Alternet Investment Reading 32: Real Estate Invest

Page No.I17 Jan 23 ThueDate / /AlternetInvestmentReading 32 o : 0 Rea Estate Invest 5Basic forms of REPrivate MarketPublic marketDirect Invest"Indirect Invest"Equity InvestDebt invest"Equity invest"Debt investPurchasing aLeading moneyInvesting inpropertyto a purchaserREITsCharacteristics of REClassification of REHeterogeneity MeterogeneousUniq REHigh unit valueBonglow Residential :Active mang"Single - -family houses andHigh transaction costmulti family appartmentsDepApartmentNeed for debt CapitalDebtNon residential :illiquidityCommercial properties farmalandDifficulty in price determination& timberlandPr REIT over come some of the problem with direct Invest Page No.2Date//This figure summarizes the basic forms of RE invest" & can beused to identity the invest" anthat best meets investorsobjetivesPublic EquityDebt PublicPublic Indirect Invest operating REMorgage RETTSShares of REOCs Hospitalnotel,MBS (residential & commercial)Share of REITSUnsecured REITS debtother listed trusts MiquiditysmallProfessionalETFInstDebtMang"Index FundsEquityMortgagesDirect Invest"Private debtIndividual , Joint VCBank debtIndirect Invest"PrivateLPPrivate debtForms of commingle d fundsRiskPrivate REITS & REOCSPrivate equsRisk Factors : 1 Demand & SupplyABiz Conditions : Rents & property values depend onnational & local eco variables (ey GDP)BDemographics : Shifts in size & age distribution affect theoftype of property in demandExcess Supply: Demand for commercial property coincides withthebiz Cycle Downt turnsRead to reduction in rentalOF, resulting in lower returns. long lead time2 ValuationA Cost and availability of Capital : RE prices can beaffect by capital market forces. Page No.3Date//B Availability of Info : A lack of info when performingprope ty analysis increases riskc] Lack of liquidity : Due diligence takes time discount. A quick salewill typicallyredasignificantDInt rate : Valuesmaydeclineasintratesrise3 Operational RisksInsurance can mitigate some risksMang" - make Imp operational decisionsLease Terms - Rate may allow inflation to pass throughLeverage - Lenders have a superior claim in a defallESG considerations - Property may be contaminatedob solescence - From changes in tech ( etcMarket distruptions - Affecting demand for REOther risks - Property defectnaturaldisasterterrorismtReasons to Invest in RECurrent income - Rents less exp costs & taxesCapital appreciation - Increasing value booststotalreturnInflation hedge - Rents and values rise with inflationDiversification - Not strongly correlated with otherassetsTax benefits - Favarabletreatment in some countries% of debt does affect Value , bund < RE < stockRole of RE in folioBoth bond & Stock chalacteristicsAt end of lease uncertainty overrenewal 4 future rental ratesLeases: Contractual periodic fixed poq"Affects by : Competitors tenantoverall risk & return profile fallsProb, stat of ecobet debt & equity Page No. 9Date//Factors Influencing ValuationSome factors affect all property typesGDP growthWage growth tvepopulation growth tvRegulations tvl-veJob creation tvTaxesSome factors are unique to indestrial propertiesIndustrial productiongrowthDemandvalueAdvances in logistics trade& transper tationchanging supply routesCommercial Property Typesoffice (Single or multi-tenant)Industrial & warehouse (light & heavy manufacturing)Retail ( Shopping Centers to small stores)Resi dential(single & multifamily)Other : hospitality , restarunt parking recreational etcEach have unique supply demand & intensity of propertymanagement1] OfficeDemand is heavily dependent on job growthSpace per employee (Job flexibility : Home working Change in TechLease length varies around the globe : 3-5 V is commonin the us ; 10 yr in the UK Page No. 5Date/vdulity of EnpOperating RiskGross Lease :- Owners is responsible for paying operating expNet lease :- Tenant is responsible for paying operating expNet lease < Gross lease(Lease TermsTriple net (NNN) = tenant also pays share of Common areamaintenace , Fepairs property tax & insuranceRent review freq2 Industrial and warehouseDemand is driven by the Strength of eco & by GDP growthImport & export activityMajority = Net leases3 RetailConsumer spending : GDP growth Job growth population saving ratesQuality of property , size , & imp of tenant% leases Common Base + % of Sales4Single & Multifamily