Real Estate Finance and Investments Notes
Notes:
-Samenvatting part 1 leren (150 blz, gaan we niet behandelen, wel verplicht)
-Rest van het boek: tentamenstof, wordt behandeld
-slides ook compulsory literature, en wat artikelen (18 ofzo?), wordt ook behandeld
-Articles: not about technicalities, more about understanding
-Guest lectures ook compulsory. En info voor assignments.
-Big assignment: assess value of a building. Kijk ook naar wat er omheen staat, niet alleen gebouw
zelf. Think about users of the property, make alternative scenarios based on different assumptions
about future rent etc. Also, would it be nice to add this building to the portfolio of the pension fund?
Canvas: detailed instructions (9 aspects that have to be addressed).
March 1: draft version
March 3: Q&A session (someone from Vastgoeddata will be here)
March 17: hand in presentation (recorder zoom presentation / powerpoint with
Narration: summary of building plan without technical details)
March 21: hand in peer reviews on 2 presentations
March 24: hand in paper
Part 1 book notes
Supply side of RE is very inelastic. Can react to demand increase but with a great lag (permits,
building, etc.)
Rent renewal:
UK: review / lease end
US: rollover
Heart of city (Paris/London) less elastic building, more volatile rent, more growth of rent during
demand expansion.
As houses aren’t traded as much as securities, prices are influenced by valuations/appraisals, yet
people don’t always believe it is reliable.
Property is very illiquid: expensive to trade, wide bid-offer spreads
Property requires a lot of capital, is not easily diversified and carries a lot of idiosyncratic risk. It is
heterogenous, can do well when markets do badly and vice versa, which is why they provide
diversification if you hold all types of assets (which is a motivation for all types of investors to add RE
to their portfolio). Funds offer a solution to this (like REITS). REITS are also tax-efficient, in countries
where legal systems allow that.
Banks are willing to lend more with property as collateral than with equity, so it’s more leveraged.
This affects (increases) return and risk.
Properties seem related to inflation, so they can provide an inflation hedge.
Risk of property low: rent paid before dividend (/interest?), and real estate has value when empty.
Return volatility is lower than for bonds. So, in total, it’s medium-risk for medium return.
,Real estate returns are cyclical, and cycles usually last 8 to 9 years. Real estate will always be cyclical,
and forgetting this is bad. Low interest rates lead to low cap rates and higher property prices.
Since 1970, there is institutional ownership in real estate (in US), REITS were authorized in 1960.
Every real estate piece is a monopoly of the space it occupies. Moreover, supply is limited by many
factors, such as geography and regulations. Hence, supply and demand don’t explain/predict rent
prices.
Real estate is a derived demand, the space is needed for something else (so, indirect demand).
Gross profit including rent = operational profit + rent (split depends on suitable property and skilled
operator)
Land closer to city is more valuable
Rent is the price of productive space, then demand for productive space is a derivative of the
productive capacity of an economy.
Forecasting rent, two ways:
Technical analysis: establish patterns and trends and assume these will persist in the future (less
reliable)
Causal model: based on theory (more reliable/more used in the book)
All things being equal, if RE supply increases, prices fall
There are 3 real estate markets: occupier, development and investor markets.
The most important is the occupier market, as these drive rents, which impact the investor market
and returns.
There is strong correlation between rental growth and capital value growth.
There is a strong correlation between inflation and rents.
Thünen: concept of location, with reference to transport costs
Fisher: concept of highest and best use
Prices are described in what is commonly called initial yield but should be known as cap rate
Cr0 (cap rate) = NOIi (expected measure of NOI in year 1) / MV0 (market value of the property at time
0)
Cap rate is like an inverse P/E ratio
Gordon’s constant growth model:
initial yield (cap rate) = required return - net income growth
K=R-G
V = I / (R - GN)
,-V = discounted cash flow
We can add depreciation to this model:
I / V = R - GN + D
Rental growth: real and in line with inflation.
