International real estate investment: case

1. International real estate investment: case

2. Currency: the carry trade • SWF interested in buying Turkish shopping centre • Cap rate 12% • Expected IRR 20% • Turkish bond yield/interest rate 14% • What is the leveraged return in Turkish lira? • ke = [ka-(kd*LTV)]/(1-LTV) where • ke = return on levered equity • ka = return on unlevered asset • kd = cost of debt • ke = 0.2 - (.14*.6)/(1-.6) = 0.2 - 0.084/0.4 = 29% (approx.)

3. Currency: the carry trade • SWF interested in buying Turkish shopping centre • Turkish bond yield/interest rate 14% • US bond yield/interest rate 5%; • Why not borrow US dollars to buy shopping centre? • What is the new leveraged return in Turkish lira? • ke = [ka-(kd*LTV)]/(1-LTV) • ke = 0.2 - (.05*.6)/(1-.6) = 0.17/0.4 = 42.5% (approx.) • What’s the catch?

4. Turkey shopping centre: leveraged IRRs • Turkish return leveraged 26.77%

5. Turkey shopping centre: leveraged IRRs • Turkish return leveraged 26.77% • US return leveraged 37.34% (cheap debt, no currency movement)

6. Turkey shopping centre: leveraged IRRs • Turkish return leveraged 26.77% • US return leveraged 37.34% (cheap debt, no currency movement) • US leveraged return 18.03% (cheap debt, currency falls)

7. Dealing with risk • Example: Turkey – assume 8% RP, 14% RFR • Maximise excess return: IRR (K + G) – RFR – RP • (K + G) = 12% cap rate (K) + 8% growth (G) = 20% IRR • IRR – RFR – RP = 20% - 14% - 8% = -2%: SELL • Example: US – assume 4% RP, 5% RFR • Maximise excess return: IRR (K + G) – RFR – RP • (K + G) = 8% cap rate (K) + 2% growth (G) = 10% IRR • IRR – RFR - RP = 10% - 5% - 4% = 1%: BUY

8. Turkey shopping centre: unleveraged IRRs • Turkish return unleveraged 20%

9. Turkey shopping centre: unleveraged IRRs • Turkish return unleveraged 20% • US return unleveraged 10.1% (currency falls)

10. What is the risk? • Assume different buyer strategies • unleveraged, Turkish buyer • unleveraged, US buyer • leveraged, Turkish buyer • leveraged, US buyer (using local debt) • leveraged, US buyer (using US debt, carry trade) • Add variance in two variables • Examine expected returns and risks of these strategies • 35 scenarios for each strategy • Variance in currency exchange rate, exit cap rate

11. What is the risk? • Assume range of different property out-turns • different exit cap rates centred on the going-in yield of 12% • range from +3% to -3% at 1% rests • 7 possible values, equal probability • Assume different currency exchange rates • expected equal annual values based on interest rate differential of -9% • range from +9% to -27% at 9% rests • 5 possible values, equal probability

12. What is the risk?

13. What is the risk?

14. What is the risk?

15. What is the risk?

16. What is the risk?

17. What is the risk? All scenarios

18. Conclusions: unleveraged Turkish buyer • Expected return: 20% nominal • Mean return: 20.3% (11.3% real assuming 9% inflation) • Range: 16.3% – 25.2% • Risk: 3.0% • Return is immune to changes in currency • Risk-adjusted return: 6.7% nominal (3.8% real) • Chance of negative return: 0/35 • Chance of return below domestic risk-free rate: 0/35

19. Conclusions: unleveraged US buyer • Expected return: 10.1% (real and nominal, assuming 0% inflation) • Mean return: 10.9% with expected currency change, 11.9% with risk • Range: 6.7% – 14.9% with expected currency change • Range: -8.4% – +37.6% with currency risk • Risk: 3.0% with expected currency change • Risk of changes in currency boost this to 13.8% • Risk-adjusted return: 0.87% • Chance of negative return : 9/35 • Chance of return below domestic risk-free rate: 13/35

20. Conclusions: leveraged Turkish buyer • Expected return: 26.8% nominal • Mean return: 27.2% (18.2% real assuming 9% inflation) • Range: 19.3% – 36.2% • Risk: 5.7% • Return is immune to changes in currency • Risk-adjusted return: 4.8% nominal (3.2% real) • Chance of negative return : 0/35 • Chance of return below domestic risk-free rate: 0/35

21. Conclusions: leveraged US buyer (local debt) • Expected return: 15.2% • Mean return: 15.5% with expected currency change • Mean return: 4.0% with currency risk • Range: 7.9% – 24.1% with expected currency change • Range: -100% – +60.0% with currency risk • Risk: around 5.8% with expected currency change • Risk of changes in currency boost this to 48.6% • Risk-adjusted return: 0.08% • Chance of negative return : 12/35 • Chance of return below domestic risk-free rate: 13/35

22. Conclusions: leveraged US buyer (carry trade) • Expected return: 18.0% • Mean return: 18.3% with expected currency change • Mean return: 1.1% with currency risk • Range: 9.9% – 27.6% with expected currency change • Range: -100% – +64.5% with currency risk • Risk: around 5.2% with expected currency change • Risk of changes in currency boost this to 56.1% • Risk-adjusted return: 0.02% • Chance of negative return : 12/35 • Chance of return below domestic risk-free rate: 13/35

23. Conclusions • Deal is more efficient for domestic buyer • Leverage damages risk-adjusted return • Using leverage adds huge risk for US buyer • Local borrowing is less risky, but only marginally