REE 3043 Outline Chapter One 1 Classical Land Economics a Prior to 1776 economics recognized that value was derived from an asset s or its usefulness to people and it s b Early 19th century classical economists argued that rent the periodic was determined by the and in production 2 The Neoclassical Tradition is Still Followed Today a Neoclassical economists e g Alfred Marshall in the late 1800s and early 1900s demonstrated that value results from the intersection of cost and utility 3 Ideas About Property Rights and Contracts a In addition to demand and supply fundamentals value is greatly affected by the by government e g land use codes building codes and groups e g neighborhood covenants and restrictions 4 Financial Economics i Real estate investment and valuation decisions require and the application of advanced developed by financial economists 5 The Institutions a Real estate values are affected by and these include primary and secondary lending institutions local government agencies and a variety of real estate ownership vehicles e g real estate investment trusts 6 Real Estate in the World Economy a Financial assets include items such as and Real estate can be classified as a financial asset Real assets are assets e g jewelry housing etc 7 The Relative Wealth of Real Estate a The value of the world s assets was estimated by Ibbotson Associates to be 44 trillion in 1991 b Real estate assets are estimated to represent nearly of the world s wealth c Residential property e g single family apartments etc represents approximately of the real estate wealth in the U S 8 Who Owns America a Examining the question of who owns America requires consideration of both owners and lenders i and on homes jointly own the majority of U S property ii Owner occupied homes represents about of the value of all real estate in the U S Owners equity accounts for and mortgage debt for iii real estate represents about 40 of the value of all real estate in the U S Owner s equity accounts for and mortgage debt for iv While few commercial mortgages are securitized only about of the outstanding residential mortgages are unsecuritized v The trend is toward greater institutional and corporate ownership of commercial properties and increased holding of all mortgages through largely by funds and other institutional investors 9 Real Estate Defined a The term real estate is also commonly used in the following ways i Real estate may be an ii Real estate may be a or iii Real estate may be a business or iv Real estate may be the and space market v Real estate may be the rights associated with real property 10 Real Estate Perspectives a Real estate can be viewed from five perspectives and 1 Value The Central Idea Chapter 2 a Market Value can be defined as the a typical buyer would pay if the property were b Investment Value can be defined as the price a as opposed to the typical investor is willing to pay given the investor s unique situation opportunities required rate of return and expectations of the property s c Mortgage Value is defined as the of the lender s rights to receive a series of expected from the borrower over a given the rate on the loan 2 What Is Real Estate Valuation a The value of real estate is affected by the future cash flows from operations and the sale of property Hence property value is affected by an investor s estimate of i The of the expected cash flows ii The of the expected cash flows iii The probability of receiving of the expected cash flows 3 The Trade Off Between Return and Risk a is the possibility that actual outcomes cash flows will vary from what is expected b Risk averse investors require expected returns for their willingness to bear more risk Investors that are risk require no additional compensation for additional risk Risk seeking investors require as risk increases Most investors are 4 Time Value of Money a Definitions i The general concept of the time value of money in essence is understanding that individuals require to forego receiving and using their money at an earlier date ii The time line indicates the the magnitude of the and whether the cash flow is an or income or expense iii iv Using the time line cash inflows are assigned values and cash outflows values b Equations Tables and Calculators i Simple time value problems can be solved by identifying of the variables common to all of the time value equations and solving for the unknown variable The five variables common to all time value problems are 1 N the of periods 2 3 PV the amount invested or received in period I the usually monthly or annual interest rate or the discounted value of the future cash flow 4 PMT the periodic level payment or receipt and 5 FV the lump sum amount paid or at the of the time series or the value of an earlier cash flow c Six Time Value of Money Operations i Time value of money adjustments are generally accomplished using one or more of the six mathematical operations list below 1 Future value of a single 2 Future value of an 3 fund 4 Present value of a single 5 Present value of an 6 Mortgage constant d Loan Amortization i The application of the fixed mortgage payment to interest and principal is given on the loan ii The interest charged each month is the interest rate x the outstanding balance on the mortgage iii The difference between the interest charge and the debt service is applied to the principal to the outstanding balance 5 Investment Analysis a Present Value Measures i Present Value 1 The value of a property is determined by converting the from the property into a present value estimate ii Net Present Value NPV 1 The net present value is defined as the difference between the of the cash inflows and the present value of the 2 b Yield Measures i Internal rate of return IRR 1 The IRR is the rate of return at which NPV the rate of return at which the present value of the cash inflows the present value of the cash outflows 2 When referring to mortgage yields the IRR is often referred to as the yield to maturity effective yield or the effective cost 3 The decision criteria are generally consistent with the NPV criterion If the IRR is than the investor s required return the investment should be 4 The IRR decision criterion can be misleading because it assumes that cash inflows can be reinvested at the IRR rate 6 Capitalization Rate Introduced a The overall capitalization rate Ro is the ration between a property s income and its value b 1 REAL ESTATE INVESTMENT ANALYSIS a Investment