REAL ESTATE AS AN ASSET CLASS

DAN BIHI-ZENOU
 COURSE MAP
Real Estate Fundamentals

Real Estate Financial Mathematics Real Estate as an

Markets for Real Estate Asset Class

Market Valuation (DCF) Real Estate Finance

Effect of Leverage Mortgage Refinancing

Cash Flows Cap Rate Discount Rate
on Risk & Return Loan Types Decisions

Investment Analysis

Investment Analysis Leveraged Investment After Tax Investment

without Leverage Analysis Analysis

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LEARNING OBJECTIVES

• Differentiate the four major asset classes and their financial characteristics.
• Understand the financial services provided by real estate investment vehicles.
• Become familiar with the specifics of the hotel real estate sector.

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REAL ESTATE AS AN
ASSET CLASS
1. The Four Major Asset Classes
2. Real Estate Investment Vehicles
3. Specifics of the Hotel Sector
WHY INVEST?

• Two common objectives:

Growth (savings): Income (cash flow):

long-term investment horizon; short-term horizon & ongoing
no immediate need need for cash

• Common constraints and concerns:

o Risk
o Liquidity
o Time Horizon
o Expertise
o Capital constraint

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TYPES OF INVESTORS

Individuals Institutions

• 25-year-old young professional • Insurance companies

• 35-year-old, one or two kids • Pension funds
• 65-year-old retiree • Mutual funds & Endowment funds
→ Different lifestyles, life cycles, → Different constituencies, regulations,
life goals, level of wealth expertise, liabilities, size

Opportunity for product development by the investment industry

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THE FOUR MAJOR ASSET CLASSES

Aggregate Value of Asset Classes in 2017 (USA)

27%

39%

12%

22%
Stocks Cash Bonds & Mortgages Real Estate Equity*

© Ecole hôtelière de Lausanne *Excludes values in mortgages and corportate real estate. 7
HISTORICAL INVESTMENT PERFORMANCE

Source : EHL calculation, NCREIF NPI for real estate, SP500 for stocks, 10y US government bond for bonds and 1y US government bond for “cash”
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RISK / RETURN STATISTICS ON ANNUAL RETURNS(USA)

_____________Returns__________ _____Risk____
Total Income Growth CAGR Volatility Max. Loss
Cash 4.2% 0.0% 4.2% 4.2% 3.6% 0.0%
Bonds 7.6% 5.9% 1.7% 7.3% 9.9% -11.1%
Real Estate 9.2% 7.2% 2.0% 8.8% 7.4% -22.2%
Stocks 13.1% 2.7% 10.4% 12.0% 15.8% -37.4%

Source : EHL calculation

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INFLATION PROTECTION?

Inflation
3.47%

Source : EHL calculation, NCREIF NPI for real estate, SP500 for stocks, 10y US government bond for bonds and 1y US government bond for “cash”
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ASSET ALLOCATION OF INSTITUTIONAL INVESTORS

Increasing asset
allocation towards
real estate

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REAL ESTATE AS AN
ASSET CLASS
1. The Four Major Asset Classes
2. Real Estate Investment Vehicles
3. Specifics of the Hotel Sector
PROBLEMS WHEN INVESTING IN REAL ESTATE

Lot size
Usually: purchase price greater than investment volume

Information
Identification of contract partners
Legal, business and technical knowledge
Risk
No diversification

Illiquidity
High transaction cost (5 – 10%)
Long transaction time (3 – 9 months)

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SERVICES OF REAL ESTATE INVESTMENT VEHICLES

• Lot size transformation

→ Investment fund as a capital collecting vehicle
• Information transformation
→ Through size effects
• Risk transformation
→ Through diversification
• Liquidity transformation
→ Purchase and sale of shares: cheaper and faster compared to direct real estate

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 WAYS TO INVEST IN REAL ESTATE

Direct Investment Investment vehicle

Public Private Equity

Direct Private Firms / Mutual Open-end Closed-end

REITs REOCs
Ownership Partnership Funds Funds funds
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TYPES OF DIRECT REAL ESTATE INVESTMENTS
Core Core Plus Value-Add Opportunistic
Primary Goal Stable income Value appreciation Value appreciation High short term returns

Strategy Buy-and-hold Buy-and-hold Refurbishment / Sell after

Repositioning Redevelopment
Holding Period > 10 years > 10 years 3-8 years 3-8 years
Location A-Locations B-Locations A, B, C Locations B- and C-Locations
Rental Contract Long-term rental Short-term contracts High Vacancy Redevelopment /
contracts Repositioning Potential
Tenant & Strong tenant & Solid tenant & - Rents far below market
Building Quality building quality building quality level
Leverage (LTV) < 30% 30-60% 30-60% 60-90%
Typical Investors Open-end funds Open-end funds REITs & REOCs Private-Equity-Funds
Pension funds REITs & REOCs Private Equity
Insurance companies Funds
Total Return ~3-5% ~5-10% ~10-15% >15%
Target
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WHAT ARE REITS?

