Real estate Chapter 1

capitalization rate

used to indicate the rate of return that is ecpected to be generated on a real estate investment property

cap rate computation, based on net income that the property is expected to generate and is calculated by dividing net income by property asset value and expressed as a percentage 

account leverage, time value of money or future cash flow

cap rates don’t take into effect these three things

NOI/Price/Value

cap rate equation

in place cap rate

in place income over property value

year one cap rate

measures the proforma NOI (1st year hold period) over value

stabilized cap rate

NOI over value when occuapncy and rents recover

Terminal Cap rate

sale value relative to income expected to be underwritten by a property’s next investor

income capitalization approach, cost approach, sales comparison approach

The role of appraisals

Appraisals

inherently backward looking. historical rents, transactions, occupancy, expenses, cap rates and discount rates

Broker

looks to the current market understanding that the capital markets play a significant role in valuations, and backs into the value after considering all dynamics

difference between BOV and Appraisals 

Appraisals used for all sorts of functions. Neccessary

BOV used for investors and valuing property within the current market place

pension funds

guarantee of retirement funds, do not operate to maximize returns, goals is to ensure that there is enough money to pay retirees

Pension funds allocation

stocks and bonds make up the majority, real estate provides relatively predictable income

Corporate pension funds

set up by employers that pay employees a steady income after they retire, based on factors like their salary and years of service

public pension funds

for public sector employees, funded through employer and employee contributions and managed by the government.

pension fund advisors

job is to track performance, meet with sponsors, recommend opportunities

insurance companies 

13 trillion in assets, deploys capital through: commercial mortgages, commercial mortgage backed securities, equity investments, joint venture, funds

Insurance company strategy

can adjust their real estate exposure as needed, value different opportunities in house, they have patient capital and a conservative approach that has made them a stabilizing force in the CRE market

sovereign wealth funds

gathers enormous pools of capital derived primarily from natural resources, trade surpluses and foreign exchange reserves 

real estate investing a hedge against infation

appreciation in property value, rising rental income, fixed rate debt benefits, scarcity and demand, replacement cost increases, diversification and stability, tax advantages

endowments

manage pools of donated capital, approx 70 billion- 1 trillion in assets, 5-15 of their portfolios in CRE, most flows from private funds into joint ventures- rather than direct ownership

Family offices

approx 140 billion in assets, favorite target for first generation billionaires

individual investors

approximately 1.3 trillion in total assets, REITS used to be the go-to investment for smaller investors

Leverage

one of the most powerful tools in real estate, magnifies returns by reducing the amount of equity needed to control an asset, can amplify the risk as well

leverage function

works by borrowing against an asset to finance ownership

Leverage debt

more debt increases volatility- the use of leverage should be proportional to the borrower’s insight, control, and confidence in market conditions

bank debt

receive investable dollars through deposits, leading them to focus on short term loans

insurance company debt

represent one of the most stable sources of CRE debt capital- focusing on long term, fixed or floating rate loans on high quality assets, control approx 13% of the commercial mortgage market

CMBS Debt

investment banks originate and pool mortgages, rating agencies assign credit ratings based on the quality of the underlying mortgages and subordination within the mortgage pool, and then the investment banks sell bonds to fixed income investors

Loan originators

banks and insurance companies

securitizers

investment banks, mortgage REITs

Investors

pension funds, hedge funds, insurance companies

special services

handle delinquencies or defaulted loans

agency lenders debt

government sponsored entities offer stable, long-term financing for multifamily properties

Frannie Mae

Starting in 1938 by the government brought more liquidity to the market by creating a secondary market, loans originated one area and sold in another, buys FHA loans originated by lenders and either keeps the loans or packages them into pools to be sold by investors

freddie mac

created in 1970 to create and operate a secondary market for conventional mortgages, siezed by congress at the brink of bankruptcy, competes with frannie mae in the market for all types of mortgage backed securities

VA loan program

administered through the department of veteran affairs, part of the GI Bill of rights, mortgage loans with little or no down payment and low interest rates, guarantees the payment from the VA loan program made by a private lender to a qualified veteran should the veteran default

Ginnie mae

formed to fill holes that frannie mae was not filling, provides subsidized loans to lower income borrowers through various FHA programs, guarantees the timely payment of principal interest on FHA and VA mortgages. 

4 risk-return profiles

core, core plus, value add, opportunistic

core real etate

most conservative, stability and predictable income, credit worthy tenants, long term leases, generate steady cash flow with low volatility, investors aim for 7-10% returns, leverage cis conservative, 30 to 45%

core plus real estate

balances income and growth, offering moderate risk profile, high quality and well occupied, high quality and well occupied, may require light improvements, better management or tenant upgrades, demands active involvement, investors expect 8 to 10%, leverage ranges from 40-60%

value add real estate

creating growth by repositioning properties that require significant operational and physical imprvements, may have low intitial occupancy, mangement inefficiencies deferred maintnance or other challenges, requires deep market knowledge and active involvement, investors expect returns from 11 to 18%, leverage ranges from 60 to 75

opportunistic real estate

higheset degree of risk, most aggressive, involve complex ground up developments, distressed properties or repositioning assets, requires significant expertise and resources, highest potential for return, investors expect returns above 18%, leverage usually exceeds 60%

fee simple determinable

type of property ownership that automatically reverts to the original owner if a specific condition is met or not met

fee simple subject to condition subsequent

buyer receives full ownership, but the owner retains the right to reclaim the property if a specific condition is violated

fee simple subject to executory interest

type of land ownership where the current owner’s title can be cut short and automatically transferred to a third part if a specified condition occurs. 

easements

legal right to use another person’s land for a specific purpose such as utilities or a shared driveway.