So, net income growth (G) = real rental growth expected for buildings in the market (GR) + Inflation
(I) - Depreciation (D)
G = GR + I - D
Nominal rate of rental growth (GN) = GR + I
So, Net income growth (G) = GN - D
Fisher equation: interest rate (required return, R) = reward for liquidity preference (l) + expected
inflation (i) + risk premium (RP)
l = required return on government-issued index-linked bonds (there is a strong empirical relationship
between index-linked bond yields and property yields)
Finally, in equilibrium, and assuming annual growth in rent:
K = R - GN + D
(this is the fundamental cap rate expression)
It is better expressed by:
K = RFRR + I + Rp - (GR + I - D)
-K = initial yield (cap rate)
The delivered return on real estate is produced by the cap rate, plus inflation:
K + i = RFRR + i + Rp
Rp = risk premium
I = expected inflation
Week 1 Introduction
Real estate (US)
Property (UK)
Land & Buildings
Finance and Investment: Development and exploit of real estate
Real estate is also an industry
Biggest industry: housing, then infrastructure, then commercial
, Half of all real estate is held as an investment, other half held by ‘consumers’
Is RE a good investment?
-long run, yes (especially if a city grows)
-hard to provide general rules
-we still don’t know what is really behind the price increase and decrease/belief about the market,
yet they likely do not reflect fundamentals, we think.
-what we do know: location is important
Herengracht index: 3 centuries of prices (at this moment, highest ever)
VVD lives in most expensive part of Amsterdam. General = D66/GL. Poor = DENK.
Week 1 Lecture 1
What determines willingness to pay of an investor?
-investor is profit maximizer, net revenues are important and they originate from the users.
Net present value: difference between willingness to pay and asking price
Separation of ownership and use is common (nog iets)
DCF is common method (founded by Williams in 1938)
Buying an asset: exchange present good (price today) for future good (expected cash flow).
Forward-looking behaviour is needed: expectations are important and uncertainty is key, but not
always explicit. This is related to durability of real estate.
(insert basic valuation formula: second edition!)
(r should be between 6 and 8%, and 10 in bad times?)
Infinity:
P0 = CF/r
-no suffix for CF
-value building = 1/r * yield
-yield CF/P0 is equal to the capitalization rate r (often used with initial cash flow, net or gross initial
yield)
(insert/look over finite sum)
Finite sum = difference between two infinite sums. (If I want to know what I get from now until t, I
take what I get from now until infinity - what I get from t until infinity)
What you get out is the formula for an annuity (think back about Corporate Finance / Bonds)
Practice the example
Gross rental revenue
Notes:
-Samenvatting part 1 leren (150 blz, gaan we niet behandelen, wel verplicht)
-Rest van het boek: tentamenstof, wordt behandeld
-slides ook compulsory literature, en wat artikelen (18 ofzo?), wordt ook behandeld
-Articles: not about technicalities, more about understanding
-Guest lectures ook compulsory. En info voor assignments.
-Big assignment: assess value of a building. Kijk ook naar wat er omheen staat, niet alleen gebouw
zelf. Think about users of the property, make alternative scenarios based on different assumptions
about future rent etc. Also, would it be nice to add this building to the portfolio of the pension fund?
Canvas: detailed instructions (9 aspects that have to be addressed).
March 1: draft version
March 3: Q&A session (someone from Vastgoeddata will be here)
March 17: hand in presentation (recorder zoom presentation / powerpoint with
Narration: summary of building plan without technical details)
March 21: hand in peer reviews on 2 presentations
March 24: hand in paper
Part 1 book notes
Supply side of RE is very inelastic. Can react to demand increase but with a great lag (permits,
building, etc.)
Rent renewal:
UK: review / lease end
US: rollover
Heart of city (Paris/London) less elastic building, more volatile rent, more growth of rent during
demand expansion.
As houses aren’t traded as much as securities, prices are influenced by valuations/appraisals, yet
people don’t always believe it is reliable.
Property is very illiquid: expensive to trade, wide bid-offer spreads
Property requires a lot of capital, is not easily diversified and carries a lot of idiosyncratic risk. It is
heterogenous, can do well when markets do badly and vice versa, which is why they provide
diversification if you hold all types of assets (which is a motivation for all types of investors to add RE
to their portfolio). Funds offer a solution to this (like REITS). REITS are also tax-efficient, in countries
where legal systems allow that.
Banks are willing to lend more with property as collateral than with equity, so it’s more leveraged.
This affects (increases) return and risk.
Properties seem related to inflation, so they can provide an inflation hedge.
Risk of property low: rent paid before dividend (/interest?), and real estate has value when empty.
Return volatility is lower than for bonds. So, in total, it’s medium-risk for medium return.
