Real Estate Fundamentals Final Exam

What is meant by partitioning the internal rate of return? Why is this procedure meaningful? To illustrate what is meant by partitioning the IRR, remember that the IRR is made up of two components of cash flow:

1. cash flow from operations 2. cash flow from the sale of the investment Partitioning the IRR is done to obtain some idea of the relative weights of these components of return and to get an idea of the timing of the receipt of the largest portion of that return. Partitioning the IRR is meaningful because it helps the investor to determine how much of the return is from annual operating cash flow and how much is from the projected resale cash flow. Operating cash flow is generally more certain than projected resale cash flow. Therefore, the greater the proportion of resale cash flow versus operating cash flow, the greater the risk facing the investor. This could be useful in comparing multiple investments.

Name the four general real estate investment styles and describe each. Identify three investment strategies within these general categories and give examples of each.

(4) styles: Core, Core Plus, Value Added, Opportunistic Under Core: The return driver is the current income, 8% - 10% total return. Lower risk, lower return, lower leverage. Office Properties Trophy Properties Gateway Markets Under Core Plus: 12%-16% total return. Some risk, mid-level returns, mid-level leverage. Properties to be re-tenanted Properties needing minor capital improvements Properties to be leveraged Under Value Added: 18%+ total return. Higher risk, higher return, higher leverage. Properties with excess land to be developed Properties to have greater amenities (fitness center, restaurant) Properties needing major improvement (e.g., parking lot expansion, improving elevators) Under Opportunistic: 18%+ total return. Higher risk, higher return, higher leverage. Raw land development Distressed assets Loans in default

How do industrial properties compare with other property types from an investment perspective?

-Less capital intensive. -Short development timeline. -Lower volatility in rental rates and values, lower $/sqft rents, but also lower construction cost/sqft. -Higher quality cash flows at a lower cost basis.

What drives decision-making around various forms of investment structures?

1. Ability to access the capital markets. 2. Desire to be active or passive investors. 3. Desire of investors for limited liability. 4. Liquidity requirements of investors.

What is a NNN (triple net) single-tenant pad site? What are the advantages and how are they priced?

Base Rent: NNN (triple-net): - Rental rate depends on tenant's size, type, and location in the retail center. - Reimbursable expenses are "passed-through" to tenant's pro rata share of Gross Leasable Area (GLA). -Tenants will pay some portion of Common Area Maintenance (CAM). Term: is relative to tenant type -5-10 year base terms for in-line tenants -10-20 year base terms for anchor tenants Pad sites are typically NNN Ground Leases or are sold to users. Selling the pad site allows the developer to get a lot of money back quickly and reduce their cost basis for the land. A long-term NNN ground lease can be taken by the developer and sell it as an investment vehicle that produces bond-like cash flows. Typically, a pad site is located in retail centers and are divided into parcels of 3,000 to 5,000 SF (in larger retail centers) of land and are free-standing retail buildings.

What are some of the types of risk that should be considered when analyzing real estate?

Business/Property/Market Risk Financial Risk Liquidity Risk Inflation Risk Management Risk Interest Rate Risk Legislative Risk Environmental Risk

Why would a pro forma cash flow model of a buyer be different than that of a seller?

Buyers: Will assume high cap rates and will "hammer" the cash flows, meaning having assumptions of lower income growth and higher expense growth. Sellers: Will assume low cap rates and high cash flows and lower expense growth. They want to present the investment with an optimistic outlook. Boils down to different assumptions.

What are the key design features/characteristics in industrial warehouses?

Clear Height: -Distance from floor to bottom of joist or hanging object. -Getting taller over time, ability to stack goods higher due to stacking technology. -Higher Clear heights today require THICKER and FLATTER floors. Truck Courts: -Key is depth from building to outside edge of court. -Apron: area within truck court used for loading and unloading (more durable construction). -Trailer storage can be a critical "plus". -Tenants don't directly pay for truck courts, can be costly. Dock Doors: -Dock-high Doors: four feet above the truck court. (standard tractor-trailer height) -Drive-in doors, ramp doors, rail door. -1 dock high door per 5,000 sf is a good rule of thumb.

How do multifamily properties compare with other property types from an investment perspective?

Complex Design: -High density -Facade design features and variations -Mechanical, electrical, plumbing capacity -Complicated & expensive amenity packages in some markets Complex operations: "Goldilocks Paradox": -When a project is too small: Challenging to have on-site staff. There isn't enough units to spread out property management expenses. -When a project is too large: Leasing against yourself. If renting units daily over a period of time, you could be leasing-up units as units are moving out, creating additional vacancy. Unit Mix: The number of 1 bedrooms, 2 bedrooms, 3 bedrooms and studios. Have to understand what is in demand. What are tenants willing to pay for? Multiple sizes/layouts within each building. -Amenities, room size -Stacking issues: lining up all infrastructure (like plumbing) for efficiency, so all 1 bedrooms and 2 bedrooms aren't in the same place. -Lack of future optionality: similar units cause problems of optionality.

How should we approach modeling risk in a pro forma cash flow model?

Consider what the greatest sensitivities in the pro forma are. Lease rollover risk (uncertainty of renewal by existing tenants), rental rate and expense growth rates (current and future), operating expenses and/or capital improvements, capital structure (cost, structure of debt and equity, fixed rate debt, floating rate debt), purchase risk, exit risk (cap rate and timing). Change a single assumption, what is the effect on NPV or IRR? Use scenario analysis, change multiple assumptions at once. Also you can use specialized software such as ARGUS. It is important to understand the assumptions, and to do that you must really know the market.

What kind of real estate properties/investments are riskier/less risky than others?

Core - Return Driver: Current Income - 8-10% total return, Lower risk, Lower return, Lower leverage (0%-30% LTV) - "Bond replicating cash flows," high quality assets in high quality locations in high quality markets - Fully-leased, well-located office building in Midtown Manhattan Value-Add - Return Driver: Mix of current income & appreciation - 12-16% total return, Some risk, Mid-level returns, Mid-level leverage (30-60% LTV) - Capital or tenant repositioning; asset renovation - Rehab/renovation of 1990's vintage apartment complex in Dallas Opportunistic - Return Driver: Capital appreciation - 18%+ total return, Higher risk, Higher return, Higher leverage (60-80% LTV) - Land speculation, development, or change in use - Development of an industrial distribution center in Reno

What is the main difference between the way a partnership is taxed versus the way a corporation is taxed?

