FINC 475 1st EditionFinal Exam Study Guide Lectures: Ch 15, 19, 21, and 23, REIT Notes, DCF***NOTE***This exam is cumulative. See previous study guides for a review of previous material. This study guide includes the new chapters, REIT presentation information, and DCF practice problems. New Chapters: 15, 19, 21, & 23Chapter 15What are the four categories of risk?1. Business Risk: making inappropriate business decisions or misjudging consequences of ones actions2. Financial Risk: choice of financial arrangements3. People Risk: from dependency on others4. Political Risk: from dependency on governmentWhat are a few ways to manage risk? Insurable Risk, safe deals, diversification, research, experience, shift risk to tenant, hedgingWhat are the steps in how to identify risk?Identify, Assess Probability, Determine Response Plan, Set Up Systems to Manage, MonitorWhy is it important to identify risk?- Improve Decision Making, Planning and Prioritization- Allocate Capital and Resource more Efficiently- Anticipate what might go Wrong & Reduces Firefighting- Improve Probability of SuccessWhat are the traditional tools for risk assessment?- Payback Period - Risk Adjusted Discount Rate: most common, use risk premium, each project has its own risk characteristic- Partitioning of Cash Flows: NPV of each piece to see which is most important)- Sensitivity Analysis: Extension of Partitioning in that we add the impact of changing variableWhat are the contemporary tools for risk assessment? - Rank the Risks according to probability and outcome- Work Breakdown Structure is a timeline of the projectChapter 19What are the categories of constraints for investments?- Physical: engineering limits (soil, tolerances), size limits (amount of space), neighborhood amenities (transportation, services, etc.)- Legal: zoning, court rulings, public pressure- Valuation: market considerationsWhat is the difference between feasibility and valuation?Both utilize the same data, however valuation is solely asset worth (aka already assumes reasonable feasibility) and feasibility considers more than value. What constitutes highest and best use?Legally permissible, physically possible, financially feasible, maximally productiveWhat are the steps in the feasibility study?1.Assess physical and legal aspects2.Estimate demand and tenant needs3.Analyze competition4.Estimate costs5.Determine financing costs6.Estimate absorption7.Prepare cash flow analysis8.Determine investor returnsWhat is the purpose and benefit of sensitivity analysis?The purpose is to determine the level of impact on Financial Feasibility by adjusting Variables or Assumptions. The benefits are that you can determine the level of “cushion” in the assumptions, be better prepared at negotiating table, and ultimately gain confidence in project.What does feasibility analysis attempt to do? Feasibility analysis attempts to estimate the probability of success of a specific proposed course of actionChapter 21What is development, redevelopment, and gentrification?Development is the process of adding improvements to land. Redevelopment is taking property with exiting improvements and upgrading or converting it to another use. Gentrification is the buying and renovation of houses and stores in deteriorated urban neighborhoods by upper- or middle-income families or individuals, thus improving property values but often displacing low-income families and small businesses.A successful development must do what?Meet an Existing NeedEnsure Financial SuccessOvercome Legal RequirementsWhat are the steps of basic real estate development?- Identify market demando Research- May buy raw or improved lando Control a site- Secure a tenant or build on “spec”- Secure zoning, entitlements and permits- Design- Finance- Build Improvementso 6-24 month Construction Process- Lease and occupyo Marketing, Leasing, and Building OperationsWhat are the types of subdivisions?Residential (Home Lots), Commercial (Industrial/Office Parks, Mixed Use, Mall Development), Condominium Conversion, Time SharesWhat are the steps in the subdividing process?- Determine Absorption i.e. demand- “Tie Up” of Control Lando Purchase or option- Develop Plan- Survey – locate lots/easements- Obtain Entitlements- Improve Land – grading, utilities, streets, curbs, sidewalks- SellWhat are the risks of subdividing?Return is from capital appreciation or resale. Also, the sale of the entire development may take years.Explain the J-curve with regard to the cash flow timeline.There are heavy initial cash outlays, so it starts out negative, then increases. Eventually, overhead declines with success of sales.What is the J-curve risk in land?Heavily dependent on the success of non-income producing assetChapter 23What is a REIT?REITS were modeled after the mutual fund. A REIT is a company that combines the capital of many investors to acquire and manage real estate. REITs do not pay corporate income tax and thus, investors are not “double taxed”. In order to qualify as a REIT, the company must comply with certain provisions of the IRS. What are two other real estate securities?First, there are real estate operating companies, which are conventional taxable corporations engaged in real estate investments that are more typical of development companies and hotel management. Second, there are commercial mortgage-backed securities, which are shares in pools of mortgages. What are the six requirements to qualify as a REIT?1. Invest at least 75% of its total assets in RE2. Derive at least 75% of gross income from rents of real property or interest on mortgages of real property3. Pay dividends of at least 90% of taxable income4. Be managed by a Board of Directors or Trustees5. Minimum of 100 shareholders, no less than five owning more than 50% of the voting shares6. Be a corporation, business trust or similar associationWhat is the difference between a REIT and an UPREIT?Traditionally, real estate property ownership interests were exchanged for REIT shares, thereby causing a capital gains income taxation event. The UPREIT structure was created to avoid recognition of taxable income for existing property owners on the transfer of appreciated property to a REIT. For the UPREITs, one of the major advantages are instead of paying cash is that you have the ability to issue limited partnership units. As a result, nearly two-thirds of all newly formed REITs since 1992 have resulted from an UPREIT structure. More than