Lecture 1 & 2 Good hedge against inflation?factors volatility of real estate price & rent vs inflation rate of return holding period of real estate 2asset porfolio variance =sqrt(w12σ12 + w22σ22 + 2w1w2Cov1,2 ) cov= corr/(sd*sd) optimal porfolio -> max sharpe ratio = (Rp- rf)/σp macro econ & real estate -08 crisis -> afterwards -> low interest rate ->Qe -> fund flow to hk risk: inflationary pressure, fueling asset-price bubbles volume^ price ^ -effect on rental yield : bcs rent more stable, when price ^-> rental yield decrease ( rent ^ by less than p) Property Market HKMA framework 1. Real property prices 2. Real new mortgages -> ^ when int rate low 3. Transaction Volume 4. Income leverage -mortgage/HH income ->higher int -> higher leverage 5. Buy rent gap ->mort/rent ->higher when property p high( bcs rent change slower) 6. Confirmor(speculator) transaction ->decrease if more stamp duty Change in price -too high -> affordability -falling price-> bank not willing to mortgage out bcs Loan to value will decrease -> could default easier ->hard to get loan -> or higher interest rate Affordability index =ππππππ π»π» πππ/ ππ£π ππππ‘ππππ πππ¦ππππ‘ 3 idea 2 good 1 bad ->function of Inc/price /sq meter Its problems 1.not only source of inc 2.mortgage is int+principal-> is actually saving-> put into equity 3.not separate inc groups-> pooled tgt 4.ignore foreign affordability -> some low inc own property in china Wealth effect on consumption->change C, I -decrease stock or property price -> decrease private consumption SR ->Mutliplier effect ->decrease I , decrease Y , decrease C ->loop Vancancy & GDP -negative corr -recession gdp growth slow-> vacancy ^ Housing demand for Residential Factorsβ 1.household formation rate ->size of household ->marriage divorce ->immigration ->emitgration 2.expected future inc of HH 3.demographic factor -age*not depend on racial composition Others 1.investment demand 2.change in HH structure 3.change taste/preference 4.change lifestyle Lecture 3 bubble ->deviation from fundamental value why bubbles -shortage of store of value -irrational?-> no -> rational ppl think they will get out before it burst -> buy because of expected capital gains *exists as long as dk when bubble burst V0=V*+b value today= fundamental + bubble q-> prob of not burst in 1 year (1-q)-> burst expected to grow at r (1-q)*0+q(b_t+1)=(1+r)b_t implied probability of not bursting q=(1+r) b_t /b_t+1 b2=100 b1=80 r=5% not bursting in 1 year=0.84 burst-> fall back to fundamental value what bubbles can’t be sustained? -r> growth or economy -has close substitutes -> p inc -> switch to other Lecture 4 property and capital mkt eq 1.Property market -> Rent ->rent level where supply of space= demand of space ->^ demand for space(econ growth) -> shift up Inelastic-> more vertical ->rent change doesn’t affect QD of space Elastic -> horizontal ->space usage sensitive to rent 2.Asset market -> price P=R/k k-> cap rate (rent-to-price)-> current yield required to hold real estate ->^ risk -> k increase ->other asset return ^ ->k increase cap rate^ ->clockwise movement -higher LT r -higher expected growth in rent (P^ k de) -higher tax on real estate -higher risk of rent inc 3. Asset market -> construction C-> level of building activity P(C)-> replacement cost of real estate -> cost^ ->decrease level of building for same P-> shift left S4.Property market-> stock adj Delta S=C-deltaS delta->depreciation rate at line -> depecreation = new building -> delta S=0 -> stock is constant dis eq -Starting S> ending S ->excess D for same rent at t=2 ->R, P, C must increase -Starting S< ending S ->excess S for same rent at t=2 ->R, P, C must decrease to go back to eq eg:An increase in demand for space in the property market shifts out the demand curve, increasing rents, which in turn, increases asset prices, construction, and stock of space. A decrease in capitalization rate in the asset market increases the demand for real estate assets, which increases asset prices. Increased asset prices in turn induces more construction, increasing the stock of space and decreasing rents. An increase in construction costs decreases construction levels, which in turn decreases the stock of space, driving