CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAM Investment Planning Session 16 Real Assets – Gold, Real Estate, Property Valuation ©2015, College for Financial Planning, all rights reserved. Session Details Module 9 Chapter(s) 1, 2 LOs 9-1 Explain the characteristics, risks, returns, markets, and valuation of tangible asset investments. 9-2 Evaluate the characteristics, risk, returns, financing methods, types, and forms of ownership of investment real estate. 9-3 Calculate net operating income and property value from real estate property information. 9-6 Analyze the effect of exchange rate changes on foreign security returns. 16-2 Investing in Tangible Assets • No formally organized market – price quotes • • • • not readily available, no widely disseminated report of trades Markets for tangible assets and collectibles may be inefficient Little or no regulation High degree of liquidity risk, and problems associated with theft, fraud, and fire Tangible assets can be effective inflation hedges 16-3 Types of Gold Investments • Gold coins (American Eagle – approved • • • • investment for IRA accounts) Gold bullion (reputation of dealer very important when buying and selling gold) Gold mining stocks and ETFs (more volatile than gold bullion price) Gold mutual funds (or grouped with precious metals, natural resources) Gold futures and options (provides leverage) 16-4 Real Estate Investments Types • Land – riskiest • Residential • Commercial • Industrial 16-5 Real Estate Advantages • • • • Tax benefits Inflation hedge Psychic income Leverage Disadvantages • • • • • • • Illiquidity Management High minimum investment High transaction costs Immobility of asset Fixity Economic & tax risk (subprime!) 16-6 Real Estate Ways to Invest Direct investments: • Outright ownership • General partnership Indirect investments: • Limited partnership • Corporation • REIT • REMIC 16-7 Real Estate Investment Trusts Benefits of REITs • Readily marketable, trade on stock exchanges • Personal liability limited to the amount invested, and small sums may be invested • Professional management of the properties • REITs generally purchase many properties, providing diversification • REITs are extremely popular, and provide the opportunity for many investors to include real estate as an asset class in their portfolio. 16-8 Types of REITs • Equity REIT – owns real estate property, appropriate as an inflation hedge (90.5% of market) • Mortgage REIT – similar to a bond fund, invests in mortgages not in properties, income is higher than an equity REIT, not appropriate as an inflation hedge (9.5% of market) • Hybrid REIT – invests in both properties and mortgages (in 2012, 0% of market) Note: Since REITs distribute income (dividends) and the dividends are not taxed on the company level, REIT dividends do not qualify for the preferential capital gains rate―they are taxed as ordinary income. 16-9 Income Property Valuation Net Operating Income (NOI) + = – = – = Gross rental receipts (GRR) Nonrental income (laundry, etc.) Potential gross income (PGI) Vacancy and collection losses Effective gross income (EGI) Operating expenses Net operating income (NOI) 16-10 NOI Capitalization N OI V C ap rate 16-11 NOI Example The following information applies to Spacious and Gracious Apartments: Gross rental receipts Other income (parking) Average vacancy rate $750,000 $22,000 6% of PGI Operating expenses $210,000 Mortgage loan payments $362,000 Depreciation expenses $131,000 Cap rate 12% What is the property’s net operating income based on this information? And what is the property’s value? 