Real

Estate Finance - Introduction - Topic #1 1/15/20

Real Estate Finance:

Investment and
Analysis
Winter 2020
Professor Cindy Soo
Ross Business School, Michigan

Today’s agenda
•  Why Real Estate

•  Why This Course

•  Admin

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Real Estate Finance - Introduction - Topic #1 1/15/20

Why real estate?

Q: Which has a higher value in the U.S.?

1.  Corporate equities
2.  Real Estate

Real Estate vs. Equity

Capitalization
Market Values of Real Estate and Corporate Equity
60000

50000

40000
$ Billions

30000

20000

10000

U.S. Real Estate U.S. Corporate Equities Updated to 2019 Q2

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Real Estate Finance - Introduction - Topic #1 1/15/20

Real Estate Capitalization

Comparisons
Market value (in $ billions) 2019 Q2

U.S. Real Estate 46,763

U.S Real Estate from Housing 29,103
U.S. Corporate Equities 49,799

U.S. Government Securities 27,080

U.S. Mortgages 15,627
Corporate Bonds, Foreign Bonds, and Bank Loans 17,549
Source: U.S. Federal Reserve, Flow of Funds, tables B101, B103, and L208 L214 L223
http://www.federalreserve.gov/releases/Z1/

What is Real Estate? Land

Greenfield (Undeveloped/Farm) Brownfield (Previously Developed)

Surface parking lot “land play”

Collect rents while waiting for prices to rise and for high density zoning approvals

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Real Estate Finance - Introduction - Topic #1 1/15/20

What is Real Estate? Downtown Office

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Floor plates matter for the end user
Typical office floor plates are 10 to 30k rentable SF

What is Real Estate? Suburban Office

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Real Estate Finance - Introduction - Topic #1 1/15/20

What is Real Estate? Retail

What is Real Estate? Industrial/

Warehouse

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Real Estate Finance - Introduction - Topic #1 1/15/20

What is Real Estate?

Apartments

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What is Real Estate? Hotels

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Real Estate Finance - Introduction - Topic #1 1/15/20

What is Real Estate? Houses

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Household Real Estate

Assets
1979 1989 1999 2009 2019 Q2
Real Estate 25% 27% 21% 22% 22%
Consumer Durables 9% 8% 6% 6% 4%
Deposits 13% 14% 9% 12% 10%
U.S. Government 2% 2% 3% 1% 2%
Corporate Equities 7% 8% 17% 10% 14%
Mutual Fund Shares 0.4% 2% 5% 5% 7%
Pension Fund Reserves 16% 18% 21% 22% 21%
Noncorporate Equity 19% 12% 9% 8% 10%
Other 10% 10% 8% 12% 9%

Source: Federal Reserve, Flow of Funds, Table B.101

http://www.federalreserve.gov/releases/Z1/

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Real Estate Finance - Introduction - Topic #1 1/15/20

What is unique about real

estate?
•  Institutions (taxes, leases, financing)

•  Operations/Management

•  Risk
•  Undiversified
•  Illiquid Securitization has alleviated
•  Financing tied to the asset these risk factors, but added
•  Poor price information others (e.g., agency).

•  Market dynamics

What I like about real estate

•  Important asset class
•  Real estate ↔ Broader economy

•  Interesting from both an economics and a business perspective

•  Integrates various markets (land, space, capital)
•  Physical asset (design, operations, leasing)

•  Diverse
•  Locations: local, national, global
•  Property types: office, retail, hotels etc.

•  Frictions → Opportunities
•  Institutions and regulations
•  Scope for innovation & disruption

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Real Estate Finance - Introduction - Topic #1 1/15/20

Asset Prices
250

Housing

200

150

100

Commercial

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2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Note: Indices Normalized (Dec. 2000 = 100) Case-Shiller Composite-10 RCA CPPI
Source: S&P; RCA CPPI

Transactions

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Real Estate Finance - Introduction - Topic #1 1/15/20

Market Mood

Evolving Real Estate Markets

•  Property prices have surpassed peak levels.