UP both the rents and the asset prices. Lecture 5 Financing real estate Term loan ->bond fully amortized ->normal mortgage partially amortized ->mortgage+bond β Fixed rate mortgages(FRM) -fixed interest rate-> int rate risk -borrower want save on interest -bank want more liquidity to make new loan -care about LTV 1.Growing equity mortgage(GRM) ->payment increase as time pass ->* initial payment = normal ammortized ->* increasing factor every month/year ->extra payment all hit principal Adv: less int dis: not able to pay 2.Rapid-payment mortgage(RPM) -just shorter time 3. Biweekly (BWM) faster-> monthly payment/2 -> but due to 52weeks/2-> 26 payments instead of 24 payments ->faster 4.graduated payment mortgage(GPM) -can be increasing or decreasing -> step up until threshold -> could be negative amortization(principal going up bcs initial payment<interest) for increasing -> just make pv = loan value or use step up rate given ->negative equity-> LTV(Loan/property value)>1 Adjustable rate mortgages (ARM) -libor+/-x , hibor +/-x ->adjustment if int rate increase 1.longer term same payment 2.same term higher payment Deposit linked mortgage (DLM) ->savings account with a cap of 50% mortgage balance ->same interest as mortgage rate ->if put $ in that account-> interest inc offset interest expense Shared appreciation mortgages(SAM) ->normal mortgage lower rate -> exchange 30% of appreciation value ->payable at end of 10year/when sell dis: not being able to pay or need to refinance *Agency problem -> if price appre -> pay bank -> damage or not take care property to pay less Reverse mortgage -retiree ->bank pay him until death ->bank receive property ->based on expected payment ->^ Lecture 6 securitization of mortgage Business model -mortgage bank sell off mortgage to special purpose trust-> earn fee income instead of interest-> free up captial for another mortgage -special purpose trust 1.find rating agency 2.find trustee to manage mortgages ->mark to market 3.find credit insurer-> insure against default 4.find underwriter-> issue MBS ->sell to investors What went wrong? 1.low interest rate ->mortgage to risky homeowners 2.misaligned incentive ->bank don’t care about credit of mortgages bcs they don’t bear credit risk with fee inc 3.poorly understood risk ->rating agency give safe rating to risky 4.excessive leverage use short term debt to finance these investment->vulnerable to decline in value Mortgage backed bonds(MBBs) -promised fixed coupon bond backed by mort -issuer bear prepayment risk -overcollateralized Factors affecting C -quality of mort, overcoll, credit of issuer Factors affecting r -credit rating of bond -yield on other similiar bond *weighted avg yield on mort> MBBs* Mortgage pass through securities(MPTs) -ammortized(like mortgage payments) -investor bear prepayment risk -prepayment pass through to investor -service fee=weight mort rate -pass through % PSA model -assumed avg prepayment rate 100% 2% 4% 6% 6% 0%-> no prepayment 200% 4% 8% 12% 12% eg10% 5yr 9.5%Pass through rate Financial Engineering -use in trough-> boost ST yield->pay with future rent 1. interest rate swap initially borrowing-> enter swap-> pay upfront fee-> get lower payment now -> higher payment in tmr->receive floating to pay debt -ve: can’t benefit from int decre, r not ^ later-> can’t pay, if upfront fee is from IPO,just investor 3. Rental Guarantee -seller of prop->guarantee market rent return->paydif -> yield^ ST , decrease when it ends if rent no rise 4.management receive units instead of cash~2effect Riskmanagement 1.Overcollateralization -protect against prepayment ,late payment ,defaults 2.mark to market ->ensure mortgage pool meets overcollateralization requirement-> if not -> add more mortgages 3.investment rating by independent bond rating agency Lecture 7 REITs Benefits -only gov rent & tax no need profit tax restriction -only can invest in real estate n earn inc -no trading prop-> hold at least 2 yrs -<10% asset in vacant land and prop develop -borrow at most 45% A, distribute >90% NI Why it works -offer asset light approach for developers 1.mortgage payment =263797(recal everytime) 2.prepayment (prev bal*pre rate) 3.principal payment(MP-prev bal* 10%) 