project cost- construction costs= supportable site acquisition cost. (Note this is not market value. It is investment value to adjacent property owner).

Which period better captures the collapse of the subprime conduit mortgage market? < 1995 1995 - early 2000s Early 2000s - Middle 2000s 2006 - 2015

2006-2015

Which period better captures a subprime mortgage market economy with only portfolio lenders? < 1995 1995 - early 2000s Early 2000s - Middle 2000s 2006 - 2015

< 1995

Other things being equal, which would have the lowest cap rate? (a) A building with short-term leases in a declining market. (b) A building with long-term leases in a declining market. (c) A building with short-term leases in a stable market. (d) A building with long-term leases in a growing market.

A building with long-term leases in a growing market.

Why City Prime Office Rents would fall if the UK is not able to guarantee similar free-trade conditions than the ones currently in effect with the European Union?

Absence of free-trade agreements means more tariffs and deadweight losses, so London-based companies prefer to relocate to other European capitals and not pay these taxes

Pareto Optimum

Assertion: Under perfect competition, market forces will cause resources to be allocated in such a way that it is impossible to make somebody better off without making someone else worse off. (i.e. perfect competition avoids waste) Perfect market conditions, include... Many buyers and sellers Homogeneous goods Perfect information Assumes: private cost & benefits = public cost & benefits

segmented market

Because both supply and demand are location and type specific, real estate space markets are highly segmented. That is, space markets tend to be local rather than national, and specialized around building usage categories. This is in contrast to nationally integrated markets for homogeneous commodities

Real estate space markets are segmented for all of the following reasons except: (a) Space users require specific locations and types of buildings. (b) Built space is fungible. (c) Buildings cannot move. (d) It is difficult and expensive to change buildings from one usage type to another (e.g., from office to apartment).

Built space is fungible.

Consider two islands, Debtor Island (DI) and Creditor Island (CI), and two goods in both islands, autos and haircuts. Only autos can be traded between the two islands. Also assume that people cannot move across islands. Suppose house prices collapse on DI, and levered losses lead to a sharp decline in spending on cars and haircuts. If wages and prices flexibly adjust:

Cheaper cars on CI because wages fell on DI Manufacturers in CI respond by lower auto prices and wages On CI some autoworkers leave the auto plant and become barbers This pushes down the wage of barbers until wages in the auto industry and the barbershop are equalized

impact on cap rates of Early 2000s: Tech crash, 9/11, China joins the WTO?

China (products go to US) >> U.S (dollars go to China)

What would be the implications of a collapse of the commercial real estate debt market in the U.K. for the office market in London?

Commercial real estate prices will go down

What would be the implications of a collapse of the commercial real estate debt market in the U.K. for the office market in London? Commercial real estate prices will go up Commercial real estate prices will go down Commercial real estate prices will not be affected Commercial real estate prices first go up and then down

Commercial real estate prices will go down

Which period better captures the dominance of the conduit business model in the subprime mortgage market? < 1995 1995 - early 2000s Early 2000s - Middle 2000s 2006 - 2015

Early 2000s - Middle 2000s

Consider the Dinks (double income, no kids). Mr. Dink commutes to a job in the city center (x=0), while Ms. Dink commutes to a suburban subcenter 4 miles east of the city center. The Dinks consume the same quantity of housing at all locations. Travel speed is the same in both directions. Draw the household's housing-price curve up to a distance of seven miles.

From x = 0 to x = 4, the housing-price curve is horizontal because as x increases, the increase in commuting cost for Mr. is exactly offset by a decrease for Ms. For x = 4 to x = 7, commuting costs increase for both Mr. and Ms., so the curve is negatively sloped.

Why Real Estate is Different

Geographically fixed High Externalities Highly Regulated Non-homogeneous Capital Intensive Long economic life Debt financing High transaction costs Custom and tradition

Before Brexit, the Governor of Bank of England, Mark Carney, said that if the "leave" option wins, the return that investors would demand for holding longer-term U.K. government debt—or the term premium—would rise. In the same line, analysts at BlackRock said in a report on Brexit that a 'leave' vote would likely increase gilt yields. What was the economic intuition behind this forecast?