Corporations cannot allocate losses to shareholders. Also, corporations are taxed at the corporate level and shareholders are taxed on dividends they receive. Partnerships are not taxed at the partnership level.

What is the difference between fee simple and leasehold possessory estates?

Fee Simple: The most complete bundle of rights possible and has the greatest value. Subject to limitations imposed by the government or by prior owners, all possible rights of exclusive possession, use and enjoyment, and disposition are possessed by the owner. Leasehold Possessory Estates: are possessory interests. they are limited in time, the right of disposition is diminished because the property ultimately reverts to the landlord, and they are not titled interests. Essentially, they are temporary conveyance of the rights of exclusive possession, use and enjoyment, but not the right of disposition.

How/why has the industrial warehouse market evolved over the past decade?

From goods production to goods distribution. " Just in time" logistics: minimize inventories and storage times - "through put." Explosion of E-commerce: 1/3 of all demand for large industrial space is tied to multi-channel retailers. Global Supply Chain Trends: Growing labor costs in Asia, trade tariffs and volatile fuel costs = increase demand for "on-shoring", and supply chain diversification. Movement towards onshoring back in North America, increasing demand for industrial RE here. Seeing a shift towards multi-story warehouses.

What is an open-end private equity fund? What are the advantages and disadvantages of investing via open-end funds?

Fund that holds an existing portfolio of properties. Investors enter or exit the funds at NAV, akin to a mutual fund of stocks, limited entry and exit periods - the "Queue", there are investment windows, redemption windows. Typically for core investment strategies. Doesn't trade on a market. Advantages: Liquidity (relative to other private real estate options), access to a professionally managed and diversified portfolio, relatively low fees, and can see current portfolio before investing. Disadvantages: Limited control and liquidity may not be available when most desired. This works for institutional investors and it may work for high net worth individuals but it depends on the size of the fund and the fund minimum.

What is the difference between Garden, Podium/Wrap and High-Rise properties in multifamily properties?

Garden: Traditional multifamily, low density. -1 to 3 stories, wood-frame construction. -<40 units/acre. -Typically surface parking. -Need LARGE sites - 10 to 15 acres. -12-to-15-month construction. Podium/Wrap: The wrap has to do with the parking garage. More dense than Garden apartments. Wrap: where the apartments wrap around the parking garage. Podium: where first floor and below ground is where the parking is, parking garage will be concrete and units on top can be wood frame construction. -3 to 7 stories, wood-frame and/or concrete construction (2-6 floors can be wood( construction). -50 to 110 units/acre -Structured garage parking (building wrapping around parking) -Need 2.5-to-5-acre site (don't need as much land & can charge higher rents). -16-to-20-month construction. High Rise: More expensive to build, more complex, all concrete construction. Don't need as much land. -8+ stories, typically 15+ stories. -Concrete construction. -Parking can be under or adjacent. -150 to 200 units/acre. -Need 1-to-3-acre site -20-to-30-month construction. -More expensive land, need higher rents to justify the construction costs.

What are the 4 types of deed and what covenants are associated with them?

General Warranty: 1) Seizin: Has valid title and can convey it. 2) Quiet Enjoyment: Will defend grantee against claims of others. 3) No Encumbrances: No undisclosed restrictions of conflicting claims. Special Warranty: 1) Seizin: Has valid title and can convey it. 2) Quiet Enjoyment: Will defend grantee against claims of others. 3) (LIMITED) No encumbrances Bargain and Sale: 1) (IMPLIED) Seizin 2) (UNKNOWN) Quiet Enjoyment 3) (UNKNOWN) No Encumbrances Quitclaim: Does not have any of the covenants. It is a contract that removes the ability to make any potential claim on the property.

What are the weaknesses of using IRR as a return metric?

IRR tells you nothing about the risk of the project (tenant risk, leasing risk, and cost overrun risk or exit risk). It also doesn't tell you about your expertise in managing the investment or whether the property is well designed and/or well located. The IRR also doesn't tell you the timing of the expected cash flows or the length of the investment period, or the size of the profits generated from the project. Since IRR is a periodic return, it assumes that cash flows will be reinvested at the IRR, not the actual rate investor expect to earn on reinvested cash flows.

Explain the big picture concepts that underlie the fundamental factors of urban land valuation: Density of cities and correlation with rents

If a city grows by increasing its density rather than area, property rent growth will be relatively greater closer to the center of the city.

What is the impact of its liquidity (or lack thereof) on risk in the residential real estate CAPITAL markets? (Think about lenders and/or investors who buy residential mortgages)

Illiquid- can increase risk for lenders and investors who buy residential mortgages. It can be difficult to sell assets quickly, which can lead to a decline in asset prices, causing losses for investors and lenders who are forced to sell assets at a lower price than they paid for them. - lack of transparency in the market --> difficult for investors to assess the true values of assets --> mispricing and further increasing risk. Liquid- can reduce risk for lenders and investors. Allows for quick and easy buying and selling of assets --> stabilizing prices. - can reduce likelihood of losses for investors and lenders. - provide more transparency --> better assessment of asset values --> reducing the likelihood of mispricing.

What are the general requirements regarding income, investments, and dividends with which a REIT must comply to maintain its qualification to be taxed as a REIT?

In general, at least 95 percent of a REITs gross income must be from dividends, interest, rents, or gains from the sale of certain assets. At least 75 percent of gross income must be from rents, interest on obligations secured by mortgages, gains from the sale of certain assets, or income attributable to investments in other REITs. At least 75 percent of the value of a REIT's assets must consist of real estate assets, cash, and government securities. A REIT must distribute 95 percent of its taxable income to shareholders as a dividend.

Explain the big picture concepts that underlie the fundamental factors of urban land valuation: Income growth and patterns of urban growth

Income growth. Allocation of more resources for land. Increased opportunity costs for market participants.