4.pmt to investor=MP+pre-prev bal*0.5%(servi) 5.new ending bal= prev-pre-principal 6.MP=257488.065 5.”sale-leaseback” agreement -seller pay higher rent in return for higher sale price ->-ve : if he leaves yield de bcs no one pay prem equilibrium equation sub delta S=0 sub until all equation only S as unknown find supply continue to ^ despite D not catching up? caused by -low LT int rate -increasing liquidity( capital) ->put property mkt out of eq β Least int rate risk/default risk/shortest payback *mortgage ended->no risk -> more unpaid loan -> highest risk~Duration ->least default risk due to econ slow down-> also duration ARM Cost of ownership interest expense-> principal is savings Interest cost total payment-mortgage bal Net worth of property just Asset-loan (independent of purchase price) -r>pass -> refinance -> decrease prem coupon ->value < MBBs -r<pass ->no refinance-> less volatile ~MBBs Collateralized mortgage obligations(CMOs) -requirements: weighted %< mortgage, overcollateralized,diff risk and investment need LT ST,risk safe, misprice of asset as investors 1-> MP ,int , prin 2-> Accrued int Z-> * Z bal^ 3->highest class: int + Z’AI +prin(if extra->next) 4->highest bal drop by AI+prin, pm=int + AI+prin 5->remaining int->other class 6->MP- all payment-> left to E * only principal payment drop bal* Funds from operation (FFO)& Adj FFO -FFO->exclude depre & gain lose from sale asset -AFFO->maintenance from CAPEX-> expense ->more like actual cashflow available to investors Value creation -internal higher rent, refurbishment -external->acquisition ,development(IRR>WACC) NAV(net asset value) ->set up reit, borrow, get external equity ->sell prop to reit get cash->hold fraction of prop Extra cash -other proj, pay debt, buy back pay self rent 2.distribution entitlement waiver seller of prop choose units(shares) instead of cash ->DEW-> no receive divi for few years. ->diluted instantly but ST yield^ bcs no receive divi ->rent not rise->effect of dilution show when rece divi^ Why invest in reits? investors exposure to commercial real, diversify, liquidity>real, stable inc, low corr to market,less earning shock Distrubtable inc =rent+related inc-manager fee-int exp-tax=NI +Adj(financial engineering) Lecture 8 pre-sale market with presale without presale πΈ(ππ) = ππ β * πππβπ + π(π − β) − 0. 5π π − π΅ p= ππ (1 + ππ)/π 2 2 2 πππ(ππ) = (π − β) * σ π a % of ps rev used return on ^ -> not borrowing for another project-> cost of borrowing 2 2 h= π − (π − ππ(1 + ππ))/πΊσ π uncertain price< certain ->pre sell all ->q=0 Lecture 9 valuing inc properties Projected NOI approach discount NOI back to present=value of property -required return on prop (be4 tax) -independent of capital structure q=p/(c+πΊσ π) from q equation with presale-> p now high-> q increase ->future p more stable bcs already produce q-> if unexpected increase in demand in future->no shortage -> price won’t fluctuate MV A- MV L P>NAV ->easier to find gd cash spread ->buy with cash and enjoy IRR-WACC RISK weak space market,low demand, over build ^int rate,bad econ de spending de property price asset value de without presale-> p now low(bcs no presale activity-> q decrease ->future p less stable bcs not yet produce q-> if unexpected increase in demand in future-> shortage -> price fluctuate can’t produce fast enough to meet demand Real investment performance -how to measure ->cap rate ->k=NOI_1/V +G -> includes property yield and price appreciation vs property yield -> just =NOI/V -> not fully reflect High yield=good investment? no-~high divi no good ->capital depreciation>divi ->bad investment if in real estate bear market fair value of old building depend on 1.current rental 2.value of higher better use of redevelopment 3.optimal timing of redevelop leverage ^ risk n return of equity Lecture 10 Valuation of Land Based on -what can be built on it (potential rent inc) ->highest and best use -besting timing of develop->highest PV ~to call option-> right to redevelop -> only redevelop if CF after development>cost of development V = PV of all future NOI after construction – PV of all Maintenance Cost Until Development – PV of Construction Cost
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