Higher yield is a consequence of higher uncertainty/risk and investor's decision to reallocate their investments towards other regions outside the UK

Consider a city that has vacant land (6,000 square feet of space) ready for development in a neighborhood that is desirable because of its superior schools. There are two types of households, low income (L) and high income (H). Each L-type household is willing to pay $40,000 to live in the neighborhood, and each H-type household is willing to pay $60,000. The preferred lot size is 1,000 square feet for type L, compared to 3,000 square feet for type H. a.) If there are no restrictions on lot sizes, the vacant land in the desirable neighborhood will be allocated to type [ ... ] because ...

If there are no restrictions on lot sizes, the land in the desirable neighborhood will be allocated to type [L] because L has a larger willingness to pay per square foot of land ($40, compared to $20 for H).

In order for the real estate system to function more efficiently and effectively, it is important for: (a) Investors to try to forecast the economy, the space market, development activity, and the capital market. (b) Potential tenants to make their space needs explicitly known to developers. (c) Government regulators not to place too strict requirements on real estate developers. (d) Landlords to treat tenants fairly.

Investors to try to forecast the economy, the space market, development activity, and the capital market.

What is the impact of these decisions on currency markets (USD/EUR)?

It is injecting a lot of Euros into the economy means Euro is abandoned. They are thinking to increase interest rates. To get dollars out of economy the FED should sell T-bills. Euro is abandon and the dollar is scarce. The dollar will then become more expensive. (Dollar appreciates in respect to Euro)

Suppose the economy has been growing, but at some point, for some reason - overbuilding, high interest rates, aliens from outer space, whatever - housing investment tanks. Make an economic reasoning that relates this bad news to a fall in overall consumption, GDP, RRE consumption, CRE consumption, and employment.

Less housing investment decrease house prices. Consumers decide to consume less and save more, in part because the value of their main asset that can be put as collateral in a mortgage decreased, and in part because they have precautionary motives. Because in the U.S., private consumption is the biggest chunk of GDP, usually comprising 65-70 percent of the dollar value in a given year or quarter, less consumption means a lower GDP. Firms sell less so they decide not to hire new workers and not to sign new leases for commercial real estate. So unemployment increases and commercial real estate prices fall.

MSA

MSAs, short for "metropolitan statistical areas", encompass a central city and its surrounding suburbs. Since an MSA tends to be relatively integrated economically, culturally, and socially, it is often used as the primary geographic units of space market segmentation in real estate.

Draw a curve showing the price of office space (per s.f.) within a building, with the horizontal axis measuring the (vertical) distance from the street (in meters) for the following case: People walk up and down stairs, and there are no view amenities.

Negatively sloped and relatively steep price curve.

In the fundamentals view, the interest rate channel is best described as follows:

When spending decreases, interest rates go down as demand for credit decreases with spending. And when the interest rates are low enough, consumers (and specially savers) should be induced to spend more

The liquidity trap occurs

When the nominal interest rate is zero

"Depending on the variable controlled by a land-use policy, the policy may either increase or decrease the price of undeveloped land". The "variable" is the supply of or demand for a particular type of land. Consider a development tax (DT land-use. Fill the blanks in the following statement. A development tax policy [increases, decreases] the [demand for, supply of] __________ land, and [increases, decreases] the equilibrium price of undeveloped land.

a developmental tax policy decreases the demand for land, and decreases the equilibrium price of undeveloped land.

If properties in a certain market are typically selling for prices of $100/SF and they are yielding current annual net income of $8/SF, then the typical "cap rate" prevailing in this market is:

cap rate= $8 SF/ $100 SF= .08=8%

If it costs $300/SF to develop a new class A office building and the annual net rent for office space is $22.5/SF, what is the cap rate that would make additional development feasible?

cap rate= 22.5/300 =.075 =7.5%

One week after the vote, the yield on 10-year British government bonds, called gilts, fell to 0.87%, their lowest levels in modern history. Some analysts correctly forecast gilt yields would fall, because:

domestic investors would seek a haven for cash and international investors would buy bonds in anticipation of the Bank of England cutting the interest rate. Although typically a higher yield is associated to higher uncertainty, bonds yields decreased due to such unexpected high demand for UK bonds.

equity dividend rate

equity dividend (BTCF)/ equity investment

If it costs $300/SF to develop a new class A office building and the annual net rent for office space is $22.5/SF, what is the cap rate that would make additional development feasible? Also, if office buildings are currently selling at an 8% cap rate, what would be the replacement cost rent level?

replacement cost= .08 * 300= $24/ SF

The European Union (EU) is a politico-economic union of 28 member states that are located primarily in Europe. It has an area of 4,324,782 km2 (1,669,808 sq mi), and an estimated population of over 510 million. The EU has developed an internal single market through a standardized system of laws that apply in all member states. EU policies aim to ensure

the free movement of people, goods, services, and capital within the internal market, enact legislation in justice and home affairs, and maintain common policies on trade, agriculture, fisheries, and regional development. A monetary union was established in 1999 and came into full force in 2002, and is composed of 19 EU member states which use the euro currency.