What are the demand drivers for industrial properties?

Industrial demand is a function of ACCESS to: 1) transportation infrastructure 2) population 3) labor. Market Demand is a function of: 1) manufacturing employment 2) transportation employment 3) airfreight volume 4) retail & truck volume.

What factors would result in a property increasing in value over a holding period?

Inflation: This causes rents as well as the final sale price to be higher. Demand: Increased demand for space may increase value if the supply of space doesn't increase as well. Demand: Increased demand by investors for investment properties may increase value if the supply of investment properties doesn't increase as well.

Define retail center rentable area - Gross Leasable Area (GLA)

Interior, enclosed area. Tenants do not pay for the shared areas, but do pay for maintenance of these areas.

Who do direct investment strategies work for? Who do they not work for? What are the pros and cons of direct investment strategies?

Investor has direct ownership of properties. Could involve joint venture with partner who brings specific asset and/or market expertise to partnership. Advantages: Greatest control and overall deal costs lower. Disadvantages: Need in-house expertise and need substantial capital to obtain a diversified portfolio. Might work for a high net worth individual. Probably won't work for institutional investor unless its a very large direct purchase with a high quality lease.

What are some of the potential problems with using a "going-in" capitalization rate that is obtained from previous property sales transactions to value a property being offered for sale today?

Problems occur if properties being used as "comparables" have different lease terms, maturities, and credit quality of tenants. Further, if properties are older, have depreciated, have different functional design, etc. than the subject, problems can occur. In these cases cap rates must be either adjusted to reflect these differences or not used at all.

What are the pros and cons of using single-year ratios in analyzing returns for an investment?

Pros: Quick & easy to compute, easy to understand, and facilitates comparison with similar properties. Cons: No clear benchmarks for acceptable range, only a partial view of performance, no explicit assumptions about future, and reliance could lead to suboptimal investment decisions. Examples of single-year ratios: Profitability ratios: Current NOI return (cap rate), return on cost, current return on asset, current return on equity / "cash on cash" return. Ongoing financial risk ratios: Loan-to-value (LTV), Debt service coverage ratio (DSCR), and Breakeven ratio.

When we talk about institutional investors, who are we talking about?

Public pensions, corporate pensions, foreign sovereign funds, endowments, foundations, life insurance firms, and 401k's.

In general, what effect would a reduction in risk have on "going-in" cap rates? What would this effect be if it occurred at the same time as an unexpected increase in demand? What would be the effect on property values?

A reduction in risk lowers cap rates because expected returns are lower. If this occurred at a time when demand increases, property values would rise significantly because of increases in rents from greater demand and lower cap rates.

What is a risk premium? Why does such a premium exist between interest rates on mortgages and rates of return earned on equity invested in real estate?

A risk premium is a higher expected rate of return paid to an investor as compensation for incurring additional risk on a higher risk investment. In general, investors are considered risk averse and must be compensated more for the higher risk of some investments. This premium exists between mortgage interest rates and returns on equity invested in real estate because the equity investor is assuming more risk than the mortgage lender. The lender assumes less risk because a lender would have first claim on the property should there be a default. If this were not the case, the investor would be better off lending on real estate than investing in it.

Explain the big picture concepts that underlie the fundamental factors of urban land valuation: Size of cities and correlation with rents

All else equal, larger cities will have higher average location rents.

Define and explain the differences between a general/limited partnership, limited liability company and real estate investment trust.

REIT: It is a tax designation for a corporation investing in real estate. Reduces or eliminates taxes. At least 100 shareholders. 75% of gross income from passive sources. 90% of income paid in dividends. General partnership: Equal control and liability. Taxed at individual level. Limited partnership: limited partners only risk investment and have no liability. General partner manages property, makes decisions, and has liability. Both taxes at individual level. Limited Liability Company: Any member can be an active managing partner (can have 1 or more active managing partners). Limits liability. Potentially subject to state franchise taxes and insurance requirements.

Why should we examine a property's returns on both a single-year basis and a total returns basis?

Real estate investments are not typically single-year investments. Annual returns can vary greatly from year to year based on market conditions and/or investor decisions. Returns on a single year basis can help us have a quick look at the property and compare it to other investments.

What is the difference between reimbursable and non-reimbursable operating expenses?

Reimbursable operating expenses are expenses that the tenant has agreed to pay according to the lease. Leases that allow for reimbursable operating expenses are: Modified Gross Leases (pro-rate share of specific expenses, generally electricity), Base Year Expense Stop leases (tenant pays pro-rate share of specific "recoverable" expenses above a lease-specified base year budget), and Triple Net Leases (NNN) (Tenant pays pro-rata share of all "recoverable" expenses. Typically recoverable operating expenses: Cleaning, repairs, maintenance, landscaping, electricity, business taxes, water/sewer, security, management, real estate taxes, insurance, and depreciation allowance. Expenses typically not classified as recoverable: Leasing commissions, property accounting, administrative overhead, financing fees, and capital outlays/tenant improvements.

What is an opportunistic investment strategy? What are the return profiles of opportunistic investment strategies? What are examples of opportunistic investment strategies?

Return driver: Capital appreciation. 18%+ total return. Higher risk, higher return, higher leverage. (60%-80% LTV) Land speculation, development, or change in use. Example: Development of an industrial distribution center in Reno or building an apartment building.

What is a core investment strategy? What are the return profiles of core investment strategies? What are examples of core investment strategies?

Return driver: Current income. 8%-10% total return, lower risk, lower return, lower leverage. (0%-30% LTV) Bond-replicating cash flows. High quality assets in high quality locations in high quality markets. Lower risk cash flow. Example: Fully-leased (say, to Bank of America), well-located office building in midtown manhattan.

What is a value-add investment strategy? What are the return profiles of value-add investment strategies? What are examples of value-add investment strategies?

Return driver: Mix of income and appreciation. 12%-16% total return. Some risk, mid-level returns, mid-level leverage. (30%-60% LTV) Capital or tenant repositioning; asset renovation. Example: Rehab/renovation of 1990s vintage apartment complex in Dallas.

Define and explain the difference between ROFO's and ROFR's in office properties.

