Real estate investment: strategies, structures, decisions
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2021
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| Beschreibung: | XXVIII, 558 Seiten |
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| adam_text | Contents Acknowledgements xxi About the Authors xxiii Preface XXV PART ONE Real Estate as an Investment: An Introduction CHAPTER 1 Real Estate - The Global Asset 1.1 The Global Property Investment Universe 1.2 Market Players 1.2.1 Investors 1.2.2 Fund Managers 1.2.3 Advisors 1.3 Property - Its Character as an Asset Class 1.3.1 Property Depreciates 1.3.2 Lease Contracts Control Cash Flows 1.3.3 The Supply Side is Inelastic 1.3.4 Valuations Influence Performance 1.3.5 Property is Not Liquid 1.3.6 Large Lot Sizes Produce Specific Risk 1.3.7 Leverage is Commonly Used in Real Estate Investment 1.3.8 Property Appears to be an Inflation Hedge 1.3.9 Property is a Medium-Risk Asset 1.3.10 Real Estate Cycles Control Returns 1.3.11 Property Appears to be a Diversifying Asset Specific Risk Leverage Illiquidity Taxes, Currency, and Fees 1.4 Conclusion 3 3 6 6 9 9 11 12 13 13 14 15 16 18 19 21 22 24 27 27 28 28 28 vii
CONTENTS VIII CHAPTER 2 Global Property Markets and Real Estate Cycles, 1950-2020 2.1 Introduction and Background 2.1.1 2.2 The Property Cycle A Performance History 2.2.1 2.2.2 Before 1970: Real Estate Becomes a Medium-Return Asset The 1970s: Inflation, Boom, and Bust The USA The UK 2.2.3 The 1980s: New Investors Flood the Real Estate Capital Market The USA The UK 2.2.4 The 1990s: The Rise of REITs The USA The UK: Deep Recession, Low Inflation, and Globalization 2.2.5 2002-7: A Rising Tide Lifts All Boats The USA The UK 2.2.6 The Global Real Estate Credit Crisis Hits The USA The UK 2.2.7 The Markets Recover Post-crisis 2.3 The Global Market 2.3.1 2.3.2 2.4 The European Market Develops Asia Emerges Real Estate Cycles: Conclusion Lesson 1: Too Much Lending to Property is Dangerous Lesson 2:Yields are Mean-Reverting - Unless Real Risk-Free Rates Change Lesson 3: Look at Yields on Index-Linked CHAPTER 3 Market Fundamentals and Rent 3.1 3.2 Introduction: The Global Property Cycle and Rent The Economics of Rent 3.2.1 3.2.2 Rent and Operational Profits Theories of Rent Ricardo von Thünen Fisher 3.2.3 3.2.4 3.2.5 Rent as the Price of Space Supply Demand The Cyclical Demand for Space The Structural Demand for Space Variations in Locational Demand by Use 33 33 33 34 34 36 36 37 38 38 42 43 43 45 47 47 59 60 60 67 70 72 72 75 80 80 81 ?1 83 83 84 84 86 86 87 89 90 91 93 93 94 95
IX Contents 3.3 3.4 3.2.6 The Relationship Between Rental Value and Rental Income 3.2.7 The Impact of Currency Movements on Rent 3.2.8 Property Rents and Inflation Forecasting Rents 3.3.1 Forecasting National Rents Model Types Price Demand Supply Building the Model An Historical Model A Forecasting Model 3.3.2 Forecasting at the Local Level Conceptual and Modelling Problems Data Issues Conclusion CHAPTER 4 Asset Pricing, Portfolio Theory, and Real Estate 4.1 4.2 4.3 Risk, Return, and Portfolio Theory 4.1.1 Introduction 4.1.2 Rhk and Return 4.1.3 Portfolio Theory The Efficient Frontier 4.1.4 Risk and Competitors 4.1.5 Risk and Liabilities 4.1.6 Property Portfolio Management in Practice The Investment Strategy A Property Appraisal Model 4.2.1 Introduction: The Excess Return 4.2.2 The Cap Rate or Initial Yield - A Simple Price Indicator UK Terminology US Terminology How are Cap Rates Estimated in Practice? Cap Rates are the Inverse of Price/Earnings Ratios What Drives the Cap Rate? 4.2.3 The Fisher Equation 4.2.4 A Simple Cash Flow Model 4.2.5 Gordon’s Growth Model (Constant Income Growth) 4.2.6 A Property Valuation Model Including Depreciation The Model Components 4.3.1 The Risk-Free Rate 4.3.2 The Risk Premium What is Risk? The Capital Asset Pricing Model 4.3.3 Inflation 97 99 99 101 101 101 102 102 102 104 104 105 105 106 106 107 109 109 109 110 111 111 112 113 113 114 115 115 116 116 117 118 118 119 121 121 122 122 123 123 124 124 125 127
CONTENTS x 4.3.4 4.3.5 4.3.6 4.3.7 4.4 The Required Return for Property Assets 4.4.1 The Sector Premium 4.4.2 4.4.3 4.4.4 4.5 The City Premium The Property Premium Example Tenant Tenure Leases Building Location Forecasting Real Estate Returns 4.5.1 4.5.2 4.5.3 4.5.4 4.5.5 4.5.6 4.6 Real Rental Growth Depreciation ‘Correct’ Yields An Analysis in Real Terms The Origin and Uses of Property Forecasts Forecasting Cap Rates Forecasting Property Cash Flows The Portfolio Model Example Fair Value Analysis Conclusion: A Simple Way to Think About Real Estate Returns 128 128 129 129 130 130 131 131 131 131 132 132 132 132 135 135 136 138 138 139 141 141 PART TWO Making Investment Decisions at the Property Level CHAPTER 5 Basic Valuation and Investment Analysis 5.1 Introduction 5.1.1 5.1.2 5.1.3 5.1.4 5.2 Cash Flow Risk and the Discount Rate Determining Price Determining Return Estimating Future Cash Flows 5.2.1 5.2.2 5.2.3 5.2.4 Introduction Holding Period Lease Rent Resale Price Estimated Rental Value at Resale Going-Out Capitalisation Rate 5.2.5 5.2.6 Depreciation Expenses Fees Taxes Debt Finance (Interest) 145 145 146 147 147 148 148 148 149 149 149 150 150 150 152 152 152 153
XI Contents 5.3 5.4 The Discount Rate Conclusion CHAPTER 6 Leasing 6.1 6.2 6.3 6.4 6.5 6.6 159 Introduction Legal Characteristics of Leases The Leasing Process Important Economic Elements of a Lease 6.4.1 The Term of the Lease 6.4.2 Base Rent and Rent Escalation Provisions 6.4.3 Options Renewal Options Expansion, Contraction, and Termination Options 6.4.4 Measurement of Space 6.4.5 Expense Treatment Gross Lease Triple Net Lease 6.4.6 Concessions: Tenant Improvement Allowance and Rental Abatement Tenant Improvement Allowance or Tenant Upfit/Fitout Rental Abatement (Rent-Free Periods) 6.4.7 Brokerage Commissions 6.4.8 Other Key Elements of a Lease 6.4.9 Leasing Differences Across Property Types Lease Economics and Effective Rent 6.5.1 Comparing Leases with Different ExpenseTreatment The Landlord’s Perspective The Tenant’s Perspective 6.5.2 Comparing Leases with Different Concession Allowances Landlord’s Perspective Tenant’s Perspective Conclusions Appendix: Modeling Lease Flexibility In The Uk Example Assumptions Result Explanation CHAPTER 7 Techniques for Valuing Commercial Real Estate and Determining Feasibility: The Unleveraged Case 7.1 7.2 153 156 Introduction Background on the Investment Opportunity 7.2.1 Project Details 7.2.2 Where Do You Find Information About Income and Expenses? 159 160 161 161 162 162 163 163 163 164 165 165 168 170 170 171 172 174 175 177 177 177 178 179 180 181 183 183 185 185 185 186 187 187 188 188 189
CONTENTS XII 7.3 7.4 7.5 7.6 7.7 7.8 Developing a Pro Forma Income Statement 7.3.1 Calculating Total Revenues 7.3.2 Estimating Vacancy Loss 7.3.3 Estimating Operating Expenses 7.3.4 Calculating Net Operating Income Valuation Using Net Operating Income: Single-Year Cash Flow 7.4.1 An Aside on Capitalization Rates Estimating the Market Cap Rate Cap Rates are the Inverse of Price/Earnings Ratios Using Cap Rates to Value the Apartment Project Calculating the Implied Cap Rate for the Apartment Investment Opportunity Investment Analysis Using Operating Income: Multiple-Year Cash Flows 7.5.1 Operating Cash Flows from Leasing 7.5.2 Cash Flows from Disposition Applying Discounted Cash Flow to Analyze Investment Feasibility 7.6.1 Determining Feasibility 7.6.2 Equity Multiple 7.6.3 Partitioning the Internal Rate of Return 7.6.4 Calculating the Maximum Price to Pay Sensitivity Analysis Conclusion CHAPTER 8 Mortgages: An Introduction 8.1 8.2 8.3 8.4 8.5 8.6 Introduction What is a Mortgage? 8.2.1 Promissory Note 8.2.2 Mortgage Instrument The Risks and Returns of Mortgage Investment The Financial Components of a Mortgage 8.4.1 The Bond Component 8.4.2 The Call Option Component 8.4.3 The Put Option Component The Mortgage Menu 8.5.1 Fixed or Floating-Rate Loans 8.5.2 Fully or Partially Amortizing Loans An Introduction to Mortgage Math 8.6.1 Calculating the Monthly Payment 8.6.2 The Mortgage Loan Constant 8.6.3 The Amortization Schedule 190 191 191 192 193 193 194 194 195 195 196 197 197 198 200 200 200 201 202 202 203 205 205 206 206 206 207 208 208 208 209 210 210 211 212 212 213 213
xiii Contents 8.6.4 8.7 8.8 Converting from the Contract Rate to the Compounded Rate 8.6.5 Determining the Cost of Borrowing Borrowing Cost without Up-front Fees Borrowing Costs when the Lender Charges Fees Borrowing Costs when the Loan is Prepaid Prior to Maturity Calculating Prepayment Penalties 8.7.1 Lockout Periods 8.7.2 Step-down Prepayment Penalties 8.7.3 Yield Maintenance Penalties and Yield Calculations 8.7.4 Treasury Flat Prepayment Penalty 8.7.5 Defeasance Conclusion CHAPTER 9 Commercial Mortgage Underwriting and Leveraged Feasibility Analysis 9.1 9.2 9.3 9.4 9.5 Introduction Mortgage Underwriting and the Underwriting Process 9.2.1 Ratios and Rules of Thumb Loan-to-Value Ratio Debt Coverage Ratio Debt Yield 9.2.2 Determining the Maximum Loan Amount Operating Expense Ratio Breakeven Ratio Debt Yield Investment Feasibility with Leverage: Before-Tax Analysis 9.3.1 The Two-Part Nature of Cash Flows: Operating Income and Disposition Income 9.3.2 Financing Impact on Investor Income Statements: Adding Debt Service Cash Flows Income from Disposition 9.3.3 Determining Investment Feasibility: The Leveraged Before-Tax Case Static or Single-Year Measures of Investment Performance Determining Investment Feasibility Using Multiple Year Cash Flows Equity Multiple Partitioning the IRR and NPV Determining the Maximum Price to Pay with Leverage Sensitivity Analysis Conclusion 217 217 217 219 220 220 221 221 222 22 5 228 228 229 229 229 230 230 230 232 232 236 236 237 238 238 238 239 240 240 242 242 242 243 244 245