residentialPopulation growthAge demographics of rentersHome ownership rate's vary internationally Page No. 6Date / /Jun - 23 WedDue DiligenceIncludes :Ongoing IssueLocal market conditionsMainteinance / service agreementLease review and rental historyInspection of title / legal documentotConfirmation of operating expsurveyRenewofCF statementcheck compliance with local lawEnvironmentalreportcodes / regulationPhysical / engineeringinspectionsVerify pay" : tax, insurance letcPrivate RE Indexvolatility & begtolow Correlationlower flag transaction BusdI Appraisal Based Indexvolatility is TansiNCREIR property Index (NPI) : Fundmanagerdata quartedyvalue weight avg of property returns Apprasial lagsNet operating Income = EBITReturn = Nol - Capex +( End MV - Beg MV)Based on transaction dationAPBeg MVCapital return = AMV - CapexBey MVThis return is equivalent to IRRSuch index allowsof RE with other asset classesan investors to compare the performanceGlobal RE Index: A Cap-weighted IndexIncludes local currency returnPublished quarterlyCombines data from NCREIF (us) WNEV (EU) & ANRE U (Asia) Page No. 7Date / /IITransaction - Based Indices leg transactio ntrRepeat sales Index : Repeat sales of the Same property sales- -Multiple sales of the Same property at least two needon- Regression allocates changes in value per quater Period (PR)bet'the.Hedonic index : Req only one Sale- Regression based on value based onconstituentcharacteristic( location size use age etc)varaibleValue = 4 vanablePublic Security indices (of publicly traded sec) by sope coeffientNote :Apprisal -based index allows investors to compare the perfor-manceofREwithotherassetclassesValuation Approaches1 Cost ApproachCost of land purchase and comparable building construction,less depreciationCurrent assumpt-Dep is difficult to measure (more useful for new property)Max potential value obselenanValue of land + Cost of constructing new property- - Ad, for dep &obsolesceneThe Steps involved in applying the cost approach are as follows2Est the M valueof the land2Est the building replacement cost3Make Adj for physical deterioration related to the building's age & condition Page No.8Date//2 Sales Comparision Approach Most Commonadd piem for undesirable attribule 1 disc for desirable SizeSales prices of Comparable properties adj for diffageA range of values would be obtainedtecfeaturesAppraisers need to assess other qualitative factors such aslocation physical condition & age ( & make appropriate adjto the final est)Useful when there are numereous properties similar to thesubject that have been recently sold.3] Highest and best use approachUse of a vacant Site that results in highest impliedland valueTwo Methods : Direct cap method DCF method.Value = PV of expected future income from the propertyExample : Highest & Best UseAn investor is considering a site to build either anapartment building or a shooping center Once contruction isCompleted the apartment building would have an est valueof €50 million and the sdopping center would have anest value of E40 million Construction costs including developerProfit, are est at €45 million for the apartment building &E34 million for the Shopping center .Calculate the highest & best use of the site Page No. 9Date / /AnsShopping mullbe & best use for the site because 6 millionimplied land value Compared to5millionvalueofapartmentApartment BuildingShopping CenterValue when completed50,000,00040,000,000Less: Construction costs45,000,00034,000 , 000Implied land Value5,000,0006,000,0004Incompe Approach - Direct Capitalization ***DDMEBITCapitalization of 41 No1 using capitalizationrate$Rental income if fully occupiedX+ other income+X= Potential gross incomeX- Vanancy g incom e& Collection loss (ey6y.)