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Finance Theory and Real Estate

Finance Theory and Real Estate. Goal – Asset Valuation: Risk vs. Uncertainty. Determinants of Value. Amount of after-tax CFs Timing of CFs Risk of CFs. Risk in the Context of Real Estate. Commercial Property – Real Estate Limited Partnership – Real Estate Investment Trust (REIT) –

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Finance Theory and Real Estate

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  1. Finance Theory and Real Estate • Goal – • Asset Valuation: • Risk vs. Uncertainty

  2. Determinants of Value • Amount of after-tax CFs • Timing of CFs • Risk of CFs

  3. Risk in the Context of Real Estate • Commercial Property – • Real Estate Limited Partnership – • Real Estate Investment Trust (REIT) – • Residential Mortgage – • Mortgage-Backed Security – • Collateralized Mortgage Obligations (CMOs) – • IO’s and PO’s – • Servicing Rights -

  4. Leverage and Capital Structure • Leverage Defined – • Debt increases shareholder returns… • Irrelevance of Capital Structure…

  5. Options in Real Estate Markets • Call – • Put – • Intrinsic Value • Market Value • Valuation considerations:

  6. Real Estate Options • Residential Mortgages • Prepayment – • Default – • Commercial Mortgage • Ruthless Default – • Protections – • Explicit/Real Options –

  7. Key Concepts • Financial Intermediation • Portfolio Theory • Asset Class Diversification • Diversification Within Real Estate

  8. Market Efficiency • Efficient Market Hypothesis • Levels of Market Efficiency • Conclusions?

  9. Agency Theory • Agency Relationship • Agency Problem:

  10. Agency Examples in Real Estate • Property Management - • Loan Officers – • Appraisers – • Agents -

  11. An Example Agency Problem • Suppose you’re considering undertaking a real estate development project. You plan to finance the construction of ________ with $25M (face value) of debt. Two methods/strategies exist for developing our __________. First, a safe method is available which produces profits (EBIT) of $40M if the economy is slack and $60M if the economy is robust. Alternatively, a risky process is available which produces profits (EBIT) of $0 if the economy is slack and $80M if the economy is robust. Assuming both states of the economy are equally likely to occur, which development strategy should the firm pursue? • Societal Perspective » • Creditors Perspective » • Owners Perspective » • Conclusion:

  12. Mitigating Agency Problems • Threat of Firing • Threat of Takeover • Managerial Labor Markets • Proper Structuring of Managerial Incentives

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