CONTENTS XIV CHAPTER 10 Real Estate Development 10.1 Introduction 10.2 The Development Process 10.3 Preliminary Analysis of “The Station” Development 10.3.1 “Back-of-the-Envelope” Analysis Estimating Construction Costs Estimating MarketValue 10.3.2 Adding Construction Financing 10.3.3 Sensitivity Analysis 10.4 Formal Analysis of Development of “The Station” 10.5 Budget for “The Station” Office Project 10.6 Financing Development 10.6.1 Stage One: Pre-construction 10.6.2 Stage Two: Construction Construction Loan Calculations 10.6.3 Stage Three: Lease-Up 10.6.4 Stage Four: Operations Lender Yield Calculation for the Construction Loan 10.7 Developer Profit and Return 10.8 Comparison to “Back-of-the-Envelope” Analysis 10.9 A London Office Development Through the Cycle 10.10 Conclusion 247 247 248 250 250 251 251 253 254 257 258 259 260 260 260 263 264 264 265 266 267 274 PART THREE Real Estate Investment Structures CHAPTER Ո Unlisted Real Estate Funds 11.1 Introduction to Unlisted Real Estate Funds 11.1.1 The US Market 11.1.2 The Global Market 11.2 The Growth of the Unlisted Real Estate Fund Market 11.2.1 The Global Unlisted Property Market Universe 11.2.2 How Much Global Real Estate is in Unlisted Funds? 11.3 Unlisted Fund Structures 11.3.1 Open-Ended Funds 11.3.2 Closed-Ended Funds 11.3.3 Funds of Funds 11.4 Characteristics of Unlisted Real Estate Funds 11.4.1 Style 11.4.2 Investment Restrictions 11.4.3 Property Sector and Geographic Focus 277 277 278 278 280 281 283 284 285 286 287 288 288 289 290
Contents 11.5 Liquidity and Valuation Issues 11.5.1 Liquidity 11.5.2 Valuation 11.6 The Case for and Against Unlisted Real Estate Funds 11.6.1 The Case for Unlisted Real Estate Funds Unlisted Real Estate Funds can Diversify Real Estate-Specific Risk Unlisted Funds are Priced by Reference to NAV Unlisted Funds Provide Access to Specialist Managers 11.6.2 The Case Against Unlisted Real Estate Funds The Drawdown Profile Gearing and the J-curve Effect Fees and Performance Persistence Do Trading Prices Track NAV? 11.7 Conclusion XV 291 291 294 294 294 294 294 295 295 295 296 297 297 300 CHAPTER 12 Real Estate Private Equity: Fund Structure and Cash Flow Distribution 12.1 12.2 12.3 Introduction: The Four Quadrants and Private Equity Private Equity Fund Background The Lifecycle of a Private Equity Fund 12.3.1 Initial Fundraising 12.3.2 Acquisition Stage 12.3.3 Asset Management 12.3.4 Portfolio Management 12.3.5 End of Fund Life 12.4 Fund Economics 12.4.1 Management Fees 12.4.2 Limited Partner Distributions Return of Initial Capital Preferred Return Carried Interest Promoted Interest 12.5 Waterfall Structures 12.5.1 Introduction 12.5.2 Pro-rata Investment and Distribution 12.5.3 All Equity Provided by Limited Partner, 80%/20% Carried Interest 12.5.4 Adding a Preferred Return 12.5.5 Return of Capital, Simple Interest Preferred Return, Carried Interest Adding Management Fees 12.5.6 Return of Capital, Compounded Interest Preferred Return, Carried Interest 301 301 303 304 304 305 306 306 307 307 307 307 308 308 308 309 310 310 311 311 312 314 316 317
CONTENTS XVI 12.6 12.7 Private Equity Structures in the Credit Crisis Conclusion CHAPTER 13 Listed Equity Real Estate 13.1 Introduction 13.2 REITs and REOCS 13.3 Listed Funds and Mutual Funds 13.4 Exchange-Traded Funds 13.5 The US REIT Experience 13.5.1 Introduction 13.5.2 Distributions 13.5.3 Measuring REIT Net Income Defining Net Income Funds from Operations 13.5.4 Performance Summary 13.6 The Global Market 13.6.1 The Global Property Company Universe 13.6.2 The Global REIT Universe 13.6.3 TheUKREIT 13.7 REIT Pricing 13.7.1 Using Earnings to Value REITs 13.7.2 Market Capitalization and Net Asset Value 13.7.3 Premium or Discount to NAV? Instant Exposure Liquidity/Divisibility Asset Values are Higher than the Reported NAV Projected Asset Values are Expected to Exceed the Reported NAV Management Skills Tax Debt 13.8 Conclusion CHAPTER 14 Real Estate Debt Markets 14.1 Introduction 14.2 A Brief History Lesson 14.2.1 Banking in the 1960s and 1970s 14.2.2 The Volcker Era of High and Volatile Interest Rates 14.3 Wall Street Act I: The Early Residential Mortgage-Backed Securities Market 14.3.1 The Securitization Process Explained 14.3.2 Lender Profitability from Securitization 319 321 323 323 324 324 325 325 325 326 327 327 329 332 335 335 335 335 338 339 339 340 340 341 342 342 342 342 343 343 343 345 345 347 347 349 349 350 353
Contents 14.4 Wall Street Act II: Senior-Subordinated Securities, the Advent of Structured Finance 14.4.1 The Coast Federal Savings and Loan Deal 14.4.2 Risk and Return Characteristics of the Senior-Subordinated Structures 14.5 Wall Street Act III: The Evolution of StructuredFinance 14.5.1 An Updated Look at the Senior-Subordinated Security 14.5.2 Who Profits from these Transactions? 14.6 Collateralized Debt Obligations 14.7 Mezzanine Debt 14.7.1 Mezzanine: The Background 14.7.2 Mezzanine Structures 14.7.3 A UK Example 14.8 Whole Loans and Synthetic Mezzanine 14.9 Income Strips 14.10 Cash-out Refinancing 14.11 All Good Things Must Come to an End 14.11.1 The Cash-out Refinancing Example Extended 14.12 Post-crisis Recovery 14.12.1 A Final Update to the Cash-out Refinancing Example 14.13 Conclusion xvii 354 354 358 359 359 362 363 365 365 366 368 368 369 371 373 374 381 382 383 PART FOUR Creating a Property Investment Portfolio CHAPTER 15 Building the Portfolio 15.1 The Top-Down Portfolio Construction Process 15.1.1 Introduction 15.1.2 Risk and Return Objectives The Relative Return Target The Absolute Return Target 15.1.3 Benchmarks 15.2 Strengths, Weaknesses, Constraints: Portfolio Analysis 15.2.1 Current Portfolio Structure 15.2.2 Strengths, Weaknesses, Constraints 15.2.3 Structure and Stock Selection 15.3 Portfolio Construction 15.3.1 Top-Down or Bottom-Up? 15.3.2 Mixing Listed and Unlisted Real Estate 15.3.3 Can Real Estate Investors Build Efficient Portfolios? 15.3.4 Possible Approaches Case 1: Large US Endowment Fund Case 2: UK Family Office 15.4 Conclusion 387 387 387
390 392 393 394 394 394 395 395 397 397 398 400 403 403 406 409
xviii CONTENTS CHAPTER 16 International Real Estate Investment: Issues 16.1 Introduction: The Growth of Cross-Border Real Estate Capital 16.2 The Global Real Estate Market 16.2.1 16.2.2 16.2.3 16.2.4 The Global Universe Core, Developing, Emerging Transparency The Limits to Globalisation 16.3 The Case for International Real Estate Investment The Case for International Real Estate Investment: Diversification 16.3.2 The Case for International Real Estate Investment: Enhanced Return 16.3.3 Other Drivers of International Property Investment 411 411 413 413 413 414 414 415 16.3.1 16.4 The Problems 16.4.1 16.4.2 16.4.3 16.4.4 16.4.5 16.4.6 16.5 Introduction Index Replication and Tracking Error Leverage Global Cycles, Converging Markets Execution Challenges Loss of Focus and Specialisation Formal Barriers 16.5.1 Legal Barriers 16.5.2 Capital Controls 16.5.3 Tax 16.6 Informal Barriers 16.6.1 16.6.2 16.6.3 16.6.4 16.6.5 16.6.6 16.6.7 16.6.8 Introduction Currency Risk Legal and Title Risk Liquidity Risk Geographical Barriers Political Risk Cultural Barriers Information Asymmetry 16.7 A Pricing Approach for International Property 16.7.1 Example 16.7.2 Theories of Interest Rates and Exchange Rates The Law of One Price Absolute Purchasing Power Parity Relative Purchasing Power Parity The Monetary Model of Exchange Rates The Fisher Equation Interest Rate Parity Putting Relative Purchasing Power Parity and Interest Rate Parity Together with the Fisher Equation 415 417 418 419 419 419 420 420 421 421 421 421 422 422 425 425 425 426 427 427 428 428 429 429 429 431 431 431 432 432 432 432 432
xix Contents 16.7.3 Putting Theory into Practice 16.7.4 Using Local Excess Returns 16.8 Managing Currency Exposure and Currency Risk 16.8.1 Diversifying 16.8.2 Using a‘Currency Overlay’ 16.8.3 Using Local Debt 16.8.4 Hedging Equity 16.8.5 Leverage, Tax, and Fees 16.9 Building a Portfolio 16.10 Conclusion CHAPTER 17 Performance Measurement and Attribution 17.1 17.2 Performance Measurement: An Introduction Return Measures 17.2.1 Introduction Income Return Capital Return Total Return Time-Weighted Return Internal Rate of Return 17.2.2 Example: IRR, TWRR, or Total Return? IRR or TWRR2 IRR or Total Return? 17.2.3 Required and Delivered Returns The Required Return The Delivered Return 17.2.4 Capital Expenditure Timing of Expenditure 17.2.5 Risk-Adjusted Measures of Performance 17.3 Attribution Analysis: Sources of Return 17.3.1 Changes in Initial Yields 17.3.2 The Combined Impact 17.4 Attribution Analysis: The Property Level 17.5 Attribution Analysis: The Portfolio Level 17.5.1 17.5.2 17.5.3 17.5.4 17.5.5 17.5.6 17.5.7 17.5.8 Introduction The Choice of Segmentation Style Themes City or Metropolitan Statistical Area Selection Two or Three Terms? The Formulae Results from Different Attribution Methods Case 1 Case 2 433 438 441 442 442 443 444 446 447 450 451 451 452 452 453 453 453 454 454 454 456 456 456 456 458 459 460 460 462 462 464 465 467 467 468 469 470 471 471 472 473 474 474
CONTENTS XX 17.6 Attribution and Portfolio Management: Alpha and Beta 17.6.1 Alpha and Beta Attribution: An Introduction 17.6.2 Sources ofAlpha and Beta 17.7 Performance Measurement and Return Attribution for Property Funds 17.7.1 Introduction 17.7.2 The Asymmetry of Performance Fees 17.7.3 An Attribution System for Funds 17.7.4 Alpha and Beta in Property Funds: A Case Study 17.7.5 Unlisted Fund Performance: Empirical Evidence The Data Relative Returns Alpha and Beta Timing: IRR and TWRR IRRs and Vintage Year 17.8 Conclusion CHAPTER 18 Conclusions 18.1 Why Property? 18.2 Lessons Learned 18.2.1 Liquid Structures 18.2.2 Unlisted Funds 18.2.3 International Investing 18.2.4 Best-Practice Real Estate Investing 18.2.5 Pricing 18.3 The Future 18.3.1 The PropTech Explosion 18.3.2 Smart Buildings and ESG 18.3.3 Occupier Markets: Space as a Service 18.3.4 Fractionalization and Liquidity Liquidity and Faster Transactions Tokenization and Fractionalization 18.3.5 Derivatives 18.4 Conclusion 474 474 476 477 477 478 480 482 485 485 486 486 488 488 489 491 491 493 493 494 495 495 496 496 496 499 499 500 500 502 502 504 References 509 Glossary 515 Index 527
Contents Acknowledgements xxi About the Authors xxiii Preface XXV PART ONE Real Estate as an Investment: An Introduction CHAPTER 1 Real Estate - The Global Asset 1.1 The Global Property Investment Universe 1.2 Market Players 1.2.1 Investors 1.2.2 Fund Managers 1.2.3 Advisors 1.3 Property - Its Character as an Asset Class 1.3.1 Property Depreciates 1.3.2 Lease Contracts Control Cash Flows 1.3.3 The Supply Side is Inelastic 1.3.4 Valuations Influence Performance 1.3.5 Property is Not Liquid 1.3.6 Large Lot Sizes Produce Specific Risk 1.3.7 Leverage is Commonly Used in Real Estate Investment 1.3.8 Property Appears to be an Inflation Hedge 1.3.9 Property is a Medium-Risk Asset 1.3.10 Real Estate Cycles Control Returns 1.3.11 Property Appears to be a Diversifying Asset Specific Risk Leverage Illiquidity Taxes, Currency, and Fees 1.4 Conclusion 3 3 6 6 9 9 11 12 13 13 14 15 16 18 19 21 22 24 27 27 28 28 28 vii
