Introduction to Real Estate

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Introduction to Real Estate

• History and Concepts

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Place vs. Property Rights

• Is property ownership natural?
• Is property ownership desirable?
• What does ownership entail?
• How has ownership been used?
• What can history tell us?

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Ancient History

• Old Babylonian Period, Iraq.
• In the presence of these witnesses
• 36 meters square of fallow land from Adad-nuri
• And Samas-rimeni his sone
• Sin-Remeni bought
• 14 shekels of silver, for its full price he paid
  (weighed)

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Document Reverse

• Witnesses
• Nin-melam
• Ubaia son of Abu-wedum
• Manum son of Ilanum
• Etel-pi-Sin son of Sesani
• Harri-
• Sin- the equerry
• Samas-abimu
• Sin-apil-Sin son of Idin-ili
• Idin-Estar shepherd of ?
• Gis-u-a
• Ipkusa son of Sin-maba
• Ubaiatumu son of Aputum
• Idissum-Kamarki
• Harizum so of la-
• Damu-ellassu the equerry

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Contract

• Transfer of ownership (allowing?)
• Defined quantity of land (where)
• Full price in weighed silver (why full?)
• Record of an act
• Role of witnesses (who were they?)
• Why so many?
• Why no date?

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China

• 82-character inscription
• Gebo purchased 30 plots of land from Pengsheng
  in exchange for four horses.
• The inscription indicates that they had the land
  surveyed and drew up a written agreement which
  was then divided between them.

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• Ceremonial Vessel
• Bronze Inscription
• Bronze model of bi-partite deed contract (from
  later dynasty)

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Mortgages

• Mirashu clan and contingent clan
• 500 B.C. Nippur. 423 death of Atraxerxes
• Sogdanius vs. Ochus - Darius II.
• Mortgage Defaults financed revolution

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Excavation of Nippur
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Real Estate as Rights

• Property Thing that can be used, enjoyed,
  conveyed
• Property Rights Rights that can be exercised or
  conveyed by owner
• Interests in Property created by owner, pledge
  or encumber property without giving up ownership.

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Estates

• How and how rights are owned
• Estate in possession (or not)
• Freehold vs. Leasehold
• Fee simple free to divide, encumber etc.
• Leasehold estate years vs. year to year
• Lessee leases property from lessor.
• Title, deed
• General warranty, special warranty, quitclaim

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Title

• Capital does not exist without title.
• Capital without title is dead.
• Process of transfer and development matters.
• Separates first world from third world.

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Procedure to gain access to desert land for
construction purposes and to register property
rights in Egypt (6-14 years)
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Title Freeing up Capital

• Mortgages free up capital in household savings.
  Securitization.
• Real estate as fundamental asset.

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Land Banks

• Depreciation of Silver (1600s)
• Land as fixed capital asset
• anti-inflation
• Scottish proposal Law 1705
• Examples from New England
• 1686, 1733 New London
• Goal to provide money backed by real asset.

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Henry George (1839-1897)Freehold vs. Leasehold

• We have reached the deplorable circumstance where
  in large measure a very powerful few are in
  possession of the earth's resources, the land and
  its riches and all the franchises and other
  privileges that yield a return. These positions
  are maintained virtually without taxation they
  are immune to the demands made on others. The
  very poor, who have nothing, are the object of
  compulsory charity. And the rest -- the workers,
  the middle-class, the backbone of the country --
  are made to support the lot by their labor.

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Rights to Personal Enjoyment

• Peoples rights vs. personal rights
• Elimination of private property
• In its aftermath?

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Real Estate as an Asset

• Features and valuation

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What's Special About Real Estate as an Asset
Class?

• Immobility
• Location is key characteristic
• Local economic issues prevail in valuation i.e.
  city-wide employment
• Micro economic conditions might prevail i.e.
  street locus
• Localized knowledge and expertise
• Subject to local laws, restrictions and
  conditions
• Uniqueness of location

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Undeveloped

• All potential
• Infinitely lived so timing is crucial
• Option value to development
• Land is only as valuable as the associated
  property rights
• Building as physical asset

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Developed

• Depreciating asset
• Development decision re. capacity choice
• Hard to conceal or disguise
• Long development time
• Relatively expensive
• Indivisibility of building/land
• Uniqueness of building makes pricing difficult
• Requires financing
• Requires syndication

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What's Important About Real Estate?

• Big business 10 of U.S. economy
• Component of balance sheets of all businesses as
  asset or lease liability.
• Everyone's home gt65 of households own.
• Major securitization of the bond market.
• Major personal asset and/or liability.
• gt6 of institutional investment portfolios

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Securitization

• MBS revolution in 80's pass-throughs
• High-tech revolution in 90's strips. I.O.'s
• REIT IPO billions each year.
• CMBS a major fixed income class
• Emerging derivatives market

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How it Works

• Land
• primary and ancillary righrts
• Timing of Development Construction
• Development
• Choice Office, Industrial, Retail, Residential
  Highest and best use
• Financing
• Syndication
• Management
• Bridge Permanent Management Leasing
• Turnover
• Maintenance
• Transaction
• Valuation
• Marketplace
• Negotiation
• Taxes Demolition Alternative use

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Land

• Primary and ancillary rights
• Timing of Development Construction

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Development

• Choice Office, Industrial, Retail, Residential
• Highest and best use
• Financing
• Debt/Equity choice
• Syndication, partnership structure
• Development loan
• Bridge loan

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Management

• Leasing
• Tenants
• Lease terms
• bundle of leases
• Turnover
• Maintenance

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Transaction

• Valuation
• Marketplace
• Negotiation
• Or demolition and reversion to land

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Methods of Valuation

• Comparables
• Replacement Value
• Discounted Future Cash Flows

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Sources of Value

• Land Other rights
• Building Leases
• Options -- granted and owned
• Strategic Advantage
• Mortgage "Put"

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Leases

• Lessor A person who rents property to another
  under a lease. (Landlord)
• Asking vs. effective rent
• Term of the Lease
• Base Rent
• Expense Responsibility
• Participating Income
• Renewal Option
• Expense Stops
• CPI Adjustment
• Office "Net" or "Triple Net" A lease
  providing that the tenant pay for all maintenance
  expenses, plus utilities, taxes, and insurance.
  This results in lower risk for investors, who
  usually form a limited partnership.

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Example The Century Tower

• New Haven Office Building at Church and Grove
• Class A Office Space
• 24 Floors
• Ground Floor Retail
• Parking
• 285,000 Net Leasable Area
• Built in 1989, For a price of 50 million
• Mortgaged Repossessed
• Fully Leased with professional offices _at_ 15 per
  square foot
• Flagship Tenant at 10, other tenants at 20
• Flagship Lease of 7 years, Other Leases at 3
  years

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Century Office Building Century Office Building Century Office Building Comparable Data Comparable Data Comparable Data
Area total 285,000 Construction costs 80 22,800,000
Retail 15,000 Soft Costs 10,000,000
Office 270,000 Total 32,800,000
Original Price 40,000,000
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Year 1 Year 2 Year 3 Year 4 Year 5
Rents
Flagship 1,350,000 1,350,000 1,350,000 1,350,000 1,350,000
Other 2,700,000 2,700,000 2,700,000 2,700,000 2,700,000
Retail 150,000 150,000 150,000 150,000 150,000
Total 4,200,000 4,200,000 4,200,000 4,200,000 4,200,000
Total Expenses 840,000 840,000 840,000 840,000 840,000

Net Operating Income 3,360,000 3,360,000 3,360,000 3,360,000 3,360,000

Debt Service 2,200,000 2,200,000 2,200,000 2,200,000 2,200,000

Before Tax Cash Flow 1,160,000 1,160,000 1,160,000 1,160,000 1,160,000
Tax Shields P/25.42 672,000 672,000 672,000 672,000 672,000
After Tax Cash Flow 1,832,000 1,832,000 1,832,000 1,832,000 1,832,000
Perpetuity Value 24,823,848 24,823,848 24,823,848 24,823,848 24,823,848
Cap Rate 0.0840
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Discount Rates

• CAPM possibilities - systematic risk
• Comparable possibilities
• Cash flow risk
• Building like a bond portfolio
• convertibility
• re-investment risk lease renewal
• diversification risk
• borrower risk pass-through

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Performance Measures

• Price Per Square Foot
• Gross and Rentable
• Cap Rate NOI/Price
• Going in
• Going out

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Performance Measures (cont)

• Equity Dividend Rate
• BTCF1/ Equity Investment
• Debt Coverage Ratio
• NOI/MTG PMT
• NPV
• Profitability PV/Initial Investment
• IRR
• Modified IRR

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Issues with Pro Forma

• Single forecast
• Discount rate choice
• Assumptions about resale
• Lacks dynamics and risk
• Not tied to real economy