Right of First Offer (ROFO): -landlord may ONLY offer negotiated available space for lease to third parties AFTER the tenant fails to respond to ROFO during the period of time provided in the ROFO provision. -"First Look" -More advantageous for tenants if it is structured in a way that the additional space can be leased at current leased rent rate and not have to extend lease term. Right of First Refusal (ROFR): -landlord must grant the tenant the opportunity to match any other incoming lease offers before making a lease to a 3rd party. -"Last Look" -have to match other tenants terms and may have to rent for a much longer term than desired.

Explain the classifications of retail shopping center types.

Strip Center: - convenience-oriented tenant mix. - Trade Area: 1 mile. Neighborhood or Community Center: - typically grocery anchored - in-line tenants depend on anchor for traffic - Trade Area: 3-6 miles. Power Center: - Anchors can occupy up to 90% GLA - Strength of big box anchor is critical to success of the center - Trade Area: 5-10 miles. Regional or Super-Regional Mall: -Anchors occupy 40-50% of GLA - In-line tenants contribute 90% of profits -Trade Area: 10+ miles

How does the risk associated with investment in a partnership differ for the general partner versus a limited partner?

The general partner is personally liable for the debts of the partnership whereas the limited partner has "limited liability" like shareholders in a corporation.

What is meant by equity?

The investor's initial equity in the project is equal to the purchase price less the amount borrowed. The amount of equity an investor has in a property may change over time if the property value and loan balance changes. E.g., if the property value increases and the loan balance is reduced through amortization, the investor's equity increases.

If you are successfully underwriting an investment, should the levered IRR be higher or lower than the unlevered IRR? Why?

The levered IRR should be higher than the unlevered IRR. It would be higher due to positive leverage, which is when the cost of debt is less than the expected return on equity.

What is the difference between a property's Potential Gross Income/Revenue and its Effective Gross Income/Revenue?

The potential gross income is the amount of income a property can generate if fully leased at market rent. The effective gross income is the income after subtracting Vacancy, and Credit & Collection Loss, then adjusting for Loss/Gain to Lease (unique to multifamily), and finally, adding in Other Income and Operating Expense Recovery/Reimbursements.

Should you always just model the current vacancy of a property in a pro forma?

This depends on the property, the economic conditions, the demand in the market, the average vacancy for the property type, if the property will have capital expenditures, etc. If the project will require renovations, the vacancy should be expected to increase while the units are being renovated. If the demand for the property is increasing for the property type and in the market area, then it would be reasonable to expect a decrease in vacancy, or vice versa. Also, it could help to see the history of the property, has the property had a consistent vacancy rate or has it been fluctuating?

When estimating the reversion value in the year of sale, why is the terminal cap rate applied to NOI for the year after the holding period?

When we sell a property the price paid by the next investor is an assessment of income for his or her expected period of ownership. Therefore, for the next investor, or potential buyer, the NOI for his or her first year of ownership will be the year after we sell the property. This will be the first year of his or her investment.

What are the drivers of multifamily demand?

Where people live, work and play. Job & income growth: -4-6 new jobs create demand for 1 unit. Demographics: -Highest demand for multifamily is 18-34 year-olds Household formation: -People are getting married later. Changes in household sizes: -Waiting longer to have children. -Having fewer children or waiting longer to have families increases demand for multifamily. -Decline of home ownership. -Renting is more prevalent in low-income families. -Home prices continue to rise making it less attainable which increases demand for multifamily.

If you are comparing properties for valuation purposes and your comparable has an easement that limits the use of the comparable property and your subject property does not, would the presence of the easement affect your valuation analysis?

Yes, by reducing the value of the comparable because it restricts what you can do to the RE/land.

For air rights to have value, what must you presume?

You have to assume there is demand for the air.

How can government controls in real estate markets (site development standards, zoning ordinances, property tax rates, etc.) affect a property's value, either positively or negatively? (Think broadly)

Zoning Ordinances - can restrict the use of land, which can limit the supply of properties and drive up prices. On the other hand, zoning changes that allow more development can increase supply of properties and lower prices. Property Tax - High property tax rates can make properties less affordable which can lead to lower demand and lower prices. Lower property taxes can make properties more affordable, which can lead to higher demand and higher prices.

How are leasing commissions calculated?

They vary by property type, new leases vs. renewals. They range from one month's rent to 4%-6% of entire rent revenue stream. Paid at rent commencement.

How do office properties compare with other property types from an investment perspective?

-Costly and time-consuming to build, both "shell" and "interior" construction. -Flexibility of interior design: -don't build out until there is a tenant; want flexible design to build what the tenants want. Both a pro and con. -Lengthy tenant occupancy on average. -Cyclical & volatile: People always need housing, but companies don't always need office space.

Explain retail center economics: 1) Base rent 2) Term 3) Reimbursable expenses - CAM 4) Rent as a function of sales 5) Anchor tenants 6) Percentage rent - concept and how to calculate it 7) Retail center leases: Unique lease clauses. Define: -What are use clauses? -What are co-tenancy clauses?

-Base rent is triple net. Rental rates depend on tenant size, type, and location in the center -Term is relative to tenant type: 5-10 year for in-line tenants and 10-20 years for anchor tenants -Reimbursable expenses are passed through to tenants on pro rata share of Gross Leasable Area--includes Common Area Maintenance (CAM), but an increase in center size is not directly proportional to an increase in operating expenses -Rent is a function of sales - Anchor Tenants: drive the success of the center, typically pay little to no base rent, but do pay CAM and Opex. May actually own the anchor property location as a "shadow anchor" where properties can be given to anchors to incentivize them, Anchors carry in-line tenants, who pay a higher rent for access and visibility. Percentage Rent: Aligns the goals of the tenant and the owner. Common to include percentage rent clause, which is relative to theory of industry standards for net margins. -based on percentage of tenant gross sales (4-6% is common)-total rent = base rent or the percentage rent above a "breakpoint" -Rent equals the greater of base rent or percentage rent-breakpoint is natural or artificial. Base rent / % of gross sales in lease = natural break point. Anything over this number is multiplied by the % of gross sales, and added to rent. Use clauses-Narrowly defining use: want to limit the use to build in tenant mix. Build upon synergy.- Exclusive use clause: tenants-exclusive Asian restaurant. -Co-tenancy Clauses: with an Anchor i.e., engraving business or Auntie Anne's Pretzels, if anchor is in continuous operation then smaller business is good, but if anchor closes their store, smaller tenants business will be effected, so they can pay reduced rent or terminate their lease.

