Real Estate

Final Exam - REE 6935 – Spring 2021 – Dr. Beracha

To complete this final examination you will need to answer the 11 questions listed below.

All questions must to be answered in Excel using the associated tabs included in the “Final

exam - REE6935 – Spring 21-Excel” file that is provided to you.

This final exam is due on or before March 2nd at 11:55 p.m. EST. By that time you should

submit an electronic copy (via email) of your assignment. If you turn your assignment late,

10% will be deducted from your grade for every calendar-day delay.

All the work on this final exam must be 100% your own work. You are not allowed

to discuss the exam with any of your classmates or any other person prior to the

deadline. A failing grade in the course will automatically be assigned to a student that

helps or seeks help from another person while working on the exam. You are allowed,

however, to use the textbook, classroom notes, review lectures and use any “non-

interactive” websites while working on the exam.

1. (12 points) Calculate the requested values and include your answers in their respective cells highlighted in yellow.

2. (10 points) Recall the data we discussed in class that distinguishes between the land value and the structure value associated with real estate properties in different cities

around the US.

a) Which type of cities are likely to experience higher price volatility? Cities with high ratio or low ratio of land to total property value? Briefly explain why.

b) What other important factor affects the real estate price volatility in some locations more than others? Briefly explain.

3. (9 points) You have recently invested in an office building located in NYC at a cost of $50 million. You paid for 40% of the building in cash and financed 60% with an

interest only loan. For a variety of reasons you decided to denominate the loan in

British pounds. At the time of the loan origination $1 could buy 0.81 British pounds.

If you have a clause within your loan stating that your loan-to-value must never

exceed 70%, what conversion rate will trigger a default? For simplicity, assume

that the value of your property in dollars does not change.

4. (10 points) Consider the Excel/@Risk analysis on a hypothetical income producing property shown below. The only input risk distribution defined in this analysis is

the “Terminal CAP”, which is assumed to have a normal distribution with a mean

of 5.25% and a standard deviation of 1%. The distribution shown below is the IRR

output distribution.

a. According to this analysis, what is the probability that you will earn a positive

nominal return on your investment?

b. According to this analysis, what is the probability that you will earn a return that is equal or higher than your required return?

c. Given today’s real estate and interest rate market environments, what is the problem with defining a “Terminal CAP” with a normal distribution? Suggest

a different kind of distribution that might be more suitable and explain how this

distribution is likely to affect your IRR output compared with a normal

distribution. Will it increase the chance that you will earn your required rate of

return?

5. (10 points) In order to diversify their portfolio, real estate investors should have exposure to different real estate property types, classes and geographic locations.

a. Is it more difficult to hold a diversified direct real estate investment portfolio compared to a diversified stock portfolio? Why?

b. What is a common alternative to holding a direct real estate investment portfolio that provides investors diversification with ease?

c. What type of risk is eliminated with diversification? What type of risk remains? d. Is the benefit of diversification when applied to real estate smaller or larger than

the benefit of diversification when applied to a stock portfolio? Briefly explain.

6. (8 points) Consider the following information about 5 different asset classes (A, B, C, D and E).

A B C D E

Expected Return 12% 8% 10% 9% 13%

Standard deviation 21% 14% 19% 14% 23%

Correlation matrix:

A B C D E

A 1.00

B 0.20 1.00

C 0.70 -0.30 1.00

D 0.05 0.45 0.20 1.00

E 0.90 0.50 0.78 -0.05 1.00

Assume that you currently hold asset A in your portfolio.

a. If you must choose only one additional asset to include in your portfolio, which one would you choose in order to maximize your overall portfolio expected

return?

b. If you must choose only one additional asset to include in your portfolio, which one would you choose in order to minimize your overall portfolio risk?

c. If you were to add asset C to become 50% of the value of your portfolio, what can you say about the standard deviation of your overall portfolio? Hint - It

must be lower or higher than a specific value.

d. If you were to add asset C to become 40% of the value of your portfolio, what would be the expected return on your overall portfolio?

7. (9 points) Consider the REIT valuation spreadsheet presented in class. For each of the following scenarios, and all other things equal, determine whether each scenario

will increase, decrease or won’t affect the probability that new investors will

achieve their levered required rate of return.

a. The price of the REIT is lower. b. A distribution is defined for NOI growth rate, where the average value remains

the same, but the right “tail” of the distribution is longer than the left “tail”.

c. The projected 10-year treasury rate is higher. d. The quality adjustment value is lower. e. The risk premium is lower. f. The current market cap is higher. g. The required levered return is higher.

8. (9 points) Consider the Big Mac index and its price differential among countries. a. Which factors contribute the most to the price differentials and which factors

are pushing toward price equilibrium?

b. Compare real estate to a Big Mac with respect to the factors you mentioned in part a. Would you expect a larger or smaller price differential in the price of

real estate among countries compared with the Big Mac price differential?

Why?

9. (8 points) You have gained access to a dataset that includes commercial real estate transaction that took place during the 2017-2019 time period in Miami, FL and in

San Francisco, CA. After general data “clean up” you ran the following regression:

𝑃𝑟𝑖𝑐𝑒 = 𝛼 + 𝛽1𝑆𝑄𝐹𝑇 + 𝛽2𝑌𝑒𝑎𝑟 + 𝛽3𝐶𝑙𝑎𝑠𝑠 + 𝛽4𝐷𝑢𝑚𝑀𝑖𝑎𝑚𝑖

Where:

- Price is the price in dollars paid for each property transacted. - SQFT is the size of each property transacted in squared feet. - Year takes a value of 0, 1 or 2 if the transaction took place during the year 2017,

2018 or 2019, respectively.

- Class takes a value of 0, 1 or 2 if the transacted property is of class A, B or C, respectively.

- DumMiami is a dummy variable that takes a value of 1 if the property transacted is locate in Miami and 0 otherwise.

For each of the coefficients ((𝛽1, 𝛽2, 𝛽3 and 𝛽4) please predict whether you expect it to be positive, negative or ambiguous and explain in one sentence.

10. (9 points) Referring to problem 9, what other variables would you have liked to include in your regression if you could get any information you want about each

property?

a. List 3 additional variables you would have liked to include in your regression in order to improve its accuracy and clearly explain how each variable would

be defined (like I did in in question 9)

b. Briefly explain the sign you would expect (negative, positive or ambiguous) from the coefficient of each of these variables.

11. (6 points) Which single real estate topic covered in this course you found to be most and least interesting and/or relevant? Please explain why in 3-4 sentences.

Deliverables:

Via email ([email protected]): ONE Excel file named “FirstName_LastName_6935”.