CONTENTS VIII CHAPTER 2 Global Property Markets and Real Estate Cycles, 1950-2020 2.1 Introduction and Background 2.1.1 2.2 The Property Cycle A Performance History 2.2.1 2.2.2 Before 1970: Real Estate Becomes a Medium-Return Asset The 1970s: Inflation, Boom, and Bust The USA The UK 2.2.3 The 1980s: New Investors Flood the Real Estate Capital Market The USA The UK 2.2.4 The 1990s: The Rise of REITs The USA The UK: Deep Recession, Low Inflation, and Globalization 2.2.5 2002-7: A Rising Tide Lifts All Boats The USA The UK 2.2.6 The Global Real Estate Credit Crisis Hits The USA The UK 2.2.7 The Markets Recover Post-crisis 2.3 The Global Market 2.3.1 2.3.2 2.4 The European Market Develops Asia Emerges Real Estate Cycles: Conclusion Lesson 1: Too Much Lending to Property is Dangerous Lesson 2:Yields are Mean-Reverting - Unless Real Risk-Free Rates Change Lesson 3: Look at Yields on Index-Linked CHAPTER 3 Market Fundamentals and Rent 3.1 3.2 Introduction: The Global Property Cycle and Rent The Economics of Rent 3.2.1 3.2.2 Rent and Operational Profits Theories of Rent Ricardo von Thünen Fisher 3.2.3 3.2.4 3.2.5 Rent as the Price of Space Supply Demand The Cyclical Demand for Space The Structural Demand for Space Variations in Locational Demand by Use 33 33 33 34 34 36 36 37 38 38 42 43 43 45 47 47 59 60 60 67 70 72 72 75 80 80 81 ?1 83 83 84 84 86 86 87 89 90 91 93 93 94 95
IX Contents 3.3 3.4 3.2.6 The Relationship Between Rental Value and Rental Income 3.2.7 The Impact of Currency Movements on Rent 3.2.8 Property Rents and Inflation Forecasting Rents 3.3.1 Forecasting National Rents Model Types Price Demand Supply Building the Model An Historical Model A Forecasting Model 3.3.2 Forecasting at the Local Level Conceptual and Modelling Problems Data Issues Conclusion CHAPTER 4 Asset Pricing, Portfolio Theory, and Real Estate 4.1 4.2 4.3 Risk, Return, and Portfolio Theory 4.1.1 Introduction 4.1.2 Rhk and Return 4.1.3 Portfolio Theory The Efficient Frontier 4.1.4 Risk and Competitors 4.1.5 Risk and Liabilities 4.1.6 Property Portfolio Management in Practice The Investment Strategy A Property Appraisal Model 4.2.1 Introduction: The Excess Return 4.2.2 The Cap Rate or Initial Yield - A Simple Price Indicator UK Terminology US Terminology How are Cap Rates Estimated in Practice? Cap Rates are the Inverse of Price/Earnings Ratios What Drives the Cap Rate? 4.2.3 The Fisher Equation 4.2.4 A Simple Cash Flow Model 4.2.5 Gordon’s Growth Model (Constant Income Growth) 4.2.6 A Property Valuation Model Including Depreciation The Model Components 4.3.1 The Risk-Free Rate 4.3.2 The Risk Premium What is Risk? The Capital Asset Pricing Model 4.3.3 Inflation 97 99 99 101 101 101 102 102 102 104 104 105 105 106 106 107 109 109 109 110 111 111 112 113 113 114 115 115 116 116 117 118 118 119 121 121 122 122 123 123 124 124 125 127
CONTENTS x 4.3.4 4.3.5 4.3.6 4.3.7 4.4 The Required Return for Property Assets 4.4.1 The Sector Premium 4.4.2 4.4.3 4.4.4 4.5 The City Premium The Property Premium Example Tenant Tenure Leases Building Location Forecasting Real Estate Returns 4.5.1 4.5.2 4.5.3 4.5.4 4.5.5 4.5.6 4.6 Real Rental Growth Depreciation ‘Correct’ Yields An Analysis in Real Terms The Origin and Uses of Property Forecasts Forecasting Cap Rates Forecasting Property Cash Flows The Portfolio Model Example Fair Value Analysis Conclusion: A Simple Way to Think About Real Estate Returns 128 128 129 129 130 130 131 131 131 131 132 132 132 132 135 135 136 138 138 139 141 141 PART TWO Making Investment Decisions at the Property Level CHAPTER 5 Basic Valuation and Investment Analysis 5.1 Introduction 5.1.1 5.1.2 5.1.3 5.1.4 5.2 Cash Flow Risk and the Discount Rate Determining Price Determining Return Estimating Future Cash Flows 5.2.1 5.2.2 5.2.3 5.2.4 Introduction Holding Period Lease Rent Resale Price Estimated Rental Value at Resale Going-Out Capitalisation Rate 5.2.5 5.2.6 Depreciation Expenses Fees Taxes Debt Finance (Interest) 145 145 146 147 147 148 148 148 149 149 149 150 150 150 152 152 152 153
XI Contents 5.3 5.4 The Discount Rate Conclusion CHAPTER 6 Leasing 6.1 6.2 6.3 6.4 6.5 6.6 159 Introduction Legal Characteristics of Leases The Leasing Process Important Economic Elements of a Lease 6.4.1 The Term of the Lease 6.4.2 Base Rent and Rent Escalation Provisions 6.4.3 Options Renewal Options Expansion, Contraction, and Termination Options 6.4.4 Measurement of Space 6.4.5 Expense Treatment Gross Lease Triple Net Lease 6.4.6 Concessions: Tenant Improvement Allowance and Rental Abatement Tenant Improvement Allowance or Tenant Upfit/Fitout Rental Abatement (Rent-Free Periods) 6.4.7 Brokerage Commissions 6.4.8 Other Key Elements of a Lease 6.4.9 Leasing Differences Across Property Types Lease Economics and Effective Rent 6.5.1 Comparing Leases with Different ExpenseTreatment The Landlord’s Perspective The Tenant’s Perspective 6.5.2 Comparing Leases with Different Concession Allowances Landlord’s Perspective Tenant’s Perspective Conclusions Appendix: Modeling Lease Flexibility In The Uk Example Assumptions Result Explanation CHAPTER 7 Techniques for Valuing Commercial Real Estate and Determining Feasibility: The Unleveraged Case 7.1 7.2 153 156 Introduction Background on the Investment Opportunity 7.2.1 Project Details 7.2.2 Where Do You Find Information About Income and Expenses? 159 160 161 161 162 162 163 163 163 164 165 165 168 170 170 171 172 174 175 177 177 177 178 179 180 181 183 183 185 185 185 186 187 187 188 188 189
CONTENTS XII 7.3 7.4 7.5 7.6 7.7 7.8 Developing a Pro Forma Income Statement 7.3.1 Calculating Total Revenues 7.3.2 Estimating Vacancy Loss 7.3.3 Estimating Operating Expenses 7.3.4 Calculating Net Operating Income Valuation Using Net Operating Income: Single-Year Cash Flow 7.4.1 An Aside on Capitalization Rates Estimating the Market Cap Rate Cap Rates are the Inverse of Price/Earnings Ratios Using Cap Rates to Value the Apartment Project Calculating the Implied Cap Rate for the Apartment Investment Opportunity Investment Analysis Using Operating Income: Multiple-Year Cash Flows 7.5.1 Operating Cash Flows from Leasing 7.5.2 Cash Flows from Disposition Applying Discounted Cash Flow to Analyze Investment Feasibility 7.6.1 Determining Feasibility 7.6.2 Equity Multiple 7.6.3 Partitioning the Internal Rate of Return 7.6.4 Calculating the Maximum Price to Pay Sensitivity Analysis Conclusion CHAPTER 8 Mortgages: An Introduction 8.1 8.2 8.3 8.4 8.5 8.6 Introduction What is a Mortgage? 8.2.1 Promissory Note 8.2.2 Mortgage Instrument The Risks and Returns of Mortgage Investment The Financial Components of a Mortgage 8.4.1 The Bond Component 8.4.2 The Call Option Component 8.4.3 The Put Option Component The Mortgage Menu 8.5.1 Fixed or Floating-Rate Loans 8.5.2 Fully or Partially Amortizing Loans An Introduction to Mortgage Math 8.6.1 Calculating the Monthly Payment 8.6.2 The Mortgage Loan Constant 8.6.3 The Amortization Schedule 190 191 191 192 193 193 194 194 195 195 196 197 197 198 200 200 200 201 202 202 203 205 205 206 206 206 207 208 208 208 209 210 210 211 212 212 213 213
xiii Contents 8.6.4 8.7 8.8 Converting from the Contract Rate to the Compounded Rate 8.6.5 Determining the Cost of Borrowing Borrowing Cost without Up-front Fees Borrowing Costs when the Lender Charges Fees Borrowing Costs when the Loan is Prepaid Prior to Maturity Calculating Prepayment Penalties 8.7.1 Lockout Periods 8.7.2 Step-down Prepayment Penalties 8.7.3 Yield Maintenance Penalties and Yield Calculations 8.7.4 Treasury Flat Prepayment Penalty 8.7.5 Defeasance Conclusion CHAPTER 9 Commercial Mortgage Underwriting and Leveraged Feasibility Analysis 9.1 9.2 9.3 9.4 9.5 Introduction Mortgage Underwriting and the Underwriting Process 9.2.1 Ratios and Rules of Thumb Loan-to-Value Ratio Debt Coverage Ratio Debt Yield 9.2.2 Determining the Maximum Loan Amount Operating Expense Ratio Breakeven Ratio Debt Yield Investment Feasibility with Leverage: Before-Tax Analysis 9.3.1 The Two-Part Nature of Cash Flows: Operating Income and Disposition Income 9.3.2 Financing Impact on Investor Income Statements: Adding Debt Service Cash Flows Income from Disposition 9.3.3 Determining Investment Feasibility: The Leveraged Before-Tax Case Static or Single-Year Measures of Investment Performance Determining Investment Feasibility Using Multiple Year Cash Flows Equity Multiple Partitioning the IRR and NPV Determining the Maximum Price to Pay with Leverage Sensitivity Analysis Conclusion 217 217 217 219 220 220 221 221 222 22 5 228 228 229 229 229 230 230 230 232 232 236 236 237 238 238 238 239 240 240 242 242 242 243 244 245
CONTENTS XIV CHAPTER 10 Real Estate Development 10.1 Introduction 10.2 The Development Process 10.3 Preliminary Analysis of “The Station” Development 10.3.1 “Back-of-the-Envelope” Analysis Estimating Construction Costs Estimating MarketValue 10.3.2 Adding Construction Financing 10.3.3 Sensitivity Analysis 10.4 Formal Analysis of Development of “The Station” 10.5 Budget for “The Station” Office Project 10.6 Financing Development 10.6.1 Stage One: Pre-construction 10.6.2 Stage Two: Construction Construction Loan Calculations 10.6.3 Stage Three: Lease-Up 10.6.4 Stage Four: Operations Lender Yield Calculation for the Construction Loan 10.7 Developer Profit and Return 10.8 Comparison to “Back-of-the-Envelope” Analysis 10.9 A London Office Development Through the Cycle 10.10 Conclusion 247 247 248 250 250 251 251 253 254 257 258 259 260 260 260 263 264 264 265 266 267 274 PART THREE Real Estate Investment Structures CHAPTER Ո Unlisted Real Estate Funds 11.1 Introduction to Unlisted Real Estate Funds 11.1.1 The US Market 11.1.2 The Global Market 11.2 The Growth of the Unlisted Real Estate Fund Market 11.2.1 The Global Unlisted Property Market Universe 11.2.2 How Much Global Real Estate is in Unlisted Funds? 11.3 Unlisted Fund Structures 11.3.1 Open-Ended Funds 11.3.2 Closed-Ended Funds 11.3.3 Funds of Funds 11.4 Characteristics of Unlisted Real Estate Funds 11.4.1 Style 11.4.2 Investment Restrictions 11.4.3 Property Sector and Geographic Focus 277 277 278 278 280 281 283 284 285 286 287 288 288 289 290