(x)= Effective gross incomeX- Operating Exp property tax, muinta utility(x)=Netoperating Income (No1) but not Income foxX& interestExample : NolCompute No1 using the following info :- - Property type : office buildingProperty size = 200,000 Sq foot-Gross Rental Income = E 25 per sq foot- Other If income = €75,000- - Vacany & collection loss = 5% of potential gross incomeProperty taxes and insurance = € 350,000 peryr- Utilities & maintence = € 875,000peryr11Agood p Unit g = Disc Rate - Going Cap RatePage No. 6Date//- Interest = € 400,000 Per yr- Income tax rate = 40%Sol" Rentralincomeiffullyoccupied5,000,000+ other income75,000= Potential GI5,075,000- Vacancy&Collection loss (@5%)(253,750)= Effective GI4,821,250- Operating exp(1,225,000)= Nol3,596,250The direct CapitiatizationmethodcalculatesthePV of No1using a cap rate:Disc rate = (r)Vo= DINol,Growth rate in No1=(g)r-gr-gCap Rate = Ro = (r-g)PAT = Terminal CapiateCap rate can also bederivedCap rate=Nol,fromcomparabletransactionsComparable sale priceStabilized No1 Yrif multipleValue NoloeyNo1 is not representativeRuse AvgCrenovations etc)Initial Cap rate,Comparable frantKnown as the going in (ap - rateB used to CoWhenthetenantpaysallexpvalueis7calculatedasValueTentsARY =RentARYAll - risks yieldComparable saleKind of CaplatePrice Page No. 11Date//This valuation is used in case of net lease becauseNo1 = RentExample : Stabilized No1On Jan1. renovations on d shopping center commenced ThisyrNo1isforecestat€ 6mIntheabsenceofrenovations,No1 was expectedtobe€10mNo1 is expected to glowat47Renovat" cost of 4m (10 -6)No1gRenovationswill be completed at the seller's expEst the value of the apartment, assuming investors reqa12% returnRo = I=8YValue = Stabilized Nol, = 10,000 ,000 = 125,000,000Cap rate(0.12 - 0.04)PV of temporary decline in No1 (assumingNo1arise.attheend of the period) :€4,000,000€=3,571,429(1+0.12)Value of apartments post renovation:Value6125,000,000Loss in value during renovation(€3,571,429)Total value€, 121,428,571gxs finitology&neitsfenizonel Page No. 12Date//Example : Valuation with Terminal valueBecause of existing leases the No1 of a ware houseisexpected to be $ / million per the next four yr. Begin the fifth yr, No1 is expected to increase to$1.2 m&grow at 3% annually therafterAssuming investor leg a 13% return calculate the valuethe property today assuming the warehouse is soldofafter four yr.CFo=0Color F=3SolnTheterminalV4 =(Nolsvalue afterfour Yr is : 622=$ 1,200,000= $12,000,00013mg( Cap Rate)(137.-37.)CPT 10.334 mUsing our financial Calculator the value est is ;N= 4; 1/4=130 PMT = 1,000,000; FV 12,000,000 CPTPV= 10,334,296Gross Income Multiplier Tech (GIM)MV = GI X Incompe multiplier (M)Gross Income Multiplier (M) = Sales priceGIIt can be derived from comporable transactionDetermine gross Income multipliecr (M) from comparable propertiesIgnoring Vacany Collection losses & operating exp Page No. 13Date//*DCF MethodForecaste Nol over holding period and terminal value atthe end then disc them back to noIf no growth is expected t then cap rate = disc rateNotesWhen tenant pays all exp I the rate used to value theproperty is ARYAdj are req when the contract rent ( passing or termrent) is not equal to current Market rent (open market rent)Such issue is deal with term & reversion approachUnder this approach contract rent andreversion areappraised separately using diff Cap rateDisc rate on contract rent < Reversion rate because contractrent is less riskyLayer Method :Similar to 'term and reversion approach exceptthat is considered to be perpetual and the secondlayer is the increase in rentThe two methods, result in diff valuationEquivalent Yield :Mathematical (not simple) avg of two Cap rates. Itis the rate at which two methods result in same valuation Page No.19Date//Steps for DCF analysis1Project income from existing leases.2Make assumptions about leaserenewals3Make assumptions about operatingexp4Capital exp5llVacancy6Est resale value7Select appropriate disc rateImportant points in cost & Sales comparison approachesCost approach is appropriate for unsual properties for whichComparables are not easily available.It is also appro priate for a new propertiesSales Comparison approach is appropriate when themarketisactiveIn theory all approaches must produce the same outcome,However,in practice that is not the caseappraiser must reconcile the diff to arrive at a conclusionPrivate real debt InvestUsing debt (leverage) magnifies returnsLeverage : Invest" Return > Int Paidwith leverage there is also an increase in risk Page No. 15Date / /Financial RatiosminDebt serviceCov eiage ratioDSCR = Fist yr NolMaxDebt Service,Loan -to-valueAmort monthyRuties that influenceMax loan amt.pay' X12LTV = Loan amtAppraisal Sale value priceEquity Investors return : Nol - debt ServiceEquity Div Rate=First yr CF(Cash-on-cash return)Equity = sale - LoanPrice amtLeveraged IRR : Consider CFs over holding period,salepriceandoutstanding loanReturnoverentireholdingperiodEquity investors