16-12 NOI Example Solution $750,000 Gross rents (GRR) + = 22,000 Other income $772,000 Potential Gross Income (PGI) 46,320 Average vacancy rate (6% of PGI) = $725,680 Effective Gross Income (EGI) 210,000 Operating expenses = $515,680 (NOI) Property’s value: NOI/Cap rate $515,680/.12 = $4,297,333 16-13 Gross Income Multiplier Sales Price GIM Gross Income 16-14 GIM Example Green Mountain Apartments has $216,000 in gross rental income. It is similar to three other apartment complexes in the area that recently sold for the following prices. Their gross rents are shown. Compute the fair market value of Green Mountain using the gross income multiplier approach. Use the average multiplier for the three comparable properties. Gross Rents Sales Price Property 1 $300,000 $2,700,000 Property 2 $200,000 $1,600,000 Property 3 $250,000 $2,000,000 16-15 GIM Example Solution Property 1: $2,700,000/$300,000 = 9 Property 2: $1,600,000/$200,000 = 8 Property 3: $2,000,000/$250,000 = 8 Average: 9 8 8 25 8.3 3 3 Estimated value: $216,000 x 8.3 = $1,792,800 16-16 Foreign Investments Special Considerations • Political risks • Foreign taxation • Fluctuations in exchange rates o devaluation (depreciation) o revaluation (appreciation) 16-17 Exchange Rates • Vary daily • Weak U.S. dollar boosts returns of foreign • securities Risk reduction through hedging with currency futures: o if long in a currency, short the futures o if short in a currency, go long in the futures 16-18 Exchange Rate Example You are traveling in Europe and wish to purchase euros, and the current exchange rate is $1.49 U.S. for each euro. How many euros would you receive for one U.S. dollar? 1/1.49 = 0.6711 euros, or HP10BII+: 1.49, SHIFT, 1/x HP12C: 1.49, 1/x This will give you 0.6711, if you hit 1/x again it brings you back to 1.49. 16-19 Exchange Rate Calculation From our previous example: $1.49 for one euro or $1 for 0.6711 euros Calculate how many U.S. dollars you would receive for one euro if: 0.6600 euros per U.S. dollar 0.6800 euros per U.S. dollar 16-20 Exchange Rate Calculation (2) 10BII+: 0.66, SHIFT, 1/x = 1.5152 12C: 0.66, 1/x = 1.5152 10BII+: 0.68, SHIFT, 1/x = 1.4706 12C: 0.68, 1/x = 1.4706 Discuss the relationships: In the first example the dollar has gone down in value. In the second example it has risen in value. What are the implications for a U.S. investor in each scenario? 16-21 Module 10 • • • • • • • Mutual Funds – Open End and Closed End Unit Investment Trusts (UIT’s) Exchange Traded Funds (ETF’s) Hedge Funds Guaranteed Investment Contracts (GIC’s) Dollar Cost Averaging Selecting a Fund 16-22 Question 1 Which of the following combinations of risk is associated with art and other collectibles? a. regulation risk and purchasing power risk b. liquidity risk and market risk c. market risk and business risk d. financial risk and reinvestment rate risk 16-23 Question 2 Your client is interested in purchasing gold as an inflation hedge. Which of the following describes advice you would give to this client? I. Gold is a stable investment that has been gradually increasing over time. II. Gold mining stocks have approximately the same volatility as the average U.S. large-cap stock. III. Tangible assets, such as gold and silver, have traditionally been considered good inflation hedges. IV. Gold mining mutual funds may be closed to new investors if there have been too many investment dollars flowing into the fund. a. I and II only b. I and III only c. II and III only d. III and IV only e. II, III, and IV only 16-24 Question 3 Which of the following differentiate an equity REIT from a mortgage REIT? I. Mortgage REITs invest directly in properties. II. Equity REITs have the potential for higher returns. III.Mortgage REITs provide income whereas equity REITs participate in the capital gains of the real estate property. IV. Mortgage REITs invest in mortgages that finance property purchases. a. I and II only b. I, II, and III only c. I, II, and IV only d. I, III, and IV only e. II, III, and IV only 16-25 Question 4 Fritz Vanderbilt owns an apartment building that had the following financial results for the most recent year: Rental income Parking fee income Vacancy and collection losses Depreciation Interest expense on mortgage Other operating cash expenses $340,000 $2,000 7% of PGI $33,250 $41,000 $66,500 What is the net operating income (NOI) for the property? a. $177,310 b. $210,560 c. $218,310 d. $251,560 16-26 Question 5 Charles is considering the purchase of an office building that has a net operating income of $520,000, depreciation expense of $54,000, and vacancy and collection losses of $66,000. The building is financed by an 8% mortgage loan, and interest payments for the past year were $73,000. Charles has done an analysis of other properties in the area, and has arrived at a capitalization