Contents 11.5 Liquidity and Valuation Issues 11.5.1 Liquidity 11.5.2 Valuation 11.6 The Case for and Against Unlisted Real Estate Funds 11.6.1 The Case for Unlisted Real Estate Funds Unlisted Real Estate Funds can Diversify Real Estate-Specific Risk Unlisted Funds are Priced by Reference to NAV Unlisted Funds Provide Access to Specialist Managers 11.6.2 The Case Against Unlisted Real Estate Funds The Drawdown Profile Gearing and the J-curve Effect Fees and Performance Persistence Do Trading Prices Track NAV? 11.7 Conclusion XV 291 291 294 294 294 294 294 295 295 295 296 297 297 300 CHAPTER 12 Real Estate Private Equity: Fund Structure and Cash Flow Distribution 12.1 12.2 12.3 Introduction: The Four Quadrants and Private Equity Private Equity Fund Background The Lifecycle of a Private Equity Fund 12.3.1 Initial Fundraising 12.3.2 Acquisition Stage 12.3.3 Asset Management 12.3.4 Portfolio Management 12.3.5 End of Fund Life 12.4 Fund Economics 12.4.1 Management Fees 12.4.2 Limited Partner Distributions Return of Initial Capital Preferred Return Carried Interest Promoted Interest 12.5 Waterfall Structures 12.5.1 Introduction 12.5.2 Pro-rata Investment and Distribution 12.5.3 All Equity Provided by Limited Partner, 80%/20% Carried Interest 12.5.4 Adding a Preferred Return 12.5.5 Return of Capital, Simple Interest Preferred Return, Carried Interest Adding Management Fees 12.5.6 Return of Capital, Compounded Interest Preferred Return, Carried Interest 301 301 303 304 304 305 306 306 307 307 307 307 308 308 308 309 310 310 311 311 312 314 316 317
CONTENTS XVI 12.6 12.7 Private Equity Structures in the Credit Crisis Conclusion CHAPTER 13 Listed Equity Real Estate 13.1 Introduction 13.2 REITs and REOCS 13.3 Listed Funds and Mutual Funds 13.4 Exchange-Traded Funds 13.5 The US REIT Experience 13.5.1 Introduction 13.5.2 Distributions 13.5.3 Measuring REIT Net Income Defining Net Income Funds from Operations 13.5.4 Performance Summary 13.6 The Global Market 13.6.1 The Global Property Company Universe 13.6.2 The Global REIT Universe 13.6.3 TheUKREIT 13.7 REIT Pricing 13.7.1 Using Earnings to Value REITs 13.7.2 Market Capitalization and Net Asset Value 13.7.3 Premium or Discount to NAV? Instant Exposure Liquidity/Divisibility Asset Values are Higher than the Reported NAV Projected Asset Values are Expected to Exceed the Reported NAV Management Skills Tax Debt 13.8 Conclusion CHAPTER 14 Real Estate Debt Markets 14.1 Introduction 14.2 A Brief History Lesson 14.2.1 Banking in the 1960s and 1970s 14.2.2 The Volcker Era of High and Volatile Interest Rates 14.3 Wall Street Act I: The Early Residential Mortgage-Backed Securities Market 14.3.1 The Securitization Process Explained 14.3.2 Lender Profitability from Securitization 319 321 323 323 324 324 325 325 325 326 327 327 329 332 335 335 335 335 338 339 339 340 340 341 342 342 342 342 343 343 343 345 345 347 347 349 349 350 353
Contents 14.4 Wall Street Act II: Senior-Subordinated Securities, the Advent of Structured Finance 14.4.1 The Coast Federal Savings and Loan Deal 14.4.2 Risk and Return Characteristics of the Senior-Subordinated Structures 14.5 Wall Street Act III: The Evolution of StructuredFinance 14.5.1 An Updated Look at the Senior-Subordinated Security 14.5.2 Who Profits from these Transactions? 14.6 Collateralized Debt Obligations 14.7 Mezzanine Debt 14.7.1 Mezzanine: The Background 14.7.2 Mezzanine Structures 14.7.3 A UK Example 14.8 Whole Loans and Synthetic Mezzanine 14.9 Income Strips 14.10 Cash-out Refinancing 14.11 All Good Things Must Come to an End 14.11.1 The Cash-out Refinancing Example Extended 14.12 Post-crisis Recovery 14.12.1 A Final Update to the Cash-out Refinancing Example 14.13 Conclusion xvii 354 354 358 359 359 362 363 365 365 366 368 368 369 371 373 374 381 382 383 PART FOUR Creating a Property Investment Portfolio CHAPTER 15 Building the Portfolio 15.1 The Top-Down Portfolio Construction Process 15.1.1 Introduction 15.1.2 Risk and Return Objectives The Relative Return Target The Absolute Return Target 15.1.3 Benchmarks 15.2 Strengths, Weaknesses, Constraints: Portfolio Analysis 15.2.1 Current Portfolio Structure 15.2.2 Strengths, Weaknesses, Constraints 15.2.3 Structure and Stock Selection 15.3 Portfolio Construction 15.3.1 Top-Down or Bottom-Up? 15.3.2 Mixing Listed and Unlisted Real Estate 15.3.3 Can Real Estate Investors Build Efficient Portfolios? 15.3.4 Possible Approaches Case 1: Large US Endowment Fund Case 2: UK Family Office 15.4 Conclusion 387 387 387
390 392 393 394 394 394 395 395 397 397 398 400 403 403 406 409
xviii CONTENTS CHAPTER 16 International Real Estate Investment: Issues 16.1 Introduction: The Growth of Cross-Border Real Estate Capital 16.2 The Global Real Estate Market 16.2.1 16.2.2 16.2.3 16.2.4 The Global Universe Core, Developing, Emerging Transparency The Limits to Globalisation 16.3 The Case for International Real Estate Investment The Case for International Real Estate Investment: Diversification 16.3.2 The Case for International Real Estate Investment: Enhanced Return 16.3.3 Other Drivers of International Property Investment 411 411 413 413 413 414 414 415 16.3.1 16.4 The Problems 16.4.1 16.4.2 16.4.3 16.4.4 16.4.5 16.4.6 16.5 Introduction Index Replication and Tracking Error Leverage Global Cycles, Converging Markets Execution Challenges Loss of Focus and Specialisation Formal Barriers 16.5.1 Legal Barriers 16.5.2 Capital Controls 16.5.3 Tax 16.6 Informal Barriers 16.6.1 16.6.2 16.6.3 16.6.4 16.6.5 16.6.6 16.6.7 16.6.8 Introduction Currency Risk Legal and Title Risk Liquidity Risk Geographical Barriers Political Risk Cultural Barriers Information Asymmetry 16.7 A Pricing Approach for International Property 16.7.1 Example 16.7.2 Theories of Interest Rates and Exchange Rates The Law of One Price Absolute Purchasing Power Parity Relative Purchasing Power Parity The Monetary Model of Exchange Rates The Fisher Equation Interest Rate Parity Putting Relative Purchasing Power Parity and Interest Rate Parity Together with the Fisher Equation 415 417 418 419 419 419 420 420 421 421 421 421 422 422 425 425 425 426 427 427 428 428 429 429 429 431 431 431 432 432 432 432 432
xix Contents 16.7.3 Putting Theory into Practice 16.7.4 Using Local Excess Returns 16.8 Managing Currency Exposure and Currency Risk 16.8.1 Diversifying 16.8.2 Using a‘Currency Overlay’ 16.8.3 Using Local Debt 16.8.4 Hedging Equity 16.8.5 Leverage, Tax, and Fees 16.9 Building a Portfolio 16.10 Conclusion CHAPTER 17 Performance Measurement and Attribution 17.1 17.2 Performance Measurement: An Introduction Return Measures 17.2.1 Introduction Income Return Capital Return Total Return Time-Weighted Return Internal Rate of Return 17.2.2 Example: IRR, TWRR, or Total Return? IRR or TWRR2 IRR or Total Return? 17.2.3 Required and Delivered Returns The Required Return The Delivered Return 17.2.4 Capital Expenditure Timing of Expenditure 17.2.5 Risk-Adjusted Measures of Performance 17.3 Attribution Analysis: Sources of Return 17.3.1 Changes in Initial Yields 17.3.2 The Combined Impact 17.4 Attribution Analysis: The Property Level 17.5 Attribution Analysis: The Portfolio Level 17.5.1 17.5.2 17.5.3 17.5.4 17.5.5 17.5.6 17.5.7 17.5.8 Introduction The Choice of Segmentation Style Themes City or Metropolitan Statistical Area Selection Two or Three Terms? The Formulae Results from Different Attribution Methods Case 1 Case 2 433 438 441 442 442 443 444 446 447 450 451 451 452 452 453 453 453 454 454 454 456 456 456 456 458 459 460 460 462 462 464 465 467 467 468 469 470 471 471 472 473 474 474
CONTENTS XX 17.6 Attribution and Portfolio Management: Alpha and Beta 17.6.1 Alpha and Beta Attribution: An Introduction 17.6.2 Sources ofAlpha and Beta 17.7 Performance Measurement and Return Attribution for Property Funds 17.7.1 Introduction 17.7.2 The Asymmetry of Performance Fees 17.7.3 An Attribution System for Funds 17.7.4 Alpha and Beta in Property Funds: A Case Study 17.7.5 Unlisted Fund Performance: Empirical Evidence The Data Relative Returns Alpha and Beta Timing: IRR and TWRR IRRs and Vintage Year 17.8 Conclusion CHAPTER 18 Conclusions 18.1 Why Property? 18.2 Lessons Learned 18.2.1 Liquid Structures 18.2.2 Unlisted Funds 18.2.3 International Investing 18.2.4 Best-Practice Real Estate Investing 18.2.5 Pricing 18.3 The Future 18.3.1 The PropTech Explosion 18.3.2 Smart Buildings and ESG 18.3.3 Occupier Markets: Space as a Service 18.3.4 Fractionalization and Liquidity Liquidity and Faster Transactions Tokenization and Fractionalization 18.3.5 Derivatives 18.4 Conclusion 474 474 476 477 477 478 480 482 485 485 486 486 488 488 489 491 491 493 493 494 495 495 496 496 496 499 499 500 500 502 502 504 References 509 Glossary 515 Index 527
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Contents Acknowledgements xxi About the Authors xxiii Preface XXV PART ONE Real Estate as an Investment: An Introduction CHAPTER 1 Real Estate - The Global Asset 1.1 The Global Property Investment Universe 1.2 Market Players 1.2.1 Investors 1.2.2 Fund Managers 1.2.3 Advisors 1.3 Property - Its Character as an Asset Class 1.3.1 Property Depreciates 1.3.2 Lease Contracts Control Cash Flows 1.3.3 The Supply Side is Inelastic 1.3.4 Valuations Influence Performance 1.3.5 Property is Not Liquid 1.3.6 Large Lot Sizes Produce Specific Risk 1.3.7 Leverage is Commonly Used in Real Estate Investment 1.3.8 Property Appears to be an Inflation Hedge 1.3.9 Property is a Medium-Risk Asset 1.3.10 Real Estate Cycles Control Returns 1.3.11 Property Appears to be a Diversifying Asset Specific Risk Leverage Illiquidity Taxes, Currency, and Fees 1.4 Conclusion 3 3 6 6 9 9 11 12 13 13 14 15 16 18 19 21 22 24 27 27 28 28 28 vii