return:Equity div rate = Single period returnITT3TNTot1EquityCFCF2CF3(F4Invest"No1-DSC Sale proceeds - outstanding mortgage principal)Disposal (Fn Page No. 16Date//Example .ARE lender agreed to make a 10% int -only loan onproperty that was recently appraised at €1,200,000 as longas the debt Service Coverage ratio is at least min 1.5 and theloan -to-value ratio does not exceeds 80%max135,000960,000DSisCalculate the max loan amt and equity div rate assumingthe property's No1 is € 135,000 Assumingzero Nol growthCalculate the unleverage & leverageIRR if the propertyis sold for € 1,500 000 at the end of six yrSol" Max loanMax loan using LTV = 80% X 1200,000 = € 960,000lowerMax debt Service using DSCR = 135,000 = 90,000ofMax loan (10% interest only ) = 90,000this1.5Equity = 300,000twovalue0.10=€ 900,000would beEquity Div RateselectedYr \ OF = 135,000 - 90,000= E 45000Equity = 1,200,000 - 900,000= €300,000Equity div rate = 45,000 = 15%300,000Unleveraged IRRToIfT2T3TsTsToItI135,000135K(1200,000)135K135k135K189KNolPV = = - 1, 200 , 000 Page No. 17Date / /PMT = 135,000N= 6FV = 1,500,000CPT1/414.2% > 10%levered IRR willthen undevered(magification of good time)Leveraged IRRtoT,ToT3TnTsTot++145K45K45K45K4KS45K(300,000)No1-90600,000PV = -300,000PMT = 45,000N=6FV = 600,000CPTvy24.1 % >14.21,500,000 - 900000TypesofPubliclyTradedRESecsulepriceleanPublicly Traded RE SecEquityDebtMortage REITSRMBS/CMBSREOC.Equity RESTSMarriote ltdOperatingflexibityREITSClosed. - endTax --advantagedCompanies(trusts)Exempt fromcorporateIncome taxEquity REITSownandmanageincome -producing REMortagesRETs make loansthat use RE as Collateral Page No 18Date / /Real Estate Operating Companies (REOCs)Ordinary Co that own RENot tax advantage Double taxat"Ineligible to organize as REITS :-May - intent to develop and sell RE rather thangeneratingpassive rental income- May allow be based in a Country that simply does nottax - advantaged RElts.Advantage of RElts Vs Direct Invest"Superior liquidity ; Trade on a stock exchLower min invest" : $ not $ millionrTransparency : About Current & historical pricesAccess Predictable earnings : Rental income is fixed by contractsto prem properties: Landmarks etcActive professional mung' : No skill feqDiversification : Single property too expDisdvantage7 High Payoutlow retaintionLimited income growthg = & XROELower diversification benefitRetentionFREIT + equity 1 SpringteLack flexibility ; Invest" retaining incomeEqualApproaches to REITS ValuationI] Net asset valueValue of REIT assets to a private marker buyer Page No. 19Date / /2] Price - to - fund from operations (P / FFO )Most Common multiple used to analyseREITSPrie3Price -to - adj FFO (P/AFFO)multipleAFFO is a better measure of eco income4Disc CF DDMAppried in the same way as of in other industriesTypes of REITSRentail REITS : Aka sloopping center REITsSmall retailers pay greater of fixed rent & % of saleAnchor retailers either pay fixed rent or own their premisesIndustrial REITS: Invest in properties that are used as warehousdistribution centers, manufacturing facilities & small officesThey are long - term leaseStorage REITS : They own and operate self- - Storage properties(mini - warehouses)They are gross leasesRented on monthly basisHotel RELTS : They lease proporties to management CompaniesRev PAR Avy soon rate X Avg occupancyAffected by biz cycle. Page No. 20Date//office REITs : Invest in multi-tenanted office propertiesThey are net leasesResidential REITS : Aka multi-family REITsInvest in rental apartmentsThey are gross leasesThey are one -yr leasesHealth care REITS : Unaffected by recession However t affectedby demographics govt funding etcNAVPS in REITSvaluationNAVPS vs BVPSValue of asset - Liabilitiesstockholder equityBVPS - BV per share# of sharesBased on reported accounting valuesAssets are carried at dep historicalcostoften a poor representation of ecovalueNet asset value per share (NAVPS)Based on assets market valuesNAUPS = REIT assets - liabilities Lpes share)Better measure of funda mental value than BVPSRE be valuedcan by Capitali a Nol R after adj for non cash rentu Page No. 21Date / /NAVPS = MV of asset - MV of liabilities# Sharesif existing appriasals are not available , value of operating REis est by cap Nol ( Rent)Value = Expected NolCap RateNon-Cash Rent : Diff bet" avg rent over the term of contract& Cash rent actually paidIf MPS > NAVPS