rate of 9%. What is the maximum that Charles should pay for the property? a. $4,444,444 b. $5,044,444 c. $5,777,777 d. $6,500,000 16-27 Question 6 Jacqueline is doing a preliminary analysis of investment property in her city, and has come up with the following recent sales: Number of units Monthly rent Sales price Serenity Pointe 35 $700 $2,058,000 Village Pines 40 $600 $2,592,000 Whispering Meadows 55 $550 $2,904,000 Jacqueline is considering the purchase of a 45-unit complex, Morning Vistas, with monthly rents of $500. Morning Vistas is similar and near to the properties shown in the chart. Morning Vistas is being offered for $2,300,000. Which of the following statements is true? a. b. c. d. Based upon the comparable sales, Jacqueline should only pay up to $2,160,000 for this complex. Based upon the comparable sales, Jacqueline should consider paying the $2,300,000 offering price for this complex. Based upon the comparable sales, Jacqueline should act quickly since an offering price as high as $2,600,000 would still be reasonable. There is no reliable way to determine whether the $2,300,000 offering price may be reasonable based upon the information provided. 16-28 Question 7 Robert is in the market for a small office building to purchase. He has researched recent sales of similar properties in the area and has determined that the average sales price of the properties is $2,100,000 and that the average gross rents for the properties is $280,000. He has narrowed his choices of properties to buy to Building A, which is listed for $1,750,000 and has gross rents of $225,000, and Building B, which is listed for $1,400,000 and has gross rents of $200,000. The cap rate for properties in the area is 10%. Which one of the two buildings is the best investment option for Robert and why? a. b. c. d. Either, because the gross rents divided by the cap rate give values for both properties in excess of the listed prices. Building A, because its gross rent multiplier of 7.8 is greater than the gross rent multiplier of 7.5 for the recently sold properties. Building B because its value ($1,500,000) is greater than its listed price ($1,400,000). Either, because gross rents divided by the listed price give a cap rate in excess of 10%. 16-29 Question 8 Which of the following statements is true? a. Single country closed-end fund standard deviations are higher than the standard deviations of broadly diversified international funds. b. The variability of returns in developed markets is similar to the variability of returns in emerging markets. c. Because of tax treaties, taxes may not be withheld on dividends paid on foreign securities. d. A rise in the value of the dollar would benefit a U.S. investor who has purchased international stocks. 16-30 Question 9 If a Japanese investor buys U.S. Treasury bonds for his portfolio, which one of the following scenarios would result in the greatest capital gain? a. U.S. interest rates fall and the yen strengthens against the U.S. dollar. b. U.S. interest rates rise and the U.S. dollar weakens against the yen. c. U.S. interest rates fall and the U.S. dollar strengthens against the yen. d. U.S. interest rates rise and the yen weakens against the U.S. dollar. 16-31 Question 10 You took a trip to Europe and exchanged U.S. dollars into euros when the exchange rate was $1.51 (U.S. dollars) for each euro. Upon your return you exchanged the euros back into U.S. dollars when the exchange rate was .68 euros for each U.S. dollar. What has transpired concerning exchange rates between the beginning and end of your trip? I. The dollar has strengthened, and you will only receive $1.47 for each euro. II. The dollar has weakened and you will only receive $1.47 for each euro. III. The euro has strengthened, and you will now receive less U.S. dollars for each euro. IV. The euro has weakened since it will take .68 euros for each U.S. dollar at the end of the trip, compared with .66 euros for each U.S. dollar at the beginning. a. I only b. II only c. I and IV only d. II and III only 16-32 CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAM Investment Planning Session 16 End of Slides ©2015, College for Financial Planning, all rights reserved.