CONTENTS VIII CHAPTER 2 Global Property Markets and Real Estate Cycles, 1950-2020 2.1 Introduction and Background 2.1.1 2.2 The Property Cycle A Performance History 2.2.1 2.2.2 Before 1970: Real Estate Becomes a Medium-Return Asset The 1970s: Inflation, Boom, and Bust The USA The UK 2.2.3 The 1980s: New Investors Flood the Real Estate Capital Market The USA The UK 2.2.4 The 1990s: The Rise of REITs The USA The UK: Deep Recession, Low Inflation, and Globalization 2.2.5 2002-7: A Rising Tide Lifts All Boats The USA The UK 2.2.6 The Global Real Estate Credit Crisis Hits The USA The UK 2.2.7 The Markets Recover Post-crisis 2.3 The Global Market 2.3.1 2.3.2 2.4 The European Market Develops Asia Emerges Real Estate Cycles: Conclusion Lesson 1: Too Much Lending to Property is Dangerous Lesson 2:Yields are Mean-Reverting - Unless Real Risk-Free Rates Change Lesson 3: Look at Yields on Index-Linked CHAPTER 3 Market Fundamentals and Rent 3.1 3.2 Introduction: The Global Property Cycle and Rent The Economics of Rent 3.2.1 3.2.2 Rent and Operational Profits Theories of Rent Ricardo von Thünen Fisher 3.2.3 3.2.4 3.2.5 Rent as the Price of Space Supply Demand The Cyclical Demand for Space The Structural Demand for Space Variations in Locational Demand by Use 33 33 33 34 34 36 36 37 38 38 42 43 43 45 47 47 59 60 60 67 70 72 72 75 80 80 81 ?1 83 83 84 84 86 86 87 89 90 91 93 93 94 95
IX Contents 3.3 3.4 3.2.6 The Relationship Between Rental Value and Rental Income 3.2.7 The Impact of Currency Movements on Rent 3.2.8 Property Rents and Inflation Forecasting Rents 3.3.1 Forecasting National Rents Model Types Price Demand Supply Building the Model An Historical Model A Forecasting Model 3.3.2 Forecasting at the Local Level Conceptual and Modelling Problems Data Issues Conclusion CHAPTER 4 Asset Pricing, Portfolio Theory, and Real Estate 4.1 4.2 4.3 Risk, Return, and Portfolio Theory 4.1.1 Introduction 4.1.2 Rhk and Return 4.1.3 Portfolio Theory The Efficient Frontier 4.1.4 Risk and Competitors 4.1.5 Risk and Liabilities 4.1.6 Property Portfolio Management in Practice The Investment Strategy A Property Appraisal Model 4.2.1 Introduction: The Excess Return 4.2.2 The Cap Rate or Initial Yield - A Simple Price Indicator UK Terminology US Terminology How are Cap Rates Estimated in Practice? Cap Rates are the Inverse of Price/Earnings Ratios What Drives the Cap Rate? 4.2.3 The Fisher Equation 4.2.4 A Simple Cash Flow Model 4.2.5 Gordon’s Growth Model (Constant Income Growth) 4.2.6 A Property Valuation Model Including Depreciation The Model Components 4.3.1 The Risk-Free Rate 4.3.2 The Risk Premium What is Risk? The Capital Asset Pricing Model 4.3.3 Inflation 97 99 99 101 101 101 102 102 102 104 104 105 105 106 106 107 109 109 109 110 111 111 112 113 113 114 115 115 116 116 117 118 118 119 121 121 122 122 123 123 124 124 125 127
CONTENTS x 4.3.4 4.3.5 4.3.6 4.3.7 4.4 The Required Return for Property Assets 4.4.1 The Sector Premium 4.4.2 4.4.3 4.4.4 4.5 The City Premium The Property Premium Example Tenant Tenure Leases Building Location Forecasting Real Estate Returns 4.5.1 4.5.2 4.5.3 4.5.4 4.5.5 4.5.6 4.6 Real Rental Growth Depreciation ‘Correct’ Yields An Analysis in Real Terms The Origin and Uses of Property Forecasts Forecasting Cap Rates Forecasting Property Cash Flows The Portfolio Model Example Fair Value Analysis Conclusion: A Simple Way to Think About Real Estate Returns 128 128 129 129 130 130 131 131 131 131 132 132 132 132 135 135 136 138 138 139 141 141 PART TWO Making Investment Decisions at the Property Level CHAPTER 5 Basic Valuation and Investment Analysis 5.1 Introduction 5.1.1 5.1.2 5.1.3 5.1.4 5.2 Cash Flow Risk and the Discount Rate Determining Price Determining Return Estimating Future Cash Flows 5.2.1 5.2.2 5.2.3 5.2.4 Introduction Holding Period Lease Rent Resale Price Estimated Rental Value at Resale Going-Out Capitalisation Rate 5.2.5 5.2.6 Depreciation Expenses Fees Taxes Debt Finance (Interest) 145 145 146 147 147 148 148 148 149 149 149 150 150 150 152 152 152 153
XI Contents 5.3 5.4 The Discount Rate Conclusion CHAPTER 6 Leasing 6.1 6.2 6.3 6.4 6.5 6.6 159 Introduction Legal Characteristics of Leases The Leasing Process Important Economic Elements of a Lease 6.4.1 The Term of the Lease 6.4.2 Base Rent and Rent Escalation Provisions 6.4.3 Options Renewal Options Expansion, Contraction, and Termination Options 6.4.4 Measurement of Space 6.4.5 Expense Treatment Gross Lease Triple Net Lease 6.4.6 Concessions: Tenant Improvement Allowance and Rental Abatement Tenant Improvement Allowance or Tenant Upfit/Fitout Rental Abatement (Rent-Free Periods) 6.4.7 Brokerage Commissions 6.4.8 Other Key Elements of a Lease 6.4.9 Leasing Differences Across Property Types Lease Economics and Effective Rent 6.5.1 Comparing Leases with Different ExpenseTreatment The Landlord’s Perspective The Tenant’s Perspective 6.5.2 Comparing Leases with Different Concession Allowances Landlord’s Perspective Tenant’s Perspective Conclusions Appendix: Modeling Lease Flexibility In The Uk Example Assumptions Result Explanation CHAPTER 7 Techniques for Valuing Commercial Real Estate and Determining Feasibility: The Unleveraged Case 7.1 7.2 153 156 Introduction Background on the Investment Opportunity 7.2.1 Project Details 7.2.2 Where Do You Find Information About Income and Expenses? 159 160 161 161 162 162 163 163 163 164 165 165 168 170 170 171 172 174 175 177 177 177 178 179 180 181 183 183 185 185 185 186 187 187 188 188 189
CONTENTS XII 7.3 7.4 7.5 7.6 7.7 7.8 Developing a Pro Forma Income Statement 7.3.1 Calculating Total Revenues 7.3.2 Estimating Vacancy Loss 7.3.3 Estimating Operating Expenses 7.3.4 Calculating Net Operating Income Valuation Using Net Operating Income: Single-Year Cash Flow 7.4.1 An Aside on Capitalization Rates Estimating the Market Cap Rate Cap Rates are the Inverse of Price/Earnings Ratios Using Cap Rates to Value the Apartment Project Calculating the Implied Cap Rate for the Apartment Investment Opportunity Investment Analysis Using Operating Income: Multiple-Year Cash Flows 7.5.1 Operating Cash Flows from Leasing 7.5.2 Cash Flows from Disposition Applying Discounted Cash Flow to Analyze Investment Feasibility 7.6.1 Determining Feasibility 7.6.2 Equity Multiple 7.6.3 Partitioning the Internal Rate of Return 7.6.4 Calculating the Maximum Price to Pay Sensitivity Analysis Conclusion CHAPTER 8 Mortgages: An Introduction 8.1 8.2 8.3 8.4 8.5 8.6 Introduction What is a Mortgage? 8.2.1 Promissory Note 8.2.2 Mortgage Instrument The Risks and Returns of Mortgage Investment The Financial Components of a Mortgage 8.4.1 The Bond Component 8.4.2 The Call Option Component 8.4.3 The Put Option Component The Mortgage Menu 8.5.1 Fixed or Floating-Rate Loans 8.5.2 Fully or Partially Amortizing Loans An Introduction to Mortgage Math 8.6.1 Calculating the Monthly Payment 8.6.2 The Mortgage Loan Constant 8.6.3 The Amortization Schedule 190 191 191 192 193 193 194 194 195 195 196 197 197 198 200 200 200 201 202 202 203 205 205 206 206 206 207 208 208 208 209 210 210 211 212 212 213 213
xiii Contents 8.6.4 8.7 8.8 Converting from the Contract Rate to the Compounded Rate 8.6.5 Determining the Cost of Borrowing Borrowing Cost without Up-front Fees Borrowing Costs when the Lender Charges Fees Borrowing Costs when the Loan is Prepaid Prior to Maturity Calculating Prepayment Penalties 8.7.1 Lockout Periods 8.7.2 Step-down Prepayment Penalties 8.7.3 Yield Maintenance Penalties and Yield Calculations 8.7.4 Treasury Flat Prepayment Penalty 8.7.5 Defeasance Conclusion CHAPTER 9 Commercial Mortgage Underwriting and Leveraged Feasibility Analysis 9.1 9.2 9.3 9.4 9.5 Introduction Mortgage Underwriting and the Underwriting Process 9.2.1 Ratios and Rules of Thumb Loan-to-Value Ratio Debt Coverage Ratio Debt Yield 9.2.2 Determining the Maximum Loan Amount Operating Expense Ratio Breakeven Ratio Debt Yield Investment Feasibility with Leverage: Before-Tax Analysis 9.3.1 The Two-Part Nature of Cash Flows: Operating Income and Disposition Income 9.3.2 Financing Impact on Investor Income Statements: Adding Debt Service Cash Flows Income from Disposition 9.3.3 Determining Investment Feasibility: The Leveraged Before-Tax Case Static or Single-Year Measures of Investment Performance Determining Investment Feasibility Using Multiple Year Cash Flows Equity Multiple Partitioning the IRR and NPV Determining the Maximum Price to Pay with Leverage Sensitivity Analysis Conclusion 217 217 217 219 220 220 221 221 222 22 5 228 228 229 229 229 230 230 230 232 232 236 236 237 238 238 238 239 240 240 242 242 242 243 244 245
CONTENTS XIV CHAPTER 10 Real Estate Development 10.1 Introduction 10.2 The Development Process 10.3 Preliminary Analysis of “The Station” Development 10.3.1 “Back-of-the-Envelope” Analysis Estimating Construction Costs Estimating MarketValue 10.3.2 Adding Construction Financing 10.3.3 Sensitivity Analysis 10.4 Formal Analysis of Development of “The Station” 10.5 Budget for “The Station” Office Project 10.6 Financing Development 10.6.1 Stage One: Pre-construction 10.6.2 Stage Two: Construction Construction Loan Calculations 10.6.3 Stage Three: Lease-Up 10.6.4 Stage Four: Operations Lender Yield Calculation for the Construction Loan 10.7 Developer Profit and Return 10.8 Comparison to “Back-of-the-Envelope” Analysis 10.9 A London Office Development Through the Cycle 10.10 Conclusion 247 247 248 250 250 251 251 253 254 257 258 259 260 260 260 263 264 264 265 266 267 274 PART THREE Real Estate Investment Structures CHAPTER Ո Unlisted Real Estate Funds 11.1 Introduction to Unlisted Real Estate Funds 11.1.1 The US Market 11.1.2 The Global Market 11.2 The Growth of the Unlisted Real Estate Fund Market 11.2.1 The Global Unlisted Property Market Universe 11.2.2 How Much Global Real Estate is in Unlisted Funds? 11.3 Unlisted Fund Structures 11.3.1 Open-Ended Funds 11.3.2 Closed-Ended Funds 11.3.3 Funds of Funds 11.4 Characteristics of Unlisted Real Estate Funds 11.4.1 Style 11.4.2 Investment Restrictions 11.4.3 Property Sector and Geographic Focus 277 277 278 278 280 281 283 284 285 286 287 288 288 289 290
Contents 11.5 Liquidity and Valuation Issues 11.5.1 Liquidity 11.5.2 Valuation 11.6 The Case for and Against Unlisted Real Estate Funds 11.6.1 The Case for Unlisted Real Estate Funds Unlisted Real Estate Funds can Diversify Real Estate-Specific Risk Unlisted Funds are Priced by Reference to NAV Unlisted Funds Provide Access to Specialist Managers 11.6.2 The Case Against Unlisted Real Estate Funds The Drawdown Profile Gearing and the J-curve Effect Fees and Performance Persistence Do Trading Prices Track NAV? 11.7 Conclusion XV 291 291 294 294 294 294 294 295 295 295 296 297 297 300 CHAPTER 12 Real Estate Private Equity: Fund Structure and Cash Flow Distribution 12.1 12.2 12.3 Introduction: The Four Quadrants and Private Equity Private Equity Fund Background The Lifecycle of a Private Equity Fund 12.3.1 Initial Fundraising 12.3.2 Acquisition Stage 12.3.3 Asset Management 12.3.4 Portfolio Management 12.3.5 End of Fund Life 12.4 Fund Economics 12.4.1 Management Fees 12.4.2 Limited Partner Distributions Return of Initial Capital Preferred Return Carried Interest Promoted Interest 12.5 Waterfall Structures 12.5.1 Introduction 12.5.2 Pro-rata Investment and Distribution 12.5.3 All Equity Provided by Limited Partner, 80%/20% Carried Interest 12.5.4 Adding a Preferred Return 12.5.5 Return of Capital, Simple Interest Preferred Return, Carried Interest Adding Management Fees 12.5.6 Return of Capital, Compounded Interest Preferred Return, Carried Interest 301 301 303 304 304 305 306 306 307 307 307 307 308 308 308 309 310 310 311 311 312 314 316 317