,Real estate returns are cyclical, and cycles usually last 8 to 9 years. Real estate will always be cyclical,
and forgetting this is bad. Low interest rates lead to low cap rates and higher property prices.
Since 1970, there is institutional ownership in real estate (in US), REITS were authorized in 1960.
Every real estate piece is a monopoly of the space it occupies. Moreover, supply is limited by many
factors, such as geography and regulations. Hence, supply and demand don’t explain/predict rent
prices.
Real estate is a derived demand, the space is needed for something else (so, indirect demand).
Gross profit including rent = operational profit + rent (split depends on suitable property and skilled
operator)
Land closer to city is more valuable
Rent is the price of productive space, then demand for productive space is a derivative of the
productive capacity of an economy.
Forecasting rent, two ways:
Technical analysis: establish patterns and trends and assume these will persist in the future (less
reliable)
Causal model: based on theory (more reliable/more used in the book)
All things being equal, if RE supply increases, prices fall
There are 3 real estate markets: occupier, development and investor markets.
The most important is the occupier market, as these drive rents, which impact the investor market
and returns.
There is strong correlation between rental growth and capital value growth.
There is a strong correlation between inflation and rents.
Thünen: concept of location, with reference to transport costs
Fisher: concept of highest and best use
Prices are described in what is commonly called initial yield but should be known as cap rate
Cr0 (cap rate) = NOIi (expected measure of NOI in year 1) / MV0 (market value of the property at time
0)
Cap rate is like an inverse P/E ratio
Gordon’s constant growth model:
initial yield (cap rate) = required return - net income growth
K=R-G
V = I / (R - GN)
,-V = discounted cash flow
We can add depreciation to this model:
I / V = R - GN + D
Rental growth: real and in line with inflation.
So, net income growth (G) = real rental growth expected for buildings in the market (GR) + Inflation
(I) - Depreciation (D)
G = GR + I - D
Nominal rate of rental growth (GN) = GR + I
So, Net income growth (G) = GN - D
Fisher equation: interest rate (required return, R) = reward for liquidity preference (l) + expected
inflation (i) + risk premium (RP)
l = required return on government-issued index-linked bonds (there is a strong empirical relationship
between index-linked bond yields and property yields)
Finally, in equilibrium, and assuming annual growth in rent:
K = R - GN + D
(this is the fundamental cap rate expression)
It is better expressed by:
K = RFRR + I + Rp - (GR + I - D)
-K = initial yield (cap rate)
The delivered return on real estate is produced by the cap rate, plus inflation:
K + i = RFRR + i + Rp
Rp = risk premium
I = expected inflation
Week 1 Introduction
Real estate (US)
Property (UK)
Land & Buildings
Finance and Investment: Development and exploit of real estate
Real estate is also an industry
Biggest industry: housing, then infrastructure, then commercial
, Half of all real estate is held as an investment, other half held by ‘consumers’
Is RE a good investment?
-long run, yes (especially if a city grows)
-hard to provide general rules
-we still don’t know what is really behind the price increase and decrease/belief about the market,
yet they likely do not reflect fundamentals, we think.
-what we do know: location is important
Herengracht index: 3 centuries of prices (at this moment, highest ever)
VVD lives in most expensive part of Amsterdam. General = D66/GL. Poor = DENK.
Week 1 Lecture 1
What determines willingness to pay of an investor?
-investor is profit maximizer, net revenues are important and they originate from the users.
Net present value: difference between willingness to pay and asking price
Separation of ownership and use is common (nog iets)
DCF is common method (founded by Williams in 1938)
Buying an asset: exchange present good (price today) for future good (expected cash flow).
Forward-looking behaviour is needed: expectations are important and uncertainty is key, but not
always explicit. This is related to durability of real estate.
(insert basic valuation formula: second edition!)
(r should be between 6 and 8%, and 10 in bad times?)
Infinity:
P0 = CF/r
-no suffix for CF
-value building = 1/r * yield
-yield CF/P0 is equal to the capitalization rate r (often used with initial cash flow, net or gross initial
yield)
(insert/look over finite sum)
Finite sum = difference between two infinite sums. (If I want to know what I get from now until t, I
take what I get from now until infinity - what I get from t until infinity)
What you get out is the formula for an annuity (think back about Corporate Finance / Bonds)
Practice the example
Gross rental revenue