If investors are buying real estate assets at either a premium or a discount to that asset's replacement cost, what is the implication about supply and demand in the user/space market, as well as in the real estate capital markets? (Think broadly)

Buying at a PREMIUM to the replacement cost could indicate the market is oversupplied with properties and that the demand for the properties is high. this could be due to strong economy, low unemployment, or a shortage of new construction. Investors may be willing to pay a higher price for properties because they believe that they will be able to rent or sell them at a higher price in the future. This could lead to higher returns for investor. Buying at a DISCOUNT to assets replacement cost could indicate the market is oversupplied with properties and the demand for these properties is low. This could be due to a variety of factors, such as weak economy, high employment, or a glut of new construction. In such a scenario, investors may be able to acquire properties at a lower price than what it would cost to build from scratch. This could also mean that the properties may be difficult to rent or sell, which could lead to lower returns for investors.

Who do indirect fund investment strategies work for? Who do they not work for? What are the pros and cons of indirect fund investment strategies?

Can be a fund level or portfolio investment via a professional investment manager. Selected by investors for expertise in specific markets, geographies, and/or execution strategies. Typically higher investment minimum ($). Typically "blind pools" of capital, manager has discretion on investment selection. Can either be structured as a "closed-end" or "open-end" fund investment. Advantages: Liquidity (relative to other private real estate options), access to a professionally managed and diversified portfolio, relatively low fees, and can see current portfolio before investing. Disadvantages: Limited control (manager chooses what to buy/sell), and liquidity may not be available when most desired.

What is the difference between property maintenance expenses and capital expenditures?

Capital expenditures are expenditures beyond normal maintenance costs. The goal is to maintain and/or improve marketability of property. Maintenance is generally cleaning, repairs, paint, carpet or other flooring repair/replacement, and re-keying units.

Explain the relationships between the various return calculations.

Current NOI Return - helpful to compare market cap rates to measure relative market income return expectations - Annual NOI / All - in acquisition cost Return (Yield) on Cost - Used in RE development analysis, Helpful to compare with market cap rates to measure profitability of development projects - Stabilized Annual NOI / All - in development cost Current Return on Asset - Useful to measure the operational performance of the investment on an annual basis, as if the project was funded with all equity- Current Property Operating CF / All - in Acquisition Cost Current Return on Equity - Useful to measure the performance of the investment on an annual basis at the equity investor level, taking capital structure into account, also referred to as the "Cash on Cash" return - Current CF Available to Equity / Total Equity Investment Breakeven Ratio Breakeven Ratio = Operating expenses + Debt Service / PGI Before Tax Unlevered IRR: return generated by CF from operations and residual proceeds (as if the project was financed with 100% equity) Before Tax Levered IRR: return generated by net CF after debt service and net residual value after repayment of debt balance After Tax Levered IRR: return generated by net CF after income tax and net residual after payment of capital gains tax.

Explain the big picture concepts that underlie the fundamental factors of urban land valuation: Transportation costs and correlation with rents

Declining transportation costs, all else being equal, decrease the relative value of land near the center.

What are the drivers of retail property demand?

Demand Analysis: 1) Employment 2) Consumer Confidence 3) Consumer Balance Sheets 4) Residential Mortgage Activity 5) Energy Costs. -Start by defining the MARKET: you can't just know the tenants; you have to know their customers. -Define competitive advantages. Market Analysis geared to defining "trade area": -Geographic definition of most likely customers. -Primary: drives 80-85% of business traffic -Secondary: 15-20% of business traffic -Tertiary: fringe area and tourist dollars

What are the non-possessory estates?

Easements, licenses, liens, restrictive covenants.

What are the two principal types of REITs?

Equity and mortgage REITs

Why should investors be concerned about market rents if they are purchasing a property subject to leases?

Even if the investment is an existing building that has already been leased, the income can be affected when the existing leases expire and are renewed at the market rent at the time.

What factors affect a property's projected NOI?

Expected market rents and vacancy rates Expenses associated with operating the property Nature of any leases on the property

Classify the different types of lenders and the types of properties they will typically lend on. Why?

Government Agencies - Sources of Capital: retained earnings, government appropriations - Pricing & Leverage: UST + 170-300 bps (fixed rate or floating rate), 45-75% LTV (affordable allows higher leverage) - Notable Lenders: Fannie Mae, Freddie Mac, HUD - Product Appetite: Multifamily and cohesive single family rental product Insurance Companies - Sources of Capital: Insurance policies, annuities - Pricing & Leverage: UST + 160-250 bps (fixed rate), 45-60% LTV, 2-10 year terms - Notable Lenders: Nationwide, State farm, Nuveen, large asset managers (KKR, BX, Apollo) - Product Appetite: Core product with predictable CF Debt Funds (aka Private Credit) - Sources of Capital: Institutional asset allocators, High net worth individuals - Pricing Leverage: Term SOFR + 280-600 bps (floating rate), 55-75% LTV - Notable Lenders: KKR, Blackstone, Apollo, Acore, Benefit Street, Fortress, Argentic - Product Appetite: Transitional assets, stabilized product seeking high leverage Conduit Lenders (CMBS, CLO) - Sources of capital: Private bond buyers -Pricing & Leverage: UST + 250-1000 bps (Fixed rates), pricing depends on tranche (from AAA to unrated), 45-65% LTV - Notable Lenders: Goldman Sachs, Barclays, JP Morgan, Morgan Stanley, Citi - Product Appetite: stabilized, cash flowing assets, usually composition in today's market is as follows today (35% multifamily, 30% industrial, 25% retail, 10% office) Banks (Large and Small) - Sources of Capital: Deposits - Pricing and Leverage: UST/SOFR + 250 - 500 bps (fixed rate or floating rate), 45-65% LTV - Notable Lenders: Money center banks, large regional banks, community banks - Product Appetite: no definitive appetite, relationship driven

What is the difference between gross and net absorption? Explain how to analyze "blocks" of available space.