CONTENTS XVI 12.6 12.7 Private Equity Structures in the Credit Crisis Conclusion CHAPTER 13 Listed Equity Real Estate 13.1 Introduction 13.2 REITs and REOCS 13.3 Listed Funds and Mutual Funds 13.4 Exchange-Traded Funds 13.5 The US REIT Experience 13.5.1 Introduction 13.5.2 Distributions 13.5.3 Measuring REIT Net Income Defining Net Income Funds from Operations 13.5.4 Performance Summary 13.6 The Global Market 13.6.1 The Global Property Company Universe 13.6.2 The Global REIT Universe 13.6.3 TheUKREIT 13.7 REIT Pricing 13.7.1 Using Earnings to Value REITs 13.7.2 Market Capitalization and Net Asset Value 13.7.3 Premium or Discount to NAV? Instant Exposure Liquidity/Divisibility Asset Values are Higher than the Reported NAV Projected Asset Values are Expected to Exceed the Reported NAV Management Skills Tax Debt 13.8 Conclusion CHAPTER 14 Real Estate Debt Markets 14.1 Introduction 14.2 A Brief History Lesson 14.2.1 Banking in the 1960s and 1970s 14.2.2 The Volcker Era of High and Volatile Interest Rates 14.3 Wall Street Act I: The Early Residential Mortgage-Backed Securities Market 14.3.1 The Securitization Process Explained 14.3.2 Lender Profitability from Securitization 319 321 323 323 324 324 325 325 325 326 327 327 329 332 335 335 335 335 338 339 339 340 340 341 342 342 342 342 343 343 343 345 345 347 347 349 349 350 353
Contents 14.4 Wall Street Act II: Senior-Subordinated Securities, the Advent of Structured Finance 14.4.1 The Coast Federal Savings and Loan Deal 14.4.2 Risk and Return Characteristics of the Senior-Subordinated Structures 14.5 Wall Street Act III: The Evolution of StructuredFinance 14.5.1 An Updated Look at the Senior-Subordinated Security 14.5.2 Who Profits from these Transactions? 14.6 Collateralized Debt Obligations 14.7 Mezzanine Debt 14.7.1 Mezzanine: The Background 14.7.2 Mezzanine Structures 14.7.3 A UK Example 14.8 Whole Loans and Synthetic Mezzanine 14.9 Income Strips 14.10 Cash-out Refinancing 14.11 All Good Things Must Come to an End 14.11.1 The Cash-out Refinancing Example Extended 14.12 Post-crisis Recovery 14.12.1 A Final Update to the Cash-out Refinancing Example 14.13 Conclusion xvii 354 354 358 359 359 362 363 365 365 366 368 368 369 371 373 374 381 382 383 PART FOUR Creating a Property Investment Portfolio CHAPTER 15 Building the Portfolio 15.1 The Top-Down Portfolio Construction Process 15.1.1 Introduction 15.1.2 Risk and Return Objectives The Relative Return Target The Absolute Return Target 15.1.3 Benchmarks 15.2 Strengths, Weaknesses, Constraints: Portfolio Analysis 15.2.1 Current Portfolio Structure 15.2.2 Strengths, Weaknesses, Constraints 15.2.3 Structure and Stock Selection 15.3 Portfolio Construction 15.3.1 Top-Down or Bottom-Up? 15.3.2 Mixing Listed and Unlisted Real Estate 15.3.3 Can Real Estate Investors Build Efficient Portfolios? 15.3.4 Possible Approaches Case 1: Large US Endowment Fund Case 2: UK Family Office 15.4 Conclusion 387 387 387
390 392 393 394 394 394 395 395 397 397 398 400 403 403 406 409
xviii CONTENTS CHAPTER 16 International Real Estate Investment: Issues 16.1 Introduction: The Growth of Cross-Border Real Estate Capital 16.2 The Global Real Estate Market 16.2.1 16.2.2 16.2.3 16.2.4 The Global Universe Core, Developing, Emerging Transparency The Limits to Globalisation 16.3 The Case for International Real Estate Investment The Case for International Real Estate Investment: Diversification 16.3.2 The Case for International Real Estate Investment: Enhanced Return 16.3.3 Other Drivers of International Property Investment 411 411 413 413 413 414 414 415 16.3.1 16.4 The Problems 16.4.1 16.4.2 16.4.3 16.4.4 16.4.5 16.4.6 16.5 Introduction Index Replication and Tracking Error Leverage Global Cycles, Converging Markets Execution Challenges Loss of Focus and Specialisation Formal Barriers 16.5.1 Legal Barriers 16.5.2 Capital Controls 16.5.3 Tax 16.6 Informal Barriers 16.6.1 16.6.2 16.6.3 16.6.4 16.6.5 16.6.6 16.6.7 16.6.8 Introduction Currency Risk Legal and Title Risk Liquidity Risk Geographical Barriers Political Risk Cultural Barriers Information Asymmetry 16.7 A Pricing Approach for International Property 16.7.1 Example 16.7.2 Theories of Interest Rates and Exchange Rates The Law of One Price Absolute Purchasing Power Parity Relative Purchasing Power Parity The Monetary Model of Exchange Rates The Fisher Equation Interest Rate Parity Putting Relative Purchasing Power Parity and Interest Rate Parity Together with the Fisher Equation 415 417 418 419 419 419 420 420 421 421 421 421 422 422 425 425 425 426 427 427 428 428 429 429 429 431 431 431 432 432 432 432 432
xix Contents 16.7.3 Putting Theory into Practice 16.7.4 Using Local Excess Returns 16.8 Managing Currency Exposure and Currency Risk 16.8.1 Diversifying 16.8.2 Using a‘Currency Overlay’ 16.8.3 Using Local Debt 16.8.4 Hedging Equity 16.8.5 Leverage, Tax, and Fees 16.9 Building a Portfolio 16.10 Conclusion CHAPTER 17 Performance Measurement and Attribution 17.1 17.2 Performance Measurement: An Introduction Return Measures 17.2.1 Introduction Income Return Capital Return Total Return Time-Weighted Return Internal Rate of Return 17.2.2 Example: IRR, TWRR, or Total Return? IRR or TWRR2 IRR or Total Return? 17.2.3 Required and Delivered Returns The Required Return The Delivered Return 17.2.4 Capital Expenditure Timing of Expenditure 17.2.5 Risk-Adjusted Measures of Performance 17.3 Attribution Analysis: Sources of Return 17.3.1 Changes in Initial Yields 17.3.2 The Combined Impact 17.4 Attribution Analysis: The Property Level 17.5 Attribution Analysis: The Portfolio Level 17.5.1 17.5.2 17.5.3 17.5.4 17.5.5 17.5.6 17.5.7 17.5.8 Introduction The Choice of Segmentation Style Themes City or Metropolitan Statistical Area Selection Two or Three Terms? The Formulae Results from Different Attribution Methods Case 1 Case 2 433 438 441 442 442 443 444 446 447 450 451 451 452 452 453 453 453 454 454 454 456 456 456 456 458 459 460 460 462 462 464 465 467 467 468 469 470 471 471 472 473 474 474
CONTENTS XX 17.6 Attribution and Portfolio Management: Alpha and Beta 17.6.1 Alpha and Beta Attribution: An Introduction 17.6.2 Sources ofAlpha and Beta 17.7 Performance Measurement and Return Attribution for Property Funds 17.7.1 Introduction 17.7.2 The Asymmetry of Performance Fees 17.7.3 An Attribution System for Funds 17.7.4 Alpha and Beta in Property Funds: A Case Study 17.7.5 Unlisted Fund Performance: Empirical Evidence The Data Relative Returns Alpha and Beta Timing: IRR and TWRR IRRs and Vintage Year 17.8 Conclusion CHAPTER 18 Conclusions 18.1 Why Property? 18.2 Lessons Learned 18.2.1 Liquid Structures 18.2.2 Unlisted Funds 18.2.3 International Investing 18.2.4 Best-Practice Real Estate Investing 18.2.5 Pricing 18.3 The Future 18.3.1 The PropTech Explosion 18.3.2 Smart Buildings and ESG 18.3.3 Occupier Markets: Space as a Service 18.3.4 Fractionalization and Liquidity Liquidity and Faster Transactions Tokenization and Fractionalization 18.3.5 Derivatives 18.4 Conclusion 474 474 476 477 477 478 480 482 485 485 486 486 488 488 489 491 491 493 493 494 495 495 496 496 496 499 499 500 500 502 502 504 References 509 Glossary 515 Index 527
Contents Acknowledgements xxi About the Authors xxiii Preface XXV PART ONE Real Estate as an Investment: An Introduction CHAPTER 1 Real Estate - The Global Asset 1.1 The Global Property Investment Universe 1.2 Market Players 1.2.1 Investors 1.2.2 Fund Managers 1.2.3 Advisors 1.3 Property - Its Character as an Asset Class 1.3.1 Property Depreciates 1.3.2 Lease Contracts Control Cash Flows 1.3.3 The Supply Side is Inelastic 1.3.4 Valuations Influence Performance 1.3.5 Property is Not Liquid 1.3.6 Large Lot Sizes Produce Specific Risk 1.3.7 Leverage is Commonly Used in Real Estate Investment 1.3.8 Property Appears to be an Inflation Hedge 1.3.9 Property is a Medium-Risk Asset 1.3.10 Real Estate Cycles Control Returns 1.3.11 Property Appears to be a Diversifying Asset Specific Risk Leverage Illiquidity Taxes, Currency, and Fees 1.4 Conclusion 3 3 6 6 9 9 11 12 13 13 14 15 16 18 19 21 22 24 27 27 28 28 28 vii
CONTENTS VIII CHAPTER 2 Global Property Markets and Real Estate Cycles, 1950-2020 2.1 Introduction and Background 2.1.1 2.2 The Property Cycle A Performance History 2.2.1 2.2.2 Before 1970: Real Estate Becomes a Medium-Return Asset The 1970s: Inflation, Boom, and Bust The USA The UK 2.2.3 The 1980s: New Investors Flood the Real Estate Capital Market The USA The UK 2.2.4 The 1990s: The Rise of REITs The USA The UK: Deep Recession, Low Inflation, and Globalization 2.2.5 2002-7: A Rising Tide Lifts All Boats The USA The UK 2.2.6 The Global Real Estate Credit Crisis Hits The USA The UK 2.2.7 The Markets Recover Post-crisis 2.3 The Global Market 2.3.1 2.3.2 2.4 The European Market Develops Asia Emerges Real Estate Cycles: Conclusion Lesson 1: Too Much Lending to Property is Dangerous Lesson 2:Yields are Mean-Reverting - Unless Real Risk-Free Rates Change Lesson 3: Look at Yields on Index-Linked CHAPTER 3 Market Fundamentals and Rent 3.1 3.2 Introduction: The Global Property Cycle and Rent The Economics of Rent 3.2.1 3.2.2 Rent and Operational Profits Theories of Rent Ricardo von Thünen Fisher 3.2.3 3.2.4 3.2.5 Rent as the Price of Space Supply Demand The Cyclical Demand for Space The Structural Demand for Space Variations in Locational Demand by Use 33 33 33 34 34 36 36 37 38 38 42 43 43 45 47 47 59 60 60 67 70 72 72 75 80 80 81 ?1 83 83 84 84 86 86 87 89 90 91 93 93 94 95
