Does the law of one price hold?Equity REIT example- price per share should be equivalent to the NAV net

Real Estate Capital Markets Flashcards Does the law of one price hold?Equity REIT example- price per share should be equivalent to the NAV (net asset value)- But doesn't happen, fluctuates between a premium and a discount What are vacancy rates like today?2024: Q1 Vacancy:- Apt: 6.3%- Ind: 3.9%- Off: 17.7%- Ret: 8.0% What percent of CRE is funded directly through public capital markets (REIT and CMBS) 20%

Office: Class A- Newer structures located in major city centers-

Prestigious tenants and high rents

Apartment: High rise- At least 10-15 stories- Typically located in large city

centers

• Expenses that vary with occupancy. Utilities Maintenance

& supplies Trash and garbage removal

Do not include in operating expenses:

On exam: use cap rate that fits as close as possibleUse terminal vs going in and when to use- going in for V0 = NOI1/R0- terminal for terminal sale value in DCF- use as specific as you can Industrial: Single-user buildings (R&D)- Typically houses specializedproduction plants and factories CRE Classifying ExampleLease

• Since quotedmarket rental ratesdo not take into

consideration differences in treatment of operating expenses, concessions, and time value of money, effective rent is more informative measure of lease income- Effective

Rent: the levelmonthlypayment over the entire lease term

that has the same PV as the lease Determining Effective Rent Limitations of direct cap- Requires high degree of comparability between subject property and comparable sales transactions to estimate market cap rate- Examines 1 year of NOI as primary determinant of value, despite fact that varying lease structures amongst property types can make longer term cash flows an important indicator of property value Basic characteristics of real estate markets - heterogeneous assets- immobile assets- localized markets- segmented markets Retail: Power Shopping Center- High ratio of anchors to ancillary tenants- Contains three or more giants in hard goodretail (e.g., Target, Home

Depot, Walmart)- Size: 250,000 to 1,000,000 sq. ft.- almost

every retailer is an anchor- if one goes bankrupt, still have 12 other anchors

in paper notesLease Clauses: Expenses

Going in vs going out cap ratesWhy?- Terminal cap rate should be higher than the going in cap rate- Because real estate deteriorates so the value is lower

UNLESS the investor spends money on capex

• Gross Lease- Net Lease- Net-net lease- Triple Net leaseOperating Expenses
• Pre-specified rent increases in contract rental rate over

time Example: Rent is $18 per sf per year for 1ST year with

escalation clause of $1 per sf per year for each year thereafter- example in notes Why would you be willing to give free rent for awhile Measures property-level profit, excluding the effects of financing and operating expenses- Similar to an operating company's gross profit margin or can be thought of as the property's "dividend" NOI must be sufficient to PGI- VC+ MI= EGIAbove line vs below line capex

Industrial: warehouseSafe?- Space for temporary storage of goods / inventory or

distribution center- prior to Amazon, was safer bc could easily bring in another tenant if one left, Amazon has complicated that bc they build infrastructure into their warehouses

Office: Class B- Less desirable location- Inefficient layout of leasable

space Retail: Neighborhood Shopping Center- Mostly convenience goods (grocery, barbershop, dry

cleaning)- Often anchored by a grocery store- Size:

50,000-150,000 sq. ft.- people will frequent and go every day- focus is on one anchor and then there's lots of other little stores Tenant pays all operating expensesNote about expected level of operating expenses the expected level of operating expenses is often built into rental rate in gross lease Expense stops

Above line:EGI- OE- Capex= NOI- Most appraisers use

above line: more conservative to make sure you can pay

off the debtBelow line:EGI- OE= NOI- Capex= Net cash

flow- Institutional investors use below line: know capex is a

choice variable and might have a competitive advantage over dealing with it, need to attract investors and make the property look good-We will use below line NOI = Flat Rent ("Straight Lease") Graduated Rent Indexed RentFlat Rent There are generally two levels of claims to bundles of rights/CFs of a commercial real estate asset -Direct Ownership Owner holds legal title of property- Indirect Ownership Trustee holds legal title on behalf of investors (i.e., invest through an intermediary) Retail: Community Shopping Center- Larger version of neighborhood shopping center- Tenants are usually discount department stores, banks, fast food, etc.- people travel here, has destination stores- multiple big anchors Tenant pays property taxes and insurance Triple net lease - tenant perspective

Apartment: midrise- Typically 4-9 stories- Located in both cities and suburbs

(CPIt - CPIt-1) / CPIt-1Indexed rent example Law of One Price-In efficient, integrated markets similar claims to the same underlying CFs should be valued the same

• Expenses that do not vary with occupancy. insurance

property taxes Variable operating expenses Lease clauses and provisions impact the magnitude, timing, and riskiness of the CFs associated with an income producing property Since every clause in a commercial lease can impact the property's operating income and value, landlords and tenants spend considerable time negotiating the following

lease terms:

A few caveats of DCF Example- Despite CFs from the underlying lease being monthly, practitioners will typically aggregate CFs annually to end of year balances- We will start with a constant discount rate, though an argument could be made for allowing discount rate to vary across time- We will need to make an assumption regarding the CF growth from year 5 to year 6 to estimate projected sale price of property at end of Year 5 Commercial property lease usually contains a clause that indicates how the property can be used and...perhaps...how it cannot be used

Use of the Premises: An Anecdote

Ordinary & regular expenditures necessary to keep a property functioning competitively Fixed operating expenses Tenant pays noneNet lease - tenant perspective

• Similar in spirit to valuing a stock using P/E ratio- Recall

from your Equity class: P/E = (Price)/(EPS)- Applying to

CRE:- Find value as a multiple of first year NOI- "Multiplier"

is obtained from observing sales price and income stream of comparable properties Cap rate = Equity assets - private and publicPrivate: Private firms, VC (Equity)Public: Stocks, mutual funds, ETF Capital markets compositionBiggest- Private equity- Private debt- Public equity, public debtSmallest

• Service the mortgage debt on the property AND- Provide

equity investor with an acceptable return on equity Potential Gross Income (PGI) Lower cap rate means- higherrelativevaluation

• if tenants stick around and give future CFs- attract high

quality tenants Indexed rent Heterogeneous assets- each property has unique features Tenant pays property taxesNet net lease - tenant perspective

Apartment: garden- Typically 2-3 stories- Located in suburban areas

We can use effective rents- Make use of time-value of money concepts to facilitate apples-to-apples comparison Effective rent PGI- VC+ MI= EGI- OE= NOIDirect capitalization Parallel asset market setting- This creates "parallel" asset market setting unique to commercial real estate investments . . .-i.e., claims to the cash flows generated by the underlying properties can be actively traded on public exchanges or over the counter via securities