then REIT is overpai valuedIf MPS < NAVPS then , RELT is undervaluedExample : NAVPS in REIT valuationViany Cestone, CFA is undertaking a valuation of the AncycoshoppingCenter REIT Inc Given the following financial data for Ancyo,est NAVPS based on forecasted Cash net ope NotEst of nxt 12 month growth in No1- 1.25 %Cop rate based on recent comparable transaction - 8%Share outstanding-15 Page No. 22Date / /680171Last 12 months Nol80 80 ex(1+0.0125)Cash & equivalents20235A/c receivable15Total debt2502 30other liability50Non-cash rents2Full-yr adj for acqILend held for future development10Prepaid / othe asset5Sol"Last 12 month Nol80Non -cash rent(2)Full -yr adj for acqIPro forma Cash Not for last 12 month79Next 12 month growthinNo1I79 X 10125Est next 12 months cashNo\80Cap Rate8 %Est value of operating REloap800.08Est value of Operating RE1000Cash & equivalents26Land held for future development10A/c receivableISPrepaid [ other asset5K<<< Page No. 23Date / /Est gross asset value1050Total debt250Other VOO liabilities50Net asset value750Share out standing15Net asset value per share50CalculatingFFO&AFFOCto before WC chang,FFO - Funds from OperationMeasure of operating income of REIT / REOCSAccounting Net earnings (as reported )EPSNormalized+ Dep exp T impairment 1 write - down- Gain (losses) from sales of property +/- Deferred tax exp=FundsfromOperationsFFO(verypopular)Adj funds from operations (AFFO) economic incomeMore accurate measure of current eco incomeAka Cash avail for distribution (CAD) I Funds avail for distribution(FAD)FFO-Non - cash rent adj (straight line a Avy rent )-recurring maintainance - type Capex and leasing commision= AFFO (Adj FFO or FAD or CAD (cash avail for distribution Page No. 24Date / /ExampleEst 12 months Cash No180Last yr actual funds from operation (FFO)70Non - -cash rents5offoRecurring maintainance -type apex15Shares outstanding10office subsector avgP / FFOmultiplelox,office subsector avyP / AFFO multiple14xFFO70Shares outstanding10FFO / share = 70710AFFOFFO70- Non-cash - rents(5)- Recurring maintainance type super(15)AFFO50# Shares10AFFO / share 2 so510Adj FFOAFFO / Share= 50/105Property subsector avgP/AFFOmultiple14x10007-Applying the officesubsector avgP (AFFo multiple of 14x yieldon value per Share of :$5 x14= 70 $ Page No. 25Date//Example : DCFAn asset managerwhoisinterestedindiversifying thefolio She managesthroughaninvest"inanofficebuildingREIT.(rabtreewantstovaluethe potential invest using a DLFapproach&thefollowinginfo(asatend2023)Expectedannualdivnxtyr(2024)5Div growth rate In 2025 & 2026 P2 & D32%Divgrowthrate(from2027into perpetualy )1% (P3)Reg return on equity9%to7,T2T3T3t1t/55.15.2f5-25=TV0.04 -0.01PV forecast div $12.9PV= 65.63PV of terminal value $ 50.681.093Total value63 .58mApproches toREIT/REOCvaluationNAVPSBasedonMVofassetsandliabilitiesLargestComponentoflotrinsicvalue of 9 RELIREC100 Page No. 26Date / /Relative ValueFreq used : P&PFFoAFFOFactors that impact these ratios :-Expectations for growth in FFO / AFFORisk associatedRisk associatedwith underlying REto 9 Capitalwith Company's capital structers &accesshigher leveragelower FFOHigher volutilityFFO AFFODCF 3& AFFOInvestorterm growth forecastsuse 2-stage with near term (intermediate -term longAdvantage of Price MultiplesMultiples are globally accepted in evaluating sharesAllows Comparisons with other invest altFFO est widely avail from reputed data providersSuch as Bloombergie concilationUsed in Conjunction with other factors (eg growth rate) forexplicity accounted for in FFD or AFFO - -need analyst Adjof diff bet REITS Similarly + leverage is notRisPEReconcilationgrowthrate Page No. 27Date / /Disadvantage of Price Multipleey undeveloped landThey are not acceptable for non - income - producing propertiesFFO est do not a/c for maintainence typeCaperOne-time gains & charges can distortFFOAFFOAdvantage of Direct Invest" vs Public RE SecDirect exposure to the RE classDiversificat.Returns dictated by property performanceTax benefits tax benefitsInflation hedgeIliquidity PremIncluded inControl and ability to pursue diverse strategiesLower carcelation with other asset Cuper diversification)classesDisadvantageIlliquidityHigh fees & expHigh min investLow tran ransparencyFewer regulatory protections for investors Vs Public secAppraisals lag actual market valuesHigher returns derived from the use of leverage butRisk