Gross Absorption: Total square feet leased without regard for vacated space during the same period. Net Absorption: The amount of occupied space at the end of a period LESS the amount of space occupied at the beginning of the same period. -Net absorption accounts for space vacated during the period as well as new additions (ex. new construction) over the applicable period. "Blocks of space" critical to analyze. -look at when leases are expiring and the size of those leases. -Used to know when space will be in demand and when will it be available to understand when and how demand may be satisfied.

Explain the big picture concepts that underlie the fundamental factors of urban land valuation: Option value of land and correlation with growth and uncertainty/certainty

Growth expectations. Faster growth and greater optionality about future users will increase land values. The "option value" of land (zoning changes, new highway, speed of changes, uncertainty attached to those changes).

What is an equity cash flow multiple? How do you calculate it? Why are they important to analyze?

How many multiples of my equity did I made? How many times your investment will be multiplied. It can help provide perspective on your IRR and NPV calculations. To calculate: divide the equity cash flow by the equity investment.

Who do indirect, syndicated investment strategies work for? Who do they not work for? What are the pros and cons of indirect, syndicated investment strategies?

It can be a single asset investment. Often referred to as "country club" investing, equity syndicator raises capital from investors for each acquisition. Advantages: Greater deal selection control for investors and typically less capital required to invest. Disadvantages: Often lack of institutional quality management and transparency, inconsistent deal flow for both syndicator and investors, harder for syndicators to raise capital; timing issues, high fees for investors.

What is a closed-end private equity fund? What are the advantages and disadvantages of investing via closed-end funds?

It has a limited investment horizon - fund "life", generally 7-10 year investment horizons. Investors commit capital, capital is called during investment period (typically up to 2-5 years). Assets are liquidated and capital return by end of fund life. Typically follow value-add or opportunistic strategies. Advantages: Access to expertise in specific areas, investors can choose fund following specific strategy - "mandate", and managers have flexibility to pursue deals. Disadvantages: Lack of liquidity, control for investors. Limited ability for manager to call capital after investment period. Higher fees generally. Potential market/business cycle timing issues.

What is the significance of a debt coverage ratio?

It is a ratio of the NOI to the mortgage payment that indicates the riskiness of a loan. It is the degree to which the NOI from the property is expected to exceed the mortgage payment. Lenders typically want a debt coverage ratio (DCR) to be at least 1.2.

What are Tenant Improvement Allowances (TI's)?

It is the cost incurred by the owners to make the space suitable for the needs of a particular tenant. This is an item that can be negotiated in a lease. Based on market conditions, balance between rent and capital expense. Typically does not cover furniture, equipment of moving expenses. Factors that can influence how much TI a tenant receives: Other concessions negotiated, desirability or creditworthiness of tenant, and condition of space.

Explain office building demand analysis

Market Analysis: -Job growth, economic growth are primary drivers. -Gross and Net absorption. "Blocks of space" critical to analyze. -look at when leases are expiring and the size of those leases. -Used to know when space will be in demand and when will it be available to understand when and how demand may be satisfied. Demand function: 10,000 jobs x 200 sf/employee = 2,000,000 sf needed. Keep in mind that when markets are soft and rents are low, tenants expecting growth may lease more space than they need, inflating the apparent sf/employee, while the reverse may happen when market are tight and rents are high. Site selection keys: 1) Access -freeway -public transportation -"front door" 2) housing -"decision makers" -workers 3) Amenities -restaurants

Explain the differences between market value, investment value and transaction prices.

Market Value: expected selling price, assuming "normal" sale conditions. Value for the "typical" market participants. Investment Value: Value to a particular individual (investor), based on the investor's unique expectations & structure: Capital structure, Tax status, return requirements, Active vs. passive management. Transaction Price: Price actually paid for a specific property, not necessarily the MV.

What are the key issues to consider when investing in multifamily properties?

Market dynamics: Highly cyclical, yet lower volatility. Rent growth can change rapidly. 1) Management intensive operations -high turnover -both tenants and staff -continual leasing 2) Traditional "Catch-22" of low interest rates. -investors would like to buy/build apartments when interest rates are low, but people also want to buy homes when interest rates are low, reducing the number of renters. 3) Lack of optionality. -flexibility once construction begins. -must design the right units for the target renters.

What is the difference between "market" risk and "financial" risk?

Market risk is the macro-economic risk and includes property and tenant risk. Financial risk increases with the amount of debt and includes the cost and structure of debt & equity.

Is a cap rate the same as an IRR? Which is generally greater? Why?

No. The cap rate is the relationship between the investor's Year 1 NOI and the present value of the property at the time the investor acquires the property. The IRR is the return on all future cash flows from the operation and sale of the property. Usually, the IRR is greater than the cap rate.

What is the difference between controllable and non-controllable operating expenses?

Non-controllable operating expenses are things such as real estate taxes and insurance, these expenses are outside of the control of the property management. Controllable expenses are things such as repairs & maintenance, marketing, utilities, payroll and general & administrative expenses. These expenses can be effectively reduced through reducing staff, being more efficient, etc.

How do operating expense reimbursements/recoveries fit into the property's operating cash flow/pro forma?

Operating expenses are line items that are subtracted from EGI to arrive at the NOI.

Explain the cost vs. flexibility in valuing lease options in office properties.

Option values depend on the uncertainty of the underlying "state" variable(s): -Rental rate growth expectations. -Inflationary expectations. -Office market supply and demand dynamics. Value of option today is largely a trade-off between COST and FLEXIBILITY. Two basic assumptions. 1. Expected tenancy is often longer than current lease term. 2. Expected rent payments beyond existing lease are riskier than those within a lease. -These two assumptions are inter-lease risk. Cost: Risk that owners will lose revenue & incur search costs. Search costs: higher leasing commissions & higher tenant improvement allowances. -Risk that tenants will pay moving expenses & disrupt business operations. ** If cost is priority, Owners & Tenants both prefer LONGER lease terms - all else equal. Flexibility: Tenants will consider the uncertainty about future space needs. -Owners will consider the desire to actively manage future rentable area in a dynamic rental market. ** If flexibility is priority, Owners & Tenants both prefer SHORTER lease terms - all else equal.

