Fil 260- Topic 17

Front 1

What is the importance of real estate Investing to American Economy rivals that of the stock market?

Back 1

the value of US income-producing real estate is in the multi-trillions of dollars

Front 2

What is Real Estate Investment Trusts (REIT's)?

Back 2

promote diversification and liquidity, and the secondary mortgage market, which has provided the foundation for many new investment products through CMO's and other mortgage-backed investment instruments

Front 3

An individual or institutional investor that buys (takes an equity interest in) an office building, apartment building, or other type of income-producting real estate has traditionally sound financial benefits in the form of (Real Estate Investment on a Stand-Alone Basis)?

Back 3

1. Yearly after-tax cash flows (ATCFs)
2. Eventual after-tax equity reversion (ATER)
3. Positive Financial Leverage
4. Income Tax Benefits

Front 4

What is yearly after-tax cash flows (ATCF's)?

Back 4

amounts left from rental revenues after operating expenses, income taxes, and loan payments have been met

Front 5

What is eventual after-tax equity reversion (ATER)?

Back 5

amount (net of loan principal repaid) received when the investment period ends and the property is sold

**higher if the property appreciates in value during the holding period

Front 6

What do ATCFs and ATER provide the basis for evaluating real estate investments with the discounted cash flow analytical techniques?

Back 6

*Net Present Value
*IRR

Front 7

What is an example of ATCFs, ATER, NPV, IRR?

Back 7

*income producing property for 125,000 (25,000 equity and 100,000 borrowed)
*generate ATCFs of 4,000
*expect to sell property end of yr 5 for 145,000--netting 34,500 as the ATER
*ROE= 16%

EQUATION:
(4000/(1.16)^1)+ (4000/(1.16^2)+(4000/1.16^3)+(4000/1.16^4)+((4000+34,500)/(1.16^5))-25,000 = NPV
NPV= 4523.07

**to find IRR, take out the ROE and set the equation to zero

Front 8

What is the relationship between IRR and NPV?

Back 8

r > cost of capital NPV +
r= cost of capital NPV 0 (helps you set bid, no one gets extra)
r < cost of capital NPV --

Front 9

What is Positive Financial Leverage?

Back 9

benefits from the use of borrowed money, ROE is influenced by the debt/equity financing mix

**leverage- two-edged sword; the fixed-dollar outlay to meet loan payments represents a low relative cost when revenues are high but a high relative cost when revenues are low

Front 10

What is an example of Positive Financial Leverage?

Back 10

**1,000,000 property that produces an after-tax cash flow of 140,000
**if owner pay entire purchase price, ROE =140,000/1,000,000 = 14%
**if owner borrows 50% of purchase (500,000) at a 10% after-tax annual interest cost (50,000), ATCF= 140,000-50,000= 90,000
ROE= 90,000 (ATCF)/500,000 (Equity)= 18%
**if owner borrows 80% of purchase price (800,000), after-tax interest cost riskier loan- 11% (88,000), ATCF= 140,000-88,000= 52,000, ROE= 52,000/200,000= 26%

**however, if the ATCF is only 90,000 then it ROE would be better or higher if you payed the entire purchase with equity money and worse if you borrowed 80%

Front 11

Congress passed the Tax Reform Act of 1986, three aspects of which greatly reduced the tax shelter benefits of real estate that people owned directly (or through partnership arrangements):

Back 11

1. Depreciation- straight-line basis over longer periods , 27.5 years for residential rental property, 39 yrs for non-residential income property
2. At-Risk Rules- investors claim depreciation deductions only based on the dollar amounts that they actually are at risk of losing, amts borrowed by an investor through nonrecourse loans generally don't provide a basis for interest deductions
3. Passive losses- reduce taxable incomes through losses claimed on investments in income-producting real estate only by using these losses to offset income on similar kinds of investments

Front 12

What is a tax-free exchange?

Back 12

an owner who wants to sell investment real estate can gain even better tax treatment by structuring the transaction

**an owner exchanges his parcel for "like-kind" real estate without paying any income tax on the realized increase in value

Front 13

What is the key to constructing an investment portfolio?

Back 13

Diversification

Front 14

In the study of real estate investing, 2 diversification issues arise?

Back 14

1. Diversifying within the real estate asset class itself.
2. Using real estate to further diversify a traditional portfolio of stocks and bonds

Front 15

How do you diversify within the real estate?