IX Contents 3.3 3.4 3.2.6 The Relationship Between Rental Value and Rental Income 3.2.7 The Impact of Currency Movements on Rent 3.2.8 Property Rents and Inflation Forecasting Rents 3.3.1 Forecasting National Rents Model Types Price Demand Supply Building the Model An Historical Model A Forecasting Model 3.3.2 Forecasting at the Local Level Conceptual and Modelling Problems Data Issues Conclusion CHAPTER 4 Asset Pricing, Portfolio Theory, and Real Estate 4.1 4.2 4.3 Risk, Return, and Portfolio Theory 4.1.1 Introduction 4.1.2 Rhk and Return 4.1.3 Portfolio Theory The Efficient Frontier 4.1.4 Risk and Competitors 4.1.5 Risk and Liabilities 4.1.6 Property Portfolio Management in Practice The Investment Strategy A Property Appraisal Model 4.2.1 Introduction: The Excess Return 4.2.2 The Cap Rate or Initial Yield - A Simple Price Indicator UK Terminology US Terminology How are Cap Rates Estimated in Practice? Cap Rates are the Inverse of Price/Earnings Ratios What Drives the Cap Rate? 4.2.3 The Fisher Equation 4.2.4 A Simple Cash Flow Model 4.2.5 Gordon’s Growth Model (Constant Income Growth) 4.2.6 A Property Valuation Model Including Depreciation The Model Components 4.3.1 The Risk-Free Rate 4.3.2 The Risk Premium What is Risk? The Capital Asset Pricing Model 4.3.3 Inflation 97 99 99 101 101 101 102 102 102 104 104 105 105 106 106 107 109 109 109 110 111 111 112 113 113 114 115 115 116 116 117 118 118 119 121 121 122 122 123 123 124 124 125 127
CONTENTS x 4.3.4 4.3.5 4.3.6 4.3.7 4.4 The Required Return for Property Assets 4.4.1 The Sector Premium 4.4.2 4.4.3 4.4.4 4.5 The City Premium The Property Premium Example Tenant Tenure Leases Building Location Forecasting Real Estate Returns 4.5.1 4.5.2 4.5.3 4.5.4 4.5.5 4.5.6 4.6 Real Rental Growth Depreciation ‘Correct’ Yields An Analysis in Real Terms The Origin and Uses of Property Forecasts Forecasting Cap Rates Forecasting Property Cash Flows The Portfolio Model Example Fair Value Analysis Conclusion: A Simple Way to Think About Real Estate Returns 128 128 129 129 130 130 131 131 131 131 132 132 132 132 135 135 136 138 138 139 141 141 PART TWO Making Investment Decisions at the Property Level CHAPTER 5 Basic Valuation and Investment Analysis 5.1 Introduction 5.1.1 5.1.2 5.1.3 5.1.4 5.2 Cash Flow Risk and the Discount Rate Determining Price Determining Return Estimating Future Cash Flows 5.2.1 5.2.2 5.2.3 5.2.4 Introduction Holding Period Lease Rent Resale Price Estimated Rental Value at Resale Going-Out Capitalisation Rate 5.2.5 5.2.6 Depreciation Expenses Fees Taxes Debt Finance (Interest) 145 145 146 147 147 148 148 148 149 149 149 150 150 150 152 152 152 153
XI Contents 5.3 5.4 The Discount Rate Conclusion CHAPTER 6 Leasing 6.1 6.2 6.3 6.4 6.5 6.6 159 Introduction Legal Characteristics of Leases The Leasing Process Important Economic Elements of a Lease 6.4.1 The Term of the Lease 6.4.2 Base Rent and Rent Escalation Provisions 6.4.3 Options Renewal Options Expansion, Contraction, and Termination Options 6.4.4 Measurement of Space 6.4.5 Expense Treatment Gross Lease Triple Net Lease 6.4.6 Concessions: Tenant Improvement Allowance and Rental Abatement Tenant Improvement Allowance or Tenant Upfit/Fitout Rental Abatement (Rent-Free Periods) 6.4.7 Brokerage Commissions 6.4.8 Other Key Elements of a Lease 6.4.9 Leasing Differences Across Property Types Lease Economics and Effective Rent 6.5.1 Comparing Leases with Different ExpenseTreatment The Landlord’s Perspective The Tenant’s Perspective 6.5.2 Comparing Leases with Different Concession Allowances Landlord’s Perspective Tenant’s Perspective Conclusions Appendix: Modeling Lease Flexibility In The Uk Example Assumptions Result Explanation CHAPTER 7 Techniques for Valuing Commercial Real Estate and Determining Feasibility: The Unleveraged Case 7.1 7.2 153 156 Introduction Background on the Investment Opportunity 7.2.1 Project Details 7.2.2 Where Do You Find Information About Income and Expenses? 159 160 161 161 162 162 163 163 163 164 165 165 168 170 170 171 172 174 175 177 177 177 178 179 180 181 183 183 185 185 185 186 187 187 188 188 189
CONTENTS XII 7.3 7.4 7.5 7.6 7.7 7.8 Developing a Pro Forma Income Statement 7.3.1 Calculating Total Revenues 7.3.2 Estimating Vacancy Loss 7.3.3 Estimating Operating Expenses 7.3.4 Calculating Net Operating Income Valuation Using Net Operating Income: Single-Year Cash Flow 7.4.1 An Aside on Capitalization Rates Estimating the Market Cap Rate Cap Rates are the Inverse of Price/Earnings Ratios Using Cap Rates to Value the Apartment Project Calculating the Implied Cap Rate for the Apartment Investment Opportunity Investment Analysis Using Operating Income: Multiple-Year Cash Flows 7.5.1 Operating Cash Flows from Leasing 7.5.2 Cash Flows from Disposition Applying Discounted Cash Flow to Analyze Investment Feasibility 7.6.1 Determining Feasibility 7.6.2 Equity Multiple 7.6.3 Partitioning the Internal Rate of Return 7.6.4 Calculating the Maximum Price to Pay Sensitivity Analysis Conclusion CHAPTER 8 Mortgages: An Introduction 8.1 8.2 8.3 8.4 8.5 8.6 Introduction What is a Mortgage? 8.2.1 Promissory Note 8.2.2 Mortgage Instrument The Risks and Returns of Mortgage Investment The Financial Components of a Mortgage 8.4.1 The Bond Component 8.4.2 The Call Option Component 8.4.3 The Put Option Component The Mortgage Menu 8.5.1 Fixed or Floating-Rate Loans 8.5.2 Fully or Partially Amortizing Loans An Introduction to Mortgage Math 8.6.1 Calculating the Monthly Payment 8.6.2 The Mortgage Loan Constant 8.6.3 The Amortization Schedule 190 191 191 192 193 193 194 194 195 195 196 197 197 198 200 200 200 201 202 202 203 205 205 206 206 206 207 208 208 208 209 210 210 211 212 212 213 213
xiii Contents 8.6.4 8.7 8.8 Converting from the Contract Rate to the Compounded Rate 8.6.5 Determining the Cost of Borrowing Borrowing Cost without Up-front Fees Borrowing Costs when the Lender Charges Fees Borrowing Costs when the Loan is Prepaid Prior to Maturity Calculating Prepayment Penalties 8.7.1 Lockout Periods 8.7.2 Step-down Prepayment Penalties 8.7.3 Yield Maintenance Penalties and Yield Calculations 8.7.4 Treasury Flat Prepayment Penalty 8.7.5 Defeasance Conclusion CHAPTER 9 Commercial Mortgage Underwriting and Leveraged Feasibility Analysis 9.1 9.2 9.3 9.4 9.5 Introduction Mortgage Underwriting and the Underwriting Process 9.2.1 Ratios and Rules of Thumb Loan-to-Value Ratio Debt Coverage Ratio Debt Yield 9.2.2 Determining the Maximum Loan Amount Operating Expense Ratio Breakeven Ratio Debt Yield Investment Feasibility with Leverage: Before-Tax Analysis 9.3.1 The Two-Part Nature of Cash Flows: Operating Income and Disposition Income 9.3.2 Financing Impact on Investor Income Statements: Adding Debt Service Cash Flows Income from Disposition 9.3.3 Determining Investment Feasibility: The Leveraged Before-Tax Case Static or Single-Year Measures of Investment Performance Determining Investment Feasibility Using Multiple Year Cash Flows Equity Multiple Partitioning the IRR and NPV Determining the Maximum Price to Pay with Leverage Sensitivity Analysis Conclusion 217 217 217 219 220 220 221 221 222 22 5 228 228 229 229 229 230 230 230 232 232 236 236 237 238 238 238 239 240 240 242 242 242 243 244 245
CONTENTS XIV CHAPTER 10 Real Estate Development 10.1 Introduction 10.2 The Development Process 10.3 Preliminary Analysis of “The Station” Development 10.3.1 “Back-of-the-Envelope” Analysis Estimating Construction Costs Estimating MarketValue 10.3.2 Adding Construction Financing 10.3.3 Sensitivity Analysis 10.4 Formal Analysis of Development of “The Station” 10.5 Budget for “The Station” Office Project 10.6 Financing Development 10.6.1 Stage One: Pre-construction 10.6.2 Stage Two: Construction Construction Loan Calculations 10.6.3 Stage Three: Lease-Up 10.6.4 Stage Four: Operations Lender Yield Calculation for the Construction Loan 10.7 Developer Profit and Return 10.8 Comparison to “Back-of-the-Envelope” Analysis 10.9 A London Office Development Through the Cycle 10.10 Conclusion 247 247 248 250 250 251 251 253 254 257 258 259 260 260 260 263 264 264 265 266 267 274 PART THREE Real Estate Investment Structures CHAPTER Ո Unlisted Real Estate Funds 11.1 Introduction to Unlisted Real Estate Funds 11.1.1 The US Market 11.1.2 The Global Market 11.2 The Growth of the Unlisted Real Estate Fund Market 11.2.1 The Global Unlisted Property Market Universe 11.2.2 How Much Global Real Estate is in Unlisted Funds? 11.3 Unlisted Fund Structures 11.3.1 Open-Ended Funds 11.3.2 Closed-Ended Funds 11.3.3 Funds of Funds 11.4 Characteristics of Unlisted Real Estate Funds 11.4.1 Style 11.4.2 Investment Restrictions 11.4.3 Property Sector and Geographic Focus 277 277 278 278 280 281 283 284 285 286 287 288 288 289 290
Contents 11.5 Liquidity and Valuation Issues 11.5.1 Liquidity 11.5.2 Valuation 11.6 The Case for and Against Unlisted Real Estate Funds 11.6.1 The Case for Unlisted Real Estate Funds Unlisted Real Estate Funds can Diversify Real Estate-Specific Risk Unlisted Funds are Priced by Reference to NAV Unlisted Funds Provide Access to Specialist Managers 11.6.2 The Case Against Unlisted Real Estate Funds The Drawdown Profile Gearing and the J-curve Effect Fees and Performance Persistence Do Trading Prices Track NAV? 11.7 Conclusion XV 291 291 294 294 294 294 294 295 295 295 296 297 297 300 CHAPTER 12 Real Estate Private Equity: Fund Structure and Cash Flow Distribution 12.1 12.2 12.3 Introduction: The Four Quadrants and Private Equity Private Equity Fund Background The Lifecycle of a Private Equity Fund 12.3.1 Initial Fundraising 12.3.2 Acquisition Stage 12.3.3 Asset Management 12.3.4 Portfolio Management 12.3.5 End of Fund Life 12.4 Fund Economics 12.4.1 Management Fees 12.4.2 Limited Partner Distributions Return of Initial Capital Preferred Return Carried Interest Promoted Interest 12.5 Waterfall Structures 12.5.1 Introduction 12.5.2 Pro-rata Investment and Distribution 12.5.3 All Equity Provided by Limited Partner, 80%/20% Carried Interest 12.5.4 Adding a Preferred Return 12.5.5 Return of Capital, Simple Interest Preferred Return, Carried Interest Adding Management Fees 12.5.6 Return of Capital, Compounded Interest Preferred Return, Carried Interest 301 301 303 304 304 305 306 306 307 307 307 307 308 308 308 309 310 310 311 311 312 314 316 317
