1 / 15

Commercial Real Estate Fundamentals

Commercial Real Estate Fundamentals . June 1, 2010. Recent CRE transaction. 2000 market street 29 stories, 665,000 square feet Sold for $50,000,000 approximately $80/sq ft Building was bought in 2003 for $77 million by DB Mortgage was $49,000,000 with prudential

domani
Download Presentation

Commercial Real Estate Fundamentals

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. Commercial Real Estate Fundamentals June 1, 2010

  2. Recent CRE transaction • 2000 market street • 29 stories, 665,000 square feet • Sold for $50,000,000 approximately $80/sq ft • Building was bought in 2003 for $77 million by DB • Mortgage was $49,000,000 with prudential • DB turned down a reported $90 million in 2007 • What happened?

  3. Size of Asset classes • Stocks $14,000,000,000,000 ($14 trillion) • Bonds $27,000,000,000,000 ($27 trillion) • CRE $5,000,000,000,000 ($ 5 trillion)

  4. Who invests in Real Estate? • Total value of assets of U.S. Households exceeds $50 trillion • Most are held for retirement or other specific targets • Majority of these dollars are held at institutions • Pension Funds (Calpers $270 billion, $21 billion in CRE) • Life Insurance companies • Mutual funds • Endowments • The goal of these institutions is what?

  5. Why CRE? • What are investors looking for? • Highest return for given level of risk – or • Lowest risk for a given level of return • How does RE work from a portfolio perspective? • CRE is somewhere between stocks and bonds on a risk/return basis and not highly correlated with either

  6. Risk and return for different asset classes • Returns (1987-2006) • Stocks 11.5% (9.2% from price appreciation) • Bonds 7.3% (mostly all income) • CRE 9.4% (3.5% from price appreciation) • Risk (Standard deviation of returns) • Stocks 16%, Bonds 6%, CRE 8% • CRE correlation is less than .3 for stocks and negative for bonds • Bottom line: • CRE acts as a hybrid between Stocks and bonds • Improves performance of long term investment portfolios

  7. Unique features of CRE • Large transactions are required • Illiquid by nature (liquidity is time dependent) • Imperfect markets (each asset is unique) • Lack of transparency in transactions (90% + privately held) • Prone to extreme cycles of boom and bust • Positive correlation with inflation • Generally highly levered (60-80% debt) • Many of these features support attractive returns for long term oriented institutions like pensions and endowments

  8. Where do CRE returns come from? • Income • Rents • vacancies • determine NOI • Growth in income • Growth in rents • Vacancy compression • Capital Gains and losses • Buying and selling prices determined by market conditions • Capital gains when rents increase and multiples increase

  9. Quick example: Wal-Mart Warehouse • Assume we have built a 300,000 sq ft warehouse in the Lehigh value for Wal-Mart • Wal-Mart has agreed to pay us $7/ft “triple net” annually for 20 years for the entire warehouse with a 2% “rent bump” each year • Triple net means Wal-Mart pays all expenses • Industrial and retail leases are often triple net • In Office and Multifamily owner handles many expenses • Assume we are consulting for a life insurance company • How much would we pay for this warehouse?

  10. Valuing the Wal-Mart warehouse • 20 year Wal-Mart bonds currently yield 4.85% • Next years cash flow = $2.1 million • Valuation method 1: Direct Capitalization • Value = NOI/cap rate • Cap rate = NOI/value (inverse of P/E multiplier) • Find comparable cap rate and use on next year’s NOI • Assume a “7 cap” value = 2.1million/.07 = $30 million • Any problems with this method? • Widely used to value assets • Is cap rate = return?

  11. DCF approach to valuation • How have you been taught to value financial assets? • Present value of the cash flows • First step: Determine cash flows for asset • Second step discount cash flows by the appropriate discount rate • For real estate cash flows are the NOI of the property • Must determine a terminal value of the property as well • What is the appropriate discount rate? • What about our current property? • See CRE.xls for this property

  12. How does debt effect returns? • When returns are higher than the cost of debt, leverage increases return to equity contributors • Is there a downside to leverage? • See CRE.xlsx for debt on the Wal-Mart example • Assume that we get a loan 10 year loan for 70% of the value of the property at 6.5%. The amortization period is 25 years • Payments would be a little more than $1.9 million annually • Unlevered IRR is 7.82% levered is 9.36%

  13. Where does the debt come from? • Commercial banks • Life insurance companies • REIT bonds and lines of credit • Conduits • CMBS • Commercial mortgage backed securities • Commercial loans are made, packaged and sold • What happens in Defaults? • Bank or Life companies handle it for direct loans • Special servicers are in charge of CMBS defaults • Currently $40 billion + of $450 billion in Fitch rates CMBS loans are delinquent

  14. Where does equity come from • Public companies • Real Estate Investment trusts (REITs) • Tax conduits that do not pay corporate taxes • Brandywine, Liberty, PREIT in our area • Less than 10% of total equity • The rest comes from private sources • Largely private equity funds • Receive fees + promote • Finite length of investment • Highly levered to meet investor demands • Core, Core+, Value Add, Opportunity

  15. Where are we now? • Rents are soft, vacancies are up • Prices are down 30-50% (but moving up recently) • Looking forward what does this mean for three components of returns? • Do you like CRE as an asset class? • What are the risks associate with debt and equity related to CRE? • Brian DiDonato (equity) and Brent Morris (debt) will give their outlooks in the second half of class

More Related