UNSW Sydney
FINS5533
Real Estate Finance & Investment
T3,2023
Lecture 2
Mohamad Mourad – Lecturer in Charge
(m.mourad@unsw.edu.au)
Lecture 2 –
Overview
• Annuities and Time Value of Money.
• Return Metrics in Commercial Real
Estate
• Exploring a Sales Analysis
• Capital Value Decomposition
• Discount Rates: A User’s Guide
• Group Formation for Course
Assignment
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real Estate Finance &
Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any way, shape or form is strictly
prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or individual, however defined, if these lecture notes
are used in valuations or providing investment advice for private or commercial purposes.
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of th se lect re notes outside th scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Lecture 1 – Recap of Concepts
- What is the key measure of realised demand in commercial real estate?
- How many ways can the incentive be structured in a lease?
- What is the key theme in commercial real estate?
- The net rent divided by the capitalisation rate gives what?
- What are two reasons why real estate is classified as inefficient relative to
stocks and bonds?
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Annuities and the Time Value of Money
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Annuity Formulas
Form Ordinary Annuity Deferred Annuity Annuity Due
Present Value
1 − (1 + )−
1 − (1 + )−
(1 + ) ×
+
1 − (1 + )−(−1)
Future Value
(1 + ) −1
If the future period, , is one where no
payments are made then beyond
period :
(1 + ) −1
(1 + )−
Otherwise
(1 + ) −1
1 + − 1
(1 + )
Note: there are different expressions for some of these annuities.
However, different expressions for the same annuity will give the same value.
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Annuity Formulas - Continued
Form Perpetuity Growing Perpetuity Growing Annuity
Present Value When payments
commence at = 1:
=
1 −
1
(1 + )
=
When the perpetual
payments are deferred by
a period > 1:
× (1 + )−1
0(1 + )
−
OR
1
−
−
1 −
1 +
1 +
Future Value N/A N/A
(1 + ) −(1 + )
−
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Time Value of Money – Multiple cash flows
- Suppose we have to make, not just one payment, but rather multiple
payments per period for a given period of time.
- Example: I want to save $150 per month (at the end of each month) for the
next 36 months at a rate of 5% p.a. What is the present value of these
periodic savings?
1 − (1 + )−
$150
1 − 1 +
0.05
12
−36
0.05
12
= $5,004.86
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Time Value of Money – Multiple cash flows
- Suppose we have to make, not just one payment, but rather multiple
payments per period for a given period of time.
- Example: I want to save $150 per month (at the end of each month) for the
next 36 months at a rate of 5% p.a. What is the future value of these periodic
savings?
(1 + ) −1
$150
1 +
0.05
12
36
− 1
0.05
12
= $5,813
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Time Value of Money – Exercise 1
A tenant signs a 2-year lease whereby the monthly rent is $3,000 for the entire
lease term payable in advance. What is the present value of this cash flow
stream to the landlord given a discount rate of 7.20% p.a?
$3,000 + $3,000
1 − 1 +
0.072
12
−(24−1)
0.072
12
= $67,271.02
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Time Value of Money – Exercise 2
The police force of Victoria signed a 30-year lease in 101 Collins Street,
Melbourne on 25,000 sqm. Suppose the rent is a constant payment of $350
psm p.a. paid at the end of each month throughout the duration of the lease
term. If the discount rate is 4.30% p.a, what is the present value of this cash
flow stream to the landlord?
$350 × 25,000
12
1 − 1 +
0.043
12
−360
0.043
12
= $147,344,664.70
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Time Value of Money – Exercise 3
An investment of $10,000 today will yield $500 in year 1, $2,000 in all years
between year 3 to year 7, and finally $5,000 in year 15. Is this a worthwhile
investment? Suppose the opportunity cost to the investor is 7.30% p.a.
=
−$10,000
(1.073)0
+
$500
(1.073)1
+
$2,000 ×
1 − 1.073 −5
0.073
(1.073)2
+
$5,000
(1.073)15
= −$730.62
Interest rates, discount rates,
compound rates, all rates are quoted
on an annual basis.
- If the discounting/compounding frequency is not annual, then the interest rate
must be adjusted to match the payment frequency. This is because interest is
earned on interest.
- The de-annualized interest rate given that r = 5% and a quarterly
compounding frequency is:
0.05
4
= 0.0125
and so on and so on.
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Time Value of Money – Note
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Time Value of Money – Note on Compounding
Source: Brueggeman and Fisher, Real Estate Finance and Investments 14th Edition p. 46
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Return Metrics in Commercial Real Estate
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Terms and their descriptions/definitions
- Initial Yield (passing income): provides the investor with an indication of
what return will likely be achieved in the first year of holding the asset. The
metric shows the short-term financial strength and ability of the building in the
current state that it is in following purchase. The yield is expressed as:
σ=1
,
−1
- Initial Yield (fully leased): identical to the yield measure above, but with one
difference. It indicates the likely return to be achieved in the first year of
holding the asset by applying market rental rates (MK) to any vacant space
(VS) within the building. It is defined as:
σ=1
, + σ=1
,,
−1
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Terms and their descriptions/definitions
- Equivalent yield (face rents): indicates the expected return the investor
would achieve by assuming that the building is fully leased and market rental
rates are being paid by all the lessees (tenants) in the building. It is defined
as:
σ=1
,
−1
Also referred to as core yield.
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Terms and their descriptions/definitions
- Blended Yield: shows the expected return for an investor in the first year of
holding the asset given two or more types of real estate within the property.
There is no distinction made by these types of real estate. The property is
considered as one despite having multiple parts.
For example: 100 Miller Street, North Sydney (office building and a hotel). The
office space earns rental income from corporate tenants while the hotel earns
rent of holiday goers/ visiting directors etc. It is mathematically defined as the
initial yield.