CONTENTS XVI 12.6 12.7 Private Equity Structures in the Credit Crisis Conclusion CHAPTER 13 Listed Equity Real Estate 13.1 Introduction 13.2 REITs and REOCS 13.3 Listed Funds and Mutual Funds 13.4 Exchange-Traded Funds 13.5 The US REIT Experience 13.5.1 Introduction 13.5.2 Distributions 13.5.3 Measuring REIT Net Income Defining Net Income Funds from Operations 13.5.4 Performance Summary 13.6 The Global Market 13.6.1 The Global Property Company Universe 13.6.2 The Global REIT Universe 13.6.3 TheUKREIT 13.7 REIT Pricing 13.7.1 Using Earnings to Value REITs 13.7.2 Market Capitalization and Net Asset Value 13.7.3 Premium or Discount to NAV? Instant Exposure Liquidity/Divisibility Asset Values are Higher than the Reported NAV Projected Asset Values are Expected to Exceed the Reported NAV Management Skills Tax Debt 13.8 Conclusion CHAPTER 14 Real Estate Debt Markets 14.1 Introduction 14.2 A Brief History Lesson 14.2.1 Banking in the 1960s and 1970s 14.2.2 The Volcker Era of High and Volatile Interest Rates 14.3 Wall Street Act I: The Early Residential Mortgage-Backed Securities Market 14.3.1 The Securitization Process Explained 14.3.2 Lender Profitability from Securitization 319 321 323 323 324 324 325 325 325 326 327 327 329 332 335 335 335 335 338 339 339 340 340 341 342 342 342 342 343 343 343 345 345 347 347 349 349 350 353
Contents 14.4 Wall Street Act II: Senior-Subordinated Securities, the Advent of Structured Finance 14.4.1 The Coast Federal Savings and Loan Deal 14.4.2 Risk and Return Characteristics of the Senior-Subordinated Structures 14.5 Wall Street Act III: The Evolution of StructuredFinance 14.5.1 An Updated Look at the Senior-Subordinated Security 14.5.2 Who Profits from these Transactions? 14.6 Collateralized Debt Obligations 14.7 Mezzanine Debt 14.7.1 Mezzanine: The Background 14.7.2 Mezzanine Structures 14.7.3 A UK Example 14.8 Whole Loans and Synthetic Mezzanine 14.9 Income Strips 14.10 Cash-out Refinancing 14.11 All Good Things Must Come to an End 14.11.1 The Cash-out Refinancing Example Extended 14.12 Post-crisis Recovery 14.12.1 A Final Update to the Cash-out Refinancing Example 14.13 Conclusion xvii 354 354 358 359 359 362 363 365 365 366 368 368 369 371 373 374 381 382 383 PART FOUR Creating a Property Investment Portfolio CHAPTER 15 Building the Portfolio 15.1 The Top-Down Portfolio Construction Process 15.1.1 Introduction 15.1.2 Risk and Return Objectives The Relative Return Target The Absolute Return Target 15.1.3 Benchmarks 15.2 Strengths, Weaknesses, Constraints: Portfolio Analysis 15.2.1 Current Portfolio Structure 15.2.2 Strengths, Weaknesses, Constraints 15.2.3 Structure and Stock Selection 15.3 Portfolio Construction 15.3.1 Top-Down or Bottom-Up? 15.3.2 Mixing Listed and Unlisted Real Estate 15.3.3 Can Real Estate Investors Build Efficient Portfolios? 15.3.4 Possible Approaches Case 1: Large US Endowment Fund Case 2: UK Family Office 15.4 Conclusion 387 387 387
390 392 393 394 394 394 395 395 397 397 398 400 403 403 406 409
xviii CONTENTS CHAPTER 16 International Real Estate Investment: Issues 16.1 Introduction: The Growth of Cross-Border Real Estate Capital 16.2 The Global Real Estate Market 16.2.1 16.2.2 16.2.3 16.2.4 The Global Universe Core, Developing, Emerging Transparency The Limits to Globalisation 16.3 The Case for International Real Estate Investment The Case for International Real Estate Investment: Diversification 16.3.2 The Case for International Real Estate Investment: Enhanced Return 16.3.3 Other Drivers of International Property Investment 411 411 413 413 413 414 414 415 16.3.1 16.4 The Problems 16.4.1 16.4.2 16.4.3 16.4.4 16.4.5 16.4.6 16.5 Introduction Index Replication and Tracking Error Leverage Global Cycles, Converging Markets Execution Challenges Loss of Focus and Specialisation Formal Barriers 16.5.1 Legal Barriers 16.5.2 Capital Controls 16.5.3 Tax 16.6 Informal Barriers 16.6.1 16.6.2 16.6.3 16.6.4 16.6.5 16.6.6 16.6.7 16.6.8 Introduction Currency Risk Legal and Title Risk Liquidity Risk Geographical Barriers Political Risk Cultural Barriers Information Asymmetry 16.7 A Pricing Approach for International Property 16.7.1 Example 16.7.2 Theories of Interest Rates and Exchange Rates The Law of One Price Absolute Purchasing Power Parity Relative Purchasing Power Parity The Monetary Model of Exchange Rates The Fisher Equation Interest Rate Parity Putting Relative Purchasing Power Parity and Interest Rate Parity Together with the Fisher Equation 415 417 418 419 419 419 420 420 421 421 421 421 422 422 425 425 425 426 427 427 428 428 429 429 429 431 431 431 432 432 432 432 432
xix Contents 16.7.3 Putting Theory into Practice 16.7.4 Using Local Excess Returns 16.8 Managing Currency Exposure and Currency Risk 16.8.1 Diversifying 16.8.2 Using a‘Currency Overlay’ 16.8.3 Using Local Debt 16.8.4 Hedging Equity 16.8.5 Leverage, Tax, and Fees 16.9 Building a Portfolio 16.10 Conclusion CHAPTER 17 Performance Measurement and Attribution 17.1 17.2 Performance Measurement: An Introduction Return Measures 17.2.1 Introduction Income Return Capital Return Total Return Time-Weighted Return Internal Rate of Return 17.2.2 Example: IRR, TWRR, or Total Return? IRR or TWRR2 IRR or Total Return? 17.2.3 Required and Delivered Returns The Required Return The Delivered Return 17.2.4 Capital Expenditure Timing of Expenditure 17.2.5 Risk-Adjusted Measures of Performance 17.3 Attribution Analysis: Sources of Return 17.3.1 Changes in Initial Yields 17.3.2 The Combined Impact 17.4 Attribution Analysis: The Property Level 17.5 Attribution Analysis: The Portfolio Level 17.5.1 17.5.2 17.5.3 17.5.4 17.5.5 17.5.6 17.5.7 17.5.8 Introduction The Choice of Segmentation Style Themes City or Metropolitan Statistical Area Selection Two or Three Terms? The Formulae Results from Different Attribution Methods Case 1 Case 2 433 438 441 442 442 443 444 446 447 450 451 451 452 452 453 453 453 454 454 454 456 456 456 456 458 459 460 460 462 462 464 465 467 467 468 469 470 471 471 472 473 474 474
CONTENTS XX 17.6 Attribution and Portfolio Management: Alpha and Beta 17.6.1 Alpha and Beta Attribution: An Introduction 17.6.2 Sources ofAlpha and Beta 17.7 Performance Measurement and Return Attribution for Property Funds 17.7.1 Introduction 17.7.2 The Asymmetry of Performance Fees 17.7.3 An Attribution System for Funds 17.7.4 Alpha and Beta in Property Funds: A Case Study 17.7.5 Unlisted Fund Performance: Empirical Evidence The Data Relative Returns Alpha and Beta Timing: IRR and TWRR IRRs and Vintage Year 17.8 Conclusion CHAPTER 18 Conclusions 18.1 Why Property? 18.2 Lessons Learned 18.2.1 Liquid Structures 18.2.2 Unlisted Funds 18.2.3 International Investing 18.2.4 Best-Practice Real Estate Investing 18.2.5 Pricing 18.3 The Future 18.3.1 The PropTech Explosion 18.3.2 Smart Buildings and ESG 18.3.3 Occupier Markets: Space as a Service 18.3.4 Fractionalization and Liquidity Liquidity and Faster Transactions Tokenization and Fractionalization 18.3.5 Derivatives 18.4 Conclusion 474 474 476 477 477 478 480 482 485 485 486 486 488 488 489 491 491 493 493 494 495 495 496 496 496 499 499 500 500 502 502 504 References 509 Glossary 515 Index 527 |
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| edition | Second edition |
| format | Book |
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| id | DE-604.BV047097199 |
| illustrated | Not Illustrated |
| index_date | 2024-07-03T16:21:42Z |
| indexdate | 2024-07-10T09:02:30Z |
| institution | BVB |
| isbn | 9781119526094 |
| language | English |
| oai_aleph_id | oai:aleph.bib-bvb.de:BVB01-032503655 |
| oclc_num | 1184118895 |
| open_access_boolean | |
| owner | DE-1043 DE-355 DE-BY-UBR DE-898 DE-BY-UBR |
| owner_facet | DE-1043 DE-355 DE-BY-UBR DE-898 DE-BY-UBR |
| physical | XXVIII, 558 Seiten |
| publishDate | 2021 |
| publishDateSearch | 2021 |
| publishDateSort | 2021 |
| publisher | John Wiley & Sons Inc |
| record_format | marc |
| spelling | Baum, Andrew 1953- Verfasser (DE-588)17092338X aut Real estate investment strategies, structures, decisions Andrew Baum, David Hartzell Second edition New York John Wiley & Sons Inc 2021 XXVIII, 558 Seiten txt rdacontent n rdamedia nc rdacarrier Immobilienanlage (DE-588)4120474-8 gnd rswk-swf Immobilienanlage (DE-588)4120474-8 s DE-604 Hartzell, David Verfasser aut Erscheint auch als Online-Ausgabe, PDF 978-1-119-52606-3 Erscheint auch als Online-Ausgabe, EPUB 978-1-119-52615-5 Digitalisierung UB Regensburg - ADAM Catalogue Enrichment application/pdf http://bvbr.bib-bvb.de:8991/F?func=service&doc_library=BVB01&local_base=BVB01&doc_number=032503655&sequence=000001&line_number=0001&func_code=DB_RECORDS&service_type=MEDIA Inhaltsverzeichnis Digitalisierung UB Regensburg - ADAM Catalogue Enrichment application/pdf http://bvbr.bib-bvb.de:8991/F?func=service&doc_library=BVB01&local_base=BVB01&doc_number=032503655&sequence=000003&line_number=0002&func_code=DB_RECORDS&service_type=MEDIA Inhaltsverzeichnis |
| spellingShingle | Baum, Andrew 1953- Hartzell, David Real estate investment strategies, structures, decisions Immobilienanlage (DE-588)4120474-8 gnd |
| subject_GND | (DE-588)4120474-8 |
| title | Real estate investment strategies, structures, decisions |
| title_auth | Real estate investment strategies, structures, decisions |
| title_exact_search | Real estate investment strategies, structures, decisions |
| title_exact_search_txtP | Real estate investment strategies, structures, decisions |
| title_full | Real estate investment strategies, structures, decisions Andrew Baum, David Hartzell |
| title_fullStr | Real estate investment strategies, structures, decisions Andrew Baum, David Hartzell |
| title_full_unstemmed | Real estate investment strategies, structures, decisions Andrew Baum, David Hartzell |
| title_short | Real estate investment |
| title_sort | real estate investment strategies structures decisions |
| title_sub | strategies, structures, decisions |
| topic | Immobilienanlage (DE-588)4120474-8 gnd |
| topic_facet | Immobilienanlage |
| url | http://bvbr.bib-bvb.de:8991/F?func=service&doc_library=BVB01&local_base=BVB01&doc_number=032503655&sequence=000001&line_number=0001&func_code=DB_RECORDS&service_type=MEDIA http://bvbr.bib-bvb.de:8991/F?func=service&doc_library=BVB01&local_base=BVB01&doc_number=032503655&sequence=000003&line_number=0002&func_code=DB_RECORDS&service_type=MEDIA |
| work_keys_str_mv | AT baumandrew realestateinvestmentstrategiesstructuresdecisions AT hartzelldavid realestateinvestmentstrategiesstructuresdecisions |
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Inhaltsverzeichnis