•  Fundamentals have stabilized at low levels.

•  Transaction activity has slowed.

•  Market confidence and capital availability have plateaued at high
levels...wait-and-see mentality.

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Real Estate Finance - Introduction - Topic #1 1/15/20

Evolving Real Estate Markets

•  Can prices sustain momentum in 2019?

•  Or, is the market due for a correction?

•  What happens in the broader economy is critical.

•  Interest rates
•  Economic growth
•  i.e. Employment + Consumption (of square feet).
•  Household formation rates

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Real Estate Finance - Introduction - Topic #1 1/15/20

Opportunities
•  Investors taking on more risk to achieve higher yields.
–  Well-priced assets still found in secondary markets and
amongst some B- and C-class properties.

•  Success in this environment depends on ability to:

–  Value properties (including embedded options).
–  Assess and manage risk.
–  Reduce expenses in face of limited revenue yield.

•  It’s not enough to just be in the market.

–  Proper underwriting is of increased importance!

Today’s agenda

•  What Is Real Estate?

•  What Is This Course?

•  Course Details

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Real Estate Finance - Introduction - Topic #1 1/15/20

Course Emphasis
•  Fundamentals of Real Estate Valuation
•  It’s not enough to just be in the market.
•  Can’t count on a rising tide to lift your ‘boat’!
•  Proper underwriting of increased importance.

•  Real Estate Market Dynamics
•  First significant downturn in a decade.
•  Understanding and mitigating risk is crucial.

•  Real Estate Securitization

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Course Scope
•  A survey of key topics:
•  Basic tools of property valuation and deal analysis.
•  Basic financing.
•  Market fundamentals.
•  Public markets and securitization.

•  Designed for students who want to understand:

•  The business decisions behind real estate deals.
•  The swings in commercial and residential real estate markets.

•  This class is not high tech models or development/law.
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•  Taught in the context of the U.S. market.

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Real Estate Finance - Introduction - Topic #1 1/15/20

Why take Real Estate Investments?

The pragmatic reasons:

•  Buying and selling properties
•  Valuation, basic debt and equity financing
•  Investing in real estate securities
•  Publicly traded real estate equity and debt
•  Companies (and households!) invest in real estate
•  Growing market with lots of entrepreneurial opportunities

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Why take Real Estate Investments?

The intellectual reasons:

•  Project valuation and analysis of risk.
•  Project financing and capital structure.
•  What can you control?
•  Incentives driving deals and investments.
•  Asymmetric information, agency conflicts, incomplete contracts
•  Securitization and stock analysis.

…in the context of real estate.

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Real Estate Finance - Introduction - Topic #1 1/15/20

Do you have prior real estate

experience?
1.  Yes
2.  No

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At the end, expect to be able to:

…hold a reasonably intelligent conversation on real estate.
•  Vocabulary
•  Understand the key structures in the industry

…value a property.

…evaluate financing.

…think about how to balance risk and return.

…have a grounding for making real estate usage decisions.
•  What lease to sign 30
•  Whether to own/rent

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Real Estate Finance - Introduction - Topic #1 1/15/20

Course Outline
1.  Property-level analysis
•  Valuation, risk and basic deal structures

2.  Market-level analysis

•  Public markets and securitization
•  Property market fundamentals

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1. Property-Level Analysis
•  Topic #2: Real estate valuation and returns

•  Topic #3: Leases and the economics of retail malls

•  Topic #4: Property-level income: sources, risk and value

•  Topic #5: Debt financing: simple mortgages

•  Topic #6: Taxes and real estate value

•  Topic #7: Debt financing: managing risk with debt structures

•  Topic #8: Property-level risk and return

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•  Topic #9: Debt structures and managing real estate risk

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Real Estate Finance - Introduction - Topic #1 1/15/20

2. Market-Level Analysis

•  Topic #10: Real estate cycles and pricing

•  Topic #11: REITs

•  Topic #12: Securitization of Debt Interests: CMBS

•  Topic #13: Rent v. Own

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Today’s agenda
•  What Is Real Estate?