Consider the effects of a growth boundary on the urban land market. Assume the boundary directly affects only residential land, not commercial or industrial land. Arrows up or down: The policy ...... the equilibrium wage (goes up) and ...... equilibrium employment. (down)

we would expect the owners of commercial and industrial land to oppose the boundary because the increases in wages will increase production costs. the policy equilibrium wage goes up and equilibrium employment goes down.

When the predictive power of hard information (e.g., FICO scores) improves and investors' appetite for subprime mortgage-backed securities further increases, The size of the conduit loan market increases with respect to the size of the portfolio loan market, and more consumers get a subprime loan, which in turn boosts house prices and home ownership The size of the portfolio loan market increases with respect to the size of the conduit loan market, and more consumers get a subprime loan, which in turn boosts house prices and home ownership. The size of the conduit loan market increases with respect to the size of the portfolio loan market, but less consumers get a subprime loan, which in turn depresses house prices and home ownership. The size of the portfolio loan market increases with respect to the size of the conduit loan market, but less consumers get a subprime loan, which in turn depresses house prices and home ownership.

The size of the conduit loan market increases with respect to the size of the portfolio loan market, and more consumers get a subprime loan, which in turn boosts house prices and home ownership

Which are the two fundamental markets in commercial real estate? (a) The space market and the asset market. (b) The space market and the money market. (c) The construction market and the land market. (d) The asset market and the stock market.

The space market and the asset market.

Consider two islands, Debtor Island (DI) and Creditor Island (CI), and two goods in both islands, autos and haircuts. Only autos can be traded between the two islands. Also assume that people cannot move across islands. Suppose house prices collapse on DI, and levered losses lead to a sharp decline in spending on cars and haircuts. If wages and prices flexibly adjust: Wages are lower in both DI and CI Wages are lower in both DI and higher in CI Wages are higher in both DI and CI Wages are higher in both DI and lower in CI

Wages are lower in both DI and CI

equity dividend

NOI- Debt service

Adverse selection in the secondary mortgage market occurs when the lender has more information about the borrower's characteristics (e.g., default risk, etc.) than the borrower the borrower has more information about his characteristics (e.g., default risk, etc.) than the lender the lender has more information about the borrower's characteristics (e.g., default risk, etc.) than the secondary market investor the secondary market investor has more information about the borrower's characteristics (e.g., default risk, etc.) than the lender

the lender has more information about the borrower's characteristics (e.g., default risk, etc.) than the secondary market investor

in a mortgage

the lender has the senior claim and the borrower experiences the first losses associated with any decline in house prices

The European Union (EU) is a politico-economic union of 28 member states that are located primarily in Europe. It has an area of 4,324,782 km2 (1,669,808 sq mi), and an estimated population of over 510 million. The EU has developed an internal single market through a standardized system of laws that apply in all member states. EU policies aim to ensure a.) the free movement of people, goods, services, and capital within the internal market, enact legislation in justice and home affairs, and maintain common policies on trade, agriculture, fisheries, and regional development. A monetary union was established in 1999 and came into full force in 2002, and is composed of 19 EU member states which use the euro currency. B.) the free movement of capital within the internal market, enact legislation in justice and home affairs, and maintain common policies on trade, agriculture, fisheries, and regional development. A monetary union was established in 1999 and came into full force in 2002, and is composed of 19 EU member states which use the euro currency.

the free movement of people, goods, services, and capital within the internal market, enact legislation in justice and home affairs, and maintain common policies on trade, agriculture, fisheries, and regional development. A monetary union was established in 1999 and came into full force in 2002, and is composed of 19 EU member states which use the euro currency.

In the question above, suppose the number of apartment units remained at 88,000 while the number of households grew from 200,000 to 220,000. To what level would real rents rise?

Rent= -88,000+ 60,000+.3+220,000/80= 475