Back 15

1. Property types- residential (rental), commercial, industrial, agricultural
2. Geographic regions- areas that appear not to be highly subject to the same economic influences
3. Lease provisions- short-term vs long-term; fixed vs variable rents

Front 16

Using real estate to further diversify a traditional portfolio of stocks and bonds:

Back 16

**returns realized on income-producing real estate haven't been highly correlated with thos realized on stocks and bonds
**casual observation in 2008's turbulent markets was that the value of my broad-based equity REIT index mutual fund shares followed the same general pattern of price movements as did my broad-based common stock index mutual fund shares, but the percentage changes were not the same, although on a gew occasions the price movements were actually in opposite directions

**shouldn't buy a house in your real estate area?

**investor's personal residence should be viewed as part of the investment portfolio in that its value will rise or fall in a manner that is strongly/weakly correlated with other asset value changes

**job skills & Real estate too correlated

Front 17

What is the purpose of the efficient frontier?

Back 17

plots the investment portfolios yielding the highest returns at specified risk levels.

**portfolio including real estate has been found to offer better opportunities in this regard than does one with stocks and bonds alone

**based on risk and std deviation: shift the efficient frontier up and to the left

Front 18

Some real estate investors may place more emphasis on goals:

Back 18

such as owning similar types of property in a small geographic area to keep management costs low and to benefit from knowledge of the local market.

Front 19

What are the two ownership forms in Investment Real Estate?

Back 19

1. Limited Liability Corporations
2. Real Esate Investment Trusts

Front 20

What is a real estate investment trust (REIT)?

Back 20

competitive market has found a way to address the diversification problem through a form of securitization of real estate

**similar to a mutual fund but with a focus on holding equity investments in real estate

**can with a fairly small investment, gain the benefits of professional management and a claim on a diversified, liquid portfolio

Front 21

What is liquidity?

Back 21

enhanced through the sahres of some REIT's being traded on the organized stock exchanges, or held by mutual funds

**Vangaurd has both a traditional index fund and Exchange traded funds (ETF) that hold shares in all US-based equity

Front 22

Early REITs tended to hold portfolios of diverse property types, but mroe recent practice has been to specialize:

Back 22

(become less diversified)- toward acheiving economies of scale in management

Front 23

An equity REIT might specialize in:

Back 23

owning many properties of a particular-type; some common examples are office buildings, warehouses, shopping centers, health care facilities, self-storage facilities, senior housing, hotels, and even prisons

Front 24

REIT is a type of corporation, but it avoids the traditional corporate problem of double taxation if it:

Back 24

1. holds 75% or more of its assets in real estate equity or debt
2. earns 95% or more of its gross income as rent on real estate equity or interest on real estate debt
3. has wide ownership, with at least 100 shareholders while the five largest holders control no more than 50% of the shares
4. pays 90% or more of its earnings each year to its shareholders

Front 25

National Association of Real Estate Investment Trusts (NAREIT) is

Back 25

Rate of return figures are compiled by a trade association

**returns must be estimates, based on periodic reappraisals, since the underlying properties are not sold frequently

Front 26

In the recent financial crisis REIT shares values:

Back 26

generally felly by even greater proportions that did common stocks
**Shares of heavily leveraged Chicago-based General Growth Properties, a REIT owning large retail properties, fell from more than $41 to just over $1 between Nov 2007 and Nov 2008

** this high decline was frustrating and surprising to REIT managers, cuz the steady dividends and the long-term nature of the leases on which REIt cash flows are based had historically kept REIT share values less volatile than those of other equity securities

Front 27

In personal investing in Real Estate: Some practical issues are:

Back 27

1. Unless held in a securitized form, like REIT, real estate is characterized by law liquidity and high transaction costs

**it is difficult to make money if you must pay outside parties to do such work as plumbing repairs, yuard work and general property management

**small investors in real estate typically earn returns both on their capital and on their labor, supplying their own management and maintenance/repairs

Front 28

We might also raise technical portfolio concerns if the returns on someone's human capital skills and financial capital thereby become too closely correlated:

Back 28

high (low) return on both in a strong (weak) rental market

**issue is merely one of correctly analyzing and measuring return on investment
**interesting portfolio question of whether a real estate broker or developer should own a house in the community where she lives

Front 29

One successful residential real estate investor has written of the benefits of owning "horizontal apartments"?

Back 29

buying numerous seperate houses instead of an apartment building

Front 30

Among the advantages citied are the ability to start small and add units over time:

Back 30

the ability to diversify geographically within a local area (some near the college, some near downtown, some near the retail area)
**the ability to offer different types of tenants (lease-with-option-to-buy for the young family, lower rent for the quiet widow than for the rowdy young party animals)
**less difficulty in dealing with tenants (no neighbor disputes to resolve, no instances of tenants taking organized action against the landlord)