•  What Is This Course?

•  Course Details

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Real Estate Finance - Introduction - Topic #1 1/15/20

Course Pre-requisites
•  Finance Core

•  Know how to use your calculator

•  Needs to be able to compute annuities
•  Useful to know how to use financial calculator: use PV, PMT etc.

•  You do not need to know any real estate
•  If you know some, some material may be repetitive

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Textbook
•  Course Textbook is Real Estate Finance and Investments by
Peter Linneman, 5th Edition
•  Earlier editions 3.1 and above are fine (page numbers will differ)
•  Literati Bookstore (downtown) has select copies in stock
•  Otherwise best place to buy is directly from Linneman’s website
(link on syllabus)

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Real Estate Finance - Introduction - Topic #1 1/15/20

Course Preparation
Do before class:
•  Read assigned textbook material (Linneman, 5th Edition)
•  Read assigned required articles
•  Fair game on exams
•  Read optional articles
•  Recommended (but not required)

Bring to class:
•  Copies of slides (Canvas)
•  Warning: not a substitute for attending class!

Do after class:
•  Practice problems (Canvas)
•  Not required, not graded, not handed in
•  BUT, they are a good proxy of midterm questions.
•  The questions are long and can be confusing in the beginning. 37

Course Requirements: Cases

•  Case studies:
•  Groups of 3 to 5
•  Variety of skills
•  Handed out in class (not posted online)
•  Two to three weeks to do
•  Cases due on day and time listed on the syllabus

•  Form a case team and register it on Canvas by 3rd week of

class.
•  If you don’t have one by then, I’ll assign you to a group.

•  You must attend class on case discussion days.

•  10% grade deduction if you miss one. 38

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Real Estate Finance - Introduction - Topic #1 1/15/20

Course Requirements: Exam

•  Exam Dates
•  FIN 566 Exam 1: Fri, February 28th
•  FIN 567 Exam 2: Fri, April 24th

•  Closed-book: one 8.5 x 11 double-sided page of notes allowed.

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Course Requirements: Participation

•  I do not keep track of attendance, but:
•  I reserve the right to use superb or sub-par class participation to
help decide grades (up to 1/3 letter).
•  Examples of sub-par participation include systematically missing
classes and/or arriving late for class.

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Real Estate Finance - Introduction - Topic #1 1/15/20

Course Requirements: Guest Lectures

•  Details:
•  Attendance is required.
•  Most likely not recorded.
•  Topics covered in exams.

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Course Grading
•  Grading:
•  40% case
•  60 % exams
•  Participation adjustment

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Real Estate Finance - Introduction - Topic #1 1/15/20

Course Webpage: Canvas

•  Updated syllabus and announcements
•  Post interesting web links or articles for the class
•  Copies of class slides
•  Example Excel spreadsheets from class
•  Practice problems (and solutions)
•  Case team sign-up
•  Case and exam FAQ

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Full Disclosure
•  You will (most likely) not be interested in all the topics.
•  This course is an introduction to Real Estate and your classmates have
different levels of exposure/knowledge of Real Estate
•  This is a conscious course design decision.

•  Syllabus timing is ambitious.

•  “A” grade does require outside classroom work:

•  Exams are 50% qualitative, 50% quantitative
•  Understanding quantitative problems requires several hours of practice
(outside classroom)

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Real Estate Finance - Introduction - Topic #1 1/15/20

To get help…
1.  Email
•  Me: csoo@umich.edu
•  If I don’t respond within 48 hours, please email again!

2.  In person:
•  Me: Email me to make appointments
•  1-2 sentences on why you would like to meet
•  If questions on problems, email me which ones ahead of time.

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