© Ecole hôtelière de Lausanne Source: https://www.youtube.com/watch?v=yDl1_uLR5Os 17

REAL ESTATE INVESTMENT TRUSTS (REITS)

• Publicly-traded company that owns income-producing real estate

o Investors trade shares with each other on public stock exchanges
→ Number of shares normally does not change

• Key benefit: No corporate tax if…

o Dividends: at least 90% of earnings have to be paid out
o Income: At least 75% of the earnings arising from real estate income (excluding
the profits from the trading of properties).
o Assets: At least 75% of assets are real estate assets.
→ Otherwise: Real Estate Operating Company (REOC)

• Key disadvantage: Stock market volatility

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REIT EXAMPLE: HOSPITALITY PROPERTIES TRUST (HPT)

Price change (%) Dividend yield (%)

19
© Ecole hôtelière de Lausanne Source: SNL.com
REITS: INTERNATIONAL OVERVIEW

© Ecole hôtelière de Lausanne Source: Nareit Real Estate: https://www.reit.com/investing/global-real-estate-investment Source: EPRA Global REIT Survey 2021
COMPARISON OF REIT REQUIREMENTS

Dividend Real Estate Assets Leverage Stock Exchange

USA > 90% > 75% - -
France > 95% Activity restricted to RE - Yes

UK > 90% > 75% DSCR >125% Yes

Japan > 90% > 95% - -

Germany > 90% > 75% < 55% Yes

DSCR=Debt-Service-Coverage Ratio

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REIT SECTORS (US)

More on REIT Sectors: https://www.reit.com/what-reit/reit-sectors

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CLOSED-END PRIVATE EQUITY REAL ESTATE FUNDS
• Closed-end:
o Predetermined lifetime; fund is liquidated after 8-15 years
• Private: Shares are not traded on public exchanges
o Fund raises capital directly from investors (private market transaction)
o Investors cannot sell back shares to the fund or buy more shares thereafter

• Pricing / Returns:
o Net asset value (NAV) is regularly reported (but not tradeable)
o Investors receive irregular distributions leaned towards the end of the fund`s life.

• Key Benefit: Flexibility for Fund Management

o No risk of capital outflows, no stock market volatility
→ Enables long-term perspective and high leverage.
• Key Disadvantage: Illiquidity for investors
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TYPICAL PRIVATE EQUITY FUND LIFE CYCLE (J-CURVE)

Source: Pictet (2016)

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OPEN-END PRIVATE EQUITY REAL ESTATE FUND
• Open-end:
o Infinite / undetermined lifetime → Varying number of shares & equity
• Private:
o Investors buy and sell shares directly from the fund
• Pricing / Returns:
o Price per unit is based on the fund`s NAV per share (largely appraisal-based)
• Key benefit: Low volatility
o No stock market risk as NAV per share depends on property appraisals
o Low financial leverage & high cash holdings

• Key disadvantage: Risk of liquidity crisis

o When investors sell quickly at the same time, fund may run out of cash
→ OEREFs can become forced sellers of illiquid real estate assets.
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OEREF EXAMPLE: UNIIMMO GLOBAL

Total Return Index Share price

Source: https://www.union-investment.de Source: https://www.finanzen.net/fonds/uniimmo:_global

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 OPEN-END REAL ESTATE FUNDS AROUND THE WORLD

Source:©Downs,
Ecole hôtelière de Lausanne
Sebastian & Woltering (2017) 27
RISK & RETURN OF RE INVESTMENT VEHICLES

Total Core (plus) Value-add Opportunistic

Return
• Speculative area
• High degree of financial leverage
• Often development necessary
High Private Equity
Real Estate
Funds
REITs &
Medium REOCs • Active management
necessary
• Considerable degree of
Open-end financial leverage
Low Real Estate
Funds
• Relatively safe investment
• High degree of risk aversion
0 • Only little financial leverage

Risk
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HISTORICAL INVESTMENT PERFORMANCE (USA)

REITs

PEREFs
OEREFs

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SUMMARY

REITs OEREFs PEREFs

Very high High
Liquidity Very illiquid
(stock exchange) (unless liquidity crisis)
Type of RE Opportunistic &
Whole spectrum Core
Investments Value-Add

Portfolio Diversified within Diversified over many Sector focus;

Diversification real estate sector properties in many sectors No diversification

Leverage
25%-75% <30% 60-85%
(% of total assets)

Total Return Target 5%-15% 3%-8% 10%-20%

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CONCEPT CHECK (1)

• This hotel is owned by a…

a) REIT
b) OEREF
c) PEREF

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CONCEPT CHECK (2)

• This hotel is owned by a…

a) REIT
b) OEREF
c) PEREF

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CONCEPT CHECK (3)

• This hotel is owned by a…

a) REIT
b) OEREF
c) PEREF

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REAL ESTATE AS AN
ASSET CLASS
1. The Four Major Asset Classes
2. Real Estate Investment Vehicles
3. Specifics of the Hotel Sector
SPECIFICS OF THE HOTEL SECTOR

Traditional Real Estate Hotels

Revenue / Value Driver Real Estate Real Estate + Service

Lease term 5-15 years 1 night

Rental demand local Local + international

Sensitivity to economy &

moderate High (upside & downside)
External events

→Hotel revenues are the most volatile.

→Hotel operations require specialist sector know-how.
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VOLATILITY OF HOTEL CASH FLOWS

Source: Own calculations based on STR Trend Report - Trend United States, Trend # 1362089_SINIM / Created August 15, 2022

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VOLATILITY OF HOTELS VS. OTHER RE SECTORS

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Source: Moody`s, RCA, Auctions.com