σ=1
−1
- Stripped Yield: distinguishes the two or more types of real estate of the
property. The stripped yield(s) is(are) designed to show what expected return
each component of the property will provide to the investor.
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Terms and their descriptions/definitions
- Gross Yield: rarely used in the industry. It simply measures the expected
return generated by the property with gross rental income. It is defined
mathematically as:
=
σ=1
,
−1
- Net Yield: similar calculation but factoring out outgoings and also opportunity
costs (such as lost rent on vacant space). For example, if the average re-let
period is 5 months then we must subtract 5 months’ worth of market rent.
The net yield is expressed as:
=
σ=1
, − σ=1
, − σ=1
,,
−1
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Terms and their descriptions/definitions
- Terminal Yield (Exit yield): The return of the building at the end of the
holding period, ℎ, for the existing investor.
σ=1
,=ℎ
=ℎ
- Total Return: the return obtained via all sources of return within the asset.
This is the income return and capital growth. It is expressed as:
=
− − + + ∆ −
−1 +
Would a foreign investor accept this formulation of the total return of an asset?
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Terms and their descriptions/definitions
- Internal Rate of Return (IRR): also known as the yield to maturity (but we
extend this to the return over the holding period). The IRR is generally
described as the interest rate that makes the NPV equal to 0:
0 = = ෍
=1
(ℎ )
(1 + )
The IRR is also known as the total return obtained over the holding period. For
example, if the income return is 8% and the capital growth is 4% then the IRR is
said to be 12%.
Let’s go through a simple illustration of what the IRR really is.
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Terms and their descriptions/definitions
- Pay-back period: the reciprocal of the yield formula. It shows how long in
years it takes for the property’s earnings to pay for the investment sum. It is
defined as:
=
- Example: Suppose Infinity Limited paid $200 million for a building. The total
rent in year 1 is expected to be $15 million. The payback period is thus:
=
$200,000,000
$15,000,000
= 13.33
- Thoughts or comments on this metric?
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Terms and their descriptions/definitions
- Weighted Average Lease Expiry (WALE): provides the investor with an idea of how
long in years the building will become vacant. There are two measures of the WALE:
▪ WALE by area
▪ WALE by income
The WALE is extremely important because it underpins the value of buildings in
commercial real estate. The mathematical expression is:
For the WALE by area =
σ=1
For the WALE by income: =
σ
=1
σ=1
෍
=1
( − ,
)
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
A Final Note on Return Metrics
- In the commercial property sector, investors are much more interested in
yields than prices (CV). Why?
market sentiment.
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Important Note
- These return metrics are not designed to
be considered in isolation (sole indicators
of an investment’s performance).
- These return metrics are context-specific.
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Risks in Commercial Real Estate
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Types of Risk in Commercial Real Estate
- Liquidity Risk: the greater effort required to sell an asset the higher the chance of the vendor having
to provide a discount on the capital value to sell.
- Inflation Risk: returns are reduced if the income deriving asset does not adjust to account for
unexpected inflation therefore reducing real returns. In real estate, income from assets does not tend
to increase with unexpected inflation in periods with low demand for space and also high vacancy
rates.
- Interest Rate Risk: the degree of sensitivity of an investment to changes in the cash rate. Typically
buildings with low WALEs are more sensitive to changes in the cash rate than comparable building
with long WALEs.
- Management Risk: the more management effort is required on the day-to-day operations of the
building the higher the risk and this will be reflected in the pricing of the building.
- Legislative Risk: Government changes to regulation such as taxation, re-zoning and disclosure
requirements can affect the profitability of investments within the commercial real estate sector.
- Environment Risk: real estate is always exposed to changing factors in the environment and also
about the awareness of the environment. Such risks can be extremely costly on building owners.
Some examples include:
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
The Role of Land in CRE Return Metrics
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Terms and their descriptions/definitions
- Englobo land: an undeveloped lot(s) zoned for further sub-division into
smaller parcels of land under current zoning regulations.
- Freehold title: the land is owned by the landlord/owner perpetually (that is,
forever). A bit of linguistics will help here: “free from hold” meaning there is
no time limit for holding the land. It is the most absolute form of ownership of
the land and there are very little restrictions placed on the landlord in a
freehold title. In 1958, Robert Torrens introduced the freehold title in
Australia. Thus, freehold title in Australia is also called ‘Torrens title’.
- Leasehold title: a non-perpetual ownership of the land. In Australia it is
common for the various levels of government to issue 99-year leases not just
on Crown land but also on other assets (such as electricity grids). The ACT is
a prime example where leasehold titles are prevalent.
- What is the implication of a leasehold title on property returns?
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Terms and their descriptions/definitions
Green field development Brown field development
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Exploring A Sales Analysis
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Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
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individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Exploring a CRE Sales Analysis
Return Metrics
WALE
Distribution of
Lease Expiry
Tenant
Composition
Comments upon
the sale
Role of asset in
investment
strategy
Exploring
a sales
analysis
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Exploring A Sales Analysis
Office
44 Market Street, Sydney
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Exploring a sales analysis – 44 Market Street, Sydney
- Key return metrics:
- WALE figures:
- Lease Expiry Distribution:
- Tenant composition:
- Comments upon sale:
- What role does this asset play in the investor’s strategy/portfolio?
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Exploring A Sales Analysis
Retail
Craigieburn Central
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Exploring a sales analysis – Craigieburn Central
- Key return metrics:
- WALE figures:
- Lease Expiry Distribution:
- Tenant composition:
- Comments upon sale:
- What role does this asset play in the investor’s strategy/portfolio?
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Exