Commercial Real Estate Analysis and Investments (with CD-ROM), 2nd Edition

Front Cover......Page 1
Title Page......Page 2
Copyright......Page 3
Contents
......Page 8
PREFACE......Page 22
ACKNOWLEDGMENTS......Page 28
ABOUT THE AUTHORS......Page 30
PART I: INTRODUCTION TO REAL ESTATE ECONOMICS......Page 34
1.1 Space Market......Page 36
1.2 Asset Market......Page 44
Key Terms......Page 51
Study Questions......Page 52
2.1 Commercial Property Development Industry......Page 54
2.2 Overview of the Real Estate System......Page 55
2.3 Four-Quadrant Model......Page 58
2.4 Using the 4Q Diagram to Help Understand Boom and Bust in Real Estate Markets......Page 60
2.5 Chapter Summary......Page 66
Study Questions......Page 67
Part I: References and Additional Reading......Page 69
PART II: URBAN ECONOMICS AND REAL ESTATE MARKET ANALYSIS......Page 70
3.1 Pattern of City Size......Page 72
3.2 Pattern of City Location......Page 74
3.3 Factors Underlying the Pattern: Centripetal and Centrifugal Forces......Page 75
3.4 Economic Base and the Growth of Cities and Regions......Page 81
3.5 Classification of Cities for Real Estate Investment Analysis......Page 87
3.6 Chapter Summary......Page 88
Study Questions......Page 89
4 Inside the City I: Some Basic Urban Economics......Page 92
4.1 Some Basic Economic Principles of Urban Land Value and Use......Page 93
4.2 Classic Monocentric City Model......Page 99
Study Questions......Page 109
5.1 From Property Rent to Property Value: The Effect of Rent Growth Expectations......Page 112
5.2 Effect of Uncertainty on Speculative Land Value......Page 114
5.3 Let's Get Real: New Twists to the Old Model......Page 117
5.4 Property Life Cycle and the Effect of Building Structure Depreciation......Page 128
5.5 Chapter Summary......Page 132
Study Questions......Page 133
6 Real Estate Market Analysis......Page 136
6.1 General Features of Real Estate Market Analysis......Page 137
6.2 Formal Model of Space Market Equilibrium Dynamics and Cyclicality......Page 146
Study Questions......Page 150
Part II: References and Additional Reading......Page 152
PART III: BASIC FINANCIAL ECONOMIC CONCEPTS AND TOOLS......Page 154
7 Real Estate as an Investment: Some Background Information......Page 156
7.1 Investment Industry, and Real Estate's Role Therein......Page 157
7.2 Real Estate as an Asset Class......Page 167
Key Terms......Page 178
Study Questions......Page 179
8 Present Value Mathematics for Real Estate......Page 182
8.1 Single-Sum Formulas......Page 183
8.2 Multiperiod Problems......Page 188
Study Questions......Page 200
9.1 Investment Returns: Basic Definitions and Classification......Page 206
9.2 Periodic Returns......Page 209
9.3 Multiperiod and Dollar-Weighted Returns......Page 222
Study Questions......Page 226
Part III: References and Additional Reading......Page 231
PART IV: REAL ESTATE VALUATION AND INVESTMENT ANALYSIS AT THE MICRO-LEVEL......Page 232
10 The Basic Idea: DCF and NPV......Page 234
10.1 Relation between Return Expectations and Property Values in the Asset Market......Page 235
10.2 Discounted Cash Flow Valuation Procedure......Page 236
10.3 Ratio Valuation Procedures: Direct Capitalization and GIM as Shortcuts......Page 241
10.4 Typical Mistakes in DCF Application to Commercial Property......Page 244
10.5 Is DCF Really Useful in the Real World?......Page 246
10.6 Capital Budgeting and the NPV Investment Decision Rule......Page 247
Appendix 10A: Method to Estimate Interlease Discount Rates......Page 253
Appendix 10B: Micro-Level Investment Performance Attribution: Parsing the IRR......Page 254
Appendix 10C: The Certainty Equivalence Approach to DCF Valuation......Page 258
Key Terms......Page 262
Study Questions......Page 263
11 Nuts and Bolts for Real Estate Valuation: Cash Flow Proformas and Discount Rates......Page 268
11.1 Proformas and Cash Flow Projection......Page 269
11.2 Discount Rates: The Opportunity Cost of Capital......Page 282
Key Terms......Page 291
Study Questions......Page 292
12 Advanced Micro-Level Valuation......Page 296
12.1 Market Value and Investment Value......Page 297
12.2 Danger and Opportunity in Market Inefficiency......Page 305
12.3 Dueling Asset Markets: The REIT Market versus the Property Market......Page 309
Appendix 12A: Basic Valuation Concepts: Transaction Prices and Market Values......Page 319
Study Questions......Page 323
Part IV: References and Additional Reading......Page 326
PART V: COMPLETING THE BASIC INVESTMENT ANALYSIS PICTURE......Page 328
13 Use of Debt in Real Estate Investment: The Effect of Leverage......Page 330
The ''Big Picture''......Page 331
13.1 Basic Definitions and Mechanics of Leverage......Page 332
13.2 Effect of Leverage on the Risk and Return to Equity......Page 334
13.3 A Useful Formula: The WACC......Page 340
13.5 Effect of Leverage on Growth and Yield......Page 343
13.6 Chapter Summary......Page 346
Study Questions......Page 347
14 After-Tax Investment Analysis & Corporate Real Estate......Page 352
14.1 General Effects of Income Taxes and Debt......Page 353
14.2 Numerical Example of After-Tax Proforma......Page 355
14.3 After-Tax Equity Valuation and Capital Budgeting......Page 363
14.4 Corporate Real Estate: The Own-Versus-Rent Decision......Page 382
14.5 Chapter Summary......Page 383
Study Questions......Page 384
15 Real Estate Investment Capital Structure......Page 388
15.1 Debt When There Is an Equity Capital Constraint......Page 389
15.2 Other Considerations Regarding the Role of Debt in Real Estate Investments......Page 392
15.3 Project-Level Capital Structure in Real Estate......Page 399
15.4 Chapter Summary......Page 413
Study Questions......Page 414
Part V: References and Additional Reading......Page 417
PART VI: MORTGAGES FROM AN INVESTMENT PERSPECTIVE......Page 418
16 Mortgage Basics I: An Introduction and Overview......Page 420
16.1 Basic Typology of Mortgages and Overview of the U.S. Mortgage Industry......Page 421
16.2 Basic Legal Concepts and Terminology for Mortgages......Page 424
16.3 Default, Foreclosure, and Bankruptcy......Page 430
16.4 Nonlitigious Actions and Workouts......Page 431
16.5 Limited Liability and Foreclosure Costs: The Borrower's Put Option and Strategic Default......Page 433
16.6 Chapter Summary......Page 436
Study Questions......Page 437
17.1 Calculating Loan Payments and Balances......Page 440
17.2 Loan Yields and Mortgage Valuation......Page 452
17.3 Refinancing Decision......Page 458
17.4 Chapter Summary......Page 464
Study Questions......Page 465
18.1 Expected Returns Versus Stated Yields: Measuring the Impact of Default Risk......Page 472
18.2 Commercial Mortgage Underwriting......Page 481
18.3 Participating Mortgages......Page 489
18.4 Chapter Summary......Page 492
Study Questions......Page 493
19.1 Some Basic Characteristics of Bonds......Page 496
19.2 Commercial Mortgage Returns: Ex Ante and Ex Post......Page 508
Study Questions......Page 518
20 Commercial Mortgage-Backed Securities......Page 522
20.1 What Are CMBS?......Page 523
20.2 CMBS Structure: Tranching and Subordination......Page 527
20.3 CMBS Rating and Yields......Page 535
20.4 CMBS: Borrower Considerations......Page 547
Study Questions......Page 548
Part VI: References and Additional Reading......Page 551
PART VII: MACRO-LEVEL REAL ESTATE INVESTMENT ISSUES......Page 554
21 Real Estate and Portfolio Theory: Strategic Investment Considerations......Page 556
21.1 Numerical Example of the Portfolio Allocation Problem: Real Estate in the Mixed-Asset Portfolio......Page 557
21.2 Basic Mean-Variance Portfolio Theory (MPT)......Page 561
21.3 Allowing for a Riskless Asset: The Two-Fund Theorem and the Sharpe-Maximizing Portfolio......Page 577
21.4 Some Broader Considerations in Portfolio Allocation......Page 581
Appendix 21A: A Review of Some Statistics about Portfolio Returns......Page 584
Cross-Sectional and Time-Series Return Statistics......Page 585
Time-Series Statistics Used in Portfolio Theory......Page 587
Study Questions......Page 592
22 Equilibrium Asset Valuation and Real Estate's Price of Risk in the Capital Market......Page 594
22.1 Review of Classical Asset Pricing Theory......Page 595
22.2 Applying the CAPM to the Private Real Estate Asset Class as a Whole......Page 604
22.3 Attempting to Quantify Sectoral Risk and Return within the Private Real Estate Asset Class: The Cutting Edge......Page 609
Study Questions......Page 615
23 Real Estate Investment Trusts (REITs)......Page 618
23.1 REIT Structure and Market Evolution......Page 619
23.2 REIT Analysis and Valuation in the Stock Market......Page 625
23.3 Some Considerations of REIT Management Strategy......Page 645
23.4 Fundamental Nature and Value of Reits: Two Models......Page 650
23.5 Chapter Summary: Some Reit Investor Considerations......Page 653
Study Questions......Page 655
24 International Real Estate Investment: Markets, Strategies, and Implementation......Page 660
24.1 There's A Big World Out There......Page 661
24.2 Going International: Rationales and Obstacles......Page 666
24.3 Developing and Implementing International Real Estate Strategies......Page 684
Study Questions......Page 689
25 Data Challenges in Measuring Real Estate Periodic Returns......Page 690
25.1 The Basics: Macro-Level Property Valuation......Page 692
25.2 From Value Levels to Returns: The General Nature of Performance Measurement Errors......Page 698
25.3 What Is Truth? Lags and the Time Line of Price Discovery in Real Estate......Page 705
25.4 What Is to Be Done?: Dealing with Temporal Lag Bias in Appraisal-Based Returns......Page 711
25.5 Chapter Summary......Page 718
Study Questions......Page 719
26 Real Estate Investment Management and Derivatives......Page 722
26.1 Macro-Level Investment Performance Attribution......Page 723
26.2 Investment Performance Evaluation and Benchmarking......Page 731
26.3 Real Estate Derivatives......Page 740
Key Terms......Page 747
Study Questions......Page 748
Part VII: References and Additional Reading......Page 751
PART VIII: REAL ESTATE DEVELOPMENT AND OTHER SELECTED TOPICS......Page 760
27 Real Options and Land Value......Page 762
27.1 The Call Option Model of Land Value......Page 763
27.2 Simple Numerical Example of OVT Applied to Land Valuation and the Development Timing Decision......Page 764
27.3 A Rigorous Model of Option Value......Page 767
27.4 The Binomial Model of Option Value......Page 773
27.5 A Perpetual Model in Continuous Time......Page 777
27.6 Using Option Theory to Understand Overbuilding......Page 783
27.7 Chapter Summary......Page 785
Study Questions......Page 786
28 Investment Analysis of Real Estate Development Projects: Overview & Background......Page 790
28.1 Overview of the Development Decision-Making Process......Page 791
28.2 Basic Information: Enumerating Project Costs and Benefits......Page 799
28.3 Construction Budget Mechanics......Page 801
28.4 Simple Financial Feasibility Analysis in Current Practice......Page 803
Key Terms......Page 808
Study Questions......Page 809
29 Investment Analysis of Real Estate Development Projects, Part 2: Economic Analysis......Page 812
29.1 The Basic Idea......Page 813
29.2 Advanced Topic: The Relationship of Development Valuation to the Real Option Model of Land Value......Page 825
29.3 Broadening the Perspective......Page 827
29.4 Evaluating Multi-Phase Developments: Real Options Theory and a Simplification......Page 832
Study Questions......Page 835
30 Leases and Leasing Strategy......Page 840
30.1 Commercial Property Lease Terminology and Typology......Page 841
30.2 Lease Characteristics Affecting Value or Rent......Page 844
30.3 Effective Rent......Page 845
30.4 Broader Leasing Strategy Considerations: Term Length and the Space Market Term Structure of Rent......Page 850
30.5 Other Leasing and Rent Issues......Page 856
Study Questions......Page 860
Part VIII: References and Additional Reading......Page 862
Index......Page 864