How do property rights effect property value? (ex: surface, air subsurface rights, fee simple, leasehold, easements, licenses, liens, restrictive covenants.)

Surface of the earth and the improvements you make. Air - can have tremendous value if allowed by the Jurisdiction. The right to use the open space above a property, usually allowing the surface to be used for another purpose. Subsurface - Oil, natural gas, coal, etc., found underground dominant to the surface and subject to remediation & damages to surface owner and can be divided Fee Simple - rights to disposition, use & enjoyment, possession, and exclusion. Leasehold - -UPE rights (use, possession, exclude)-interests revert back to landowner at end of lease Easements - two types, easements "appurtenant" and easements "in gross". Appurtenant is a relationship between two adjacent parcels of land. Gross is unrelated to any other parcel. Licenses - Similar to easement in gross, but conveys permission rather than right (limited purpose, temporary in nature, may be revoked by licensor). Restrictive Covenants - Impose restrictions on land use, requires the owner to either take of abstain from a specific action, typically created as part of a sales transaction or legal creation of a lot. Enforcement only by "parties at interest" Liens - An interest in property as security for an obligation. General liens arise from events unrelated to the property. Specific liens arise from ownership and use of the property.

What are the rights in three dimensons?

Surface, air, subsurface (minerals)

What is the advantage of the limited partnership ownership form for real estate syndications?

The advantage of a limited partnership for real estate syndications is that any losses can be allocated to the partners to reduce their personal taxable income. There is also limited liability for the limited partners.

What is a property's Potential Gross Income/Revenue?

The amount of income a property can generate if fully leased at market rent.

What are the unique development and operating issues with retail properties? ("it's all about that mix...")

The property's success depends upon the individual AND collective success of tenants. It's important upon development to attract anchor stores which drive the success of the retail center. These anchor tenants typically pay little to no base rent but do pay common area maintenance and operating expenses. Some own their location. They carry the in-line tenants, who will pay higher rents to be located near these anchor stores. Have to find tenants that have synergy amongst one another. Some unique operating issues with retail lease terms are the clauses. For example: -Use clauses (only asian restaurant, or a building can only be used for X business, to maintain proper mix.) -Radius clauses (reduces cannibalization, tenant can't open another store within a radius of the leased store) -Continuous operation clauses (kick out clause, store that goes out of business, tenant can pay reduced rent or terminate lease) -co-tenancy clauses. (tenants require another store to be there, otherwise pay reduced rent or terminate lease) Development issues would be changes in consumer preference. The current demand in retail space is open space and entertainment to create more of an experience for consumers. Another challenge is constantly adapting to the rise in e-commerce and catering to mobile pick-up and also using large retail stores as warehouses and distribution centers. The most luxurious of experience drives higher rents for owners.

Explain what load or "Add-on" factors are in office properties.

The proportion of a building's area that is allocated to tenants as non-useable floor area plus building common area. - Restrooms - Corridors - Lobby - Main electrical room, central plant. Load factor is calculated on a per floor basis -Multi-tenant vs. Single Tenant Tenant's rentable area = tenant's usable area * (1+Load factor) Example: 15% of building is common area and building is multi-tenant. Leasing 10,000 usable square feet. Total rentable area will be 10,000 * (1.15). The more efficiently designed a building is, the less the load factor will be and will cause tenants to pay less, allowing the building to be competitive with other office building rents.

How do retail properties compare with other property types from an investment perspective?

The rent is a function of sales in retail. It is common to include percentage rent lease clauses, where it will be based on a percentage of the tenant's gross sales. Percentage-rent: rent relative to theory of industry standards for net margins. Natural breakpoint = Base rent / Lease specified gross sales percentage. Retail property's success depends upon the individual and collective success of the tenants. Need tenants that drive cross-shopping. Retail is highly sensitive to socio-economic trends.

Compare and contrast the residential mortgage market with the commercial real estate mortgage market. Is the residential mortgage market largely more liquid or less liquid? Why?

The tools used in underwriting in the residential mortgage market are the three "C"s. Collateral, Creditworthiness, and capacity to pay. The ratios used are DTI (total housing expense + long-term debt obligations / gross monthly income). Residential generally are fully amortizing loans with fixed or floating interest rates. The residential market also has the Government Sponsored Enterprises (GSEs), such as Fannie Mae, Freddie Mac and Ginnie Mae. They were formed to purchase and securitize residential mortgages. They brought standardization in: Residential mortgage underwriting standards, residential mortgage terms, and residential appraisal forms and practices. They also have increased liquidity of mortgage markets, they are a major source of mortgage funds, no interstate differentials in mortgage interest rates, and no home lending disruptions when interest rates rise. Due to this, there is more liquidity in the residential mortgage market than in the commercial mortgage market. In the commercial mortgage market, the ratios used are DSCR (Annual NOI/Annual Debt Service), LTV (Loan amount/Property value), and Debt Yield (Annual NOI/Loan Amount). Commercial loans can be fully or partially amortizing with varying terms and interest rates structures. Also have short-term financing (<3 years generally) such as construction loans, mini-perm loans, bridge loans and acquisition lines of credit.

What are Common Area Maintenance (CAM) charges?

These are expenses related to common area maintenance of hallways, lobbies, etc. that are usually prorated and passed on to tenants. NOTE: This is typical for retail properties.

Explain the concept of a property's title and how property rights can have value.

Title: Collection of evidence of ownership rights. It defines what are the rights associated with the property and who "holds" them. Other acceptable forms of proof are: 1) Deeds 2) Contracts 3) Wills 4) Other property records (liens, leases, restrictive covenants, court judgments, etc) Chain of title: The sequence of conveyances passing ownership down through time. Real property is a complex bundle of rights. What are the rights and who owns them? Rights are enduring, past transactions affect rights available today. Boundaries are not obvious or natural and can change over time such as rivers moving. Title insurance protects a grantee/owner (or mortgagee/lender) against the legal costs of defending or "curing" title, and against loss of the property in case of an unsuccessful defense. It cannot save a genuinely false title. However, it indemnifies the policyholder against litigation costs, and compensation for loss of the property, should that occur. In many localities, it is customary for the seller to pay for title insurance, though this is negotiable. For a mortgage policy protecting a lender, the borrower pays. Title insurance is unique in that it is paid for through a one-time payment up-front that covers the entire time of ownership, or, for a lender, the time the mortgage exists. There are important limits or exceptions to title insurance. First, it is not hazard insurance; that is, it does not protect the owner from the threat of physical damage to the property. Second, title insurance typically excepts any facts that would be revealed by an inspection and survey of the property.

Explain retail market analysis - trade areas

Trade Area Analysis: 1) Demographics. - "Rooftops": Define those households, what do they look like, how many people are living in them, growth rate of household, income in household, average age, ethnicity, think about how they are spending their money. 2) Economic growth indicators -Job Growth 3) Traffic count and traffic patterns -Current and future -Access, can people get to my site? Define the Trade Area: Think about drive times. 1) Primary Trade Area: 8 minute drive Convenience Retail: -Grocery, Health & Personal Care, Specialty food, Daily goods & services. 2) Secondary Trade Area: 15 minute drive Food and Beverage + Destination Retail: Restaurants, Bars, Entertainment & Cultural, Electronics, Specialty Clothing & Accessories, Home and Garden Supply. Next, conduct a VOID analysis within each Trade Area. -VOID analysis is the process of evaluating market penetration and market gaps, conducting competitor threat analysis, and minimizing cannibalization of consumers. -The size of the Trade Area is determined by the format and size of the store, the population density of its trade area, the level of competitive intensity, and how well its proposition fits the needs of the consumer base.

Why are real estate markets considered to be inefficient from a valuation prospective?

Trades in private, largely unregulated markets. It's capital intensive, largely indivisible and leveraged. Supply is durable and "lumpy" Ability for parties to have asymmetric information. Highly localized markets, valuations.

What are the primary warehouse building types?

Types: 1) Manufacturing 2) Bulk distribution (big box) 3) Regional or local distribution 4) Service Center/Showroom 5) Flex/R&D OR Front Park/Front Load ("light industrial'): car and truck traffic is mixed, good for manufacturing and local distribution, cheapest to build, only has doors and entrances on one side, better building site coverage due to less truck courts and parking. Front Park/Rear Load (Mullet Buildings): car and truck traffic are separate, showroom and finish in front (Business), distribution in the back. Cross Dock/Bulk Distribution: truck court on both sides, mainly for through-put distribution, largest, deepest, and tallest. Essentially 2 front park/front load buildings and can build a wall down the middle to separate. Flex/R&D Industrial ("Value-Office"): very high finish and materiality, most common for local business with a service component to it. Industrial Parks: various industrial building types in one area.

What is the difference between an unlevered and a levered IRR calculation?

Unlevered IRR is the return generated by cash flow from operations and residual proceeds as if the project was financing with 100% equity. Levered IRR is the returns generated by net cash flow and net residual value after repayment of debt balance. The levered IRR calculation should be higher than unlevered IRR.

What is the difference between unlevered cash flow and levered cash flow in a pro forma cash flow model?

Unlevered cash flow is the net operating income of the property after paying capital expenditures, while levered cash flow is the net operating income after paying debt service and capital expenditures.

What is meant by useable versus rentable space?

Usable space: The area actually occupied by the tenant. Rentable space: The usable space plus a share of common area in a property which is included in the load factor. NOTE: This is typical for office buildings.

How do you measure rentable and usable space in office buildings?

Useable Area: -Actual occupiable area of a floor or an office suite -Can vary over the life of a building as corridors expand and contract and as floors are remodeled. Rentable Area: -Useable area PLUS tenant's pro rata share of building in common areas -Excludes vertical penetrations -RENT IS QUOTED ON RENTABLE AREA -Tenants Rentable Area = Tenant's useable area X (1 + Load)

What is the difference between the user and space markets and the capital markets?

User & Space Markets: "The Physical World", location, location, location. User markets are locationally unique! Rents for physically similar space can vary widely across locations & property types. Characterized by competition among users for physical locations and space, Primary Participants: potential occupants, both owner occupants and tenants. The demand for real estate derives from the need that these individuals, firms, and institutions have for convenient access to other locations, as well as for shelter to accommodate their activities. Either own and occupy property or lease property from others. Capital Markets: "The Financial World". Real estate competes for funds in the capital market with other asset classes, such as stocks & bonds. Investors select a mix of investments based on expected risk & returns. Equity Participants: owners of RE; they expect to receive a return on their investment through the collection of rents and through price appreciation.Debt Participants: are the lenders. They hold claims to the interest on borrowed funds that are secured by individuals, businesses, and property. Bidding by investors determines:- Risk free rates of various maturities (i.e., the Treasury "yield" curve)- required risk premiums for risky investments.

Why are they user/space markets highly localized? Why are real estate capital markets not localized?

User/Space/Property markets are locationally unique. Capital markets are made up of a mix of investments.

If investors buy properties based on expected future benefits, what is the rationale for appraising a property without making any income or resale price projections?

Using the direct capitalization approach, this technique is a very simple approach to the valuation of income producing property. The rationale is based on the idea that at any given point in time, the current NOI produced by a property is related to its current market value. A survey of other transactions including sales prices and NOI (NOI ÷ sales prices) indicates the cap rate that competitive investments have traded for. This survey provides cap rates that indicate what investors are currently paying relative to current income being produced.

Explain VOID analysis

Void analysis -evaluating market penetration and market gaps. -competitor threat analysis. -minimizing cannibalization. Size of the trade area is determined by: -the format and size of the store-population density of trade area -competitive analysis: how well its proposition fits the needs of the customer base. Analysis components: -Demographics: "rooftops" (household location and growth), household disposable income, age, number of children, ethnicity, and education. -Economic growth indicators: - job growth -Traffic Count and traffic patterns: current and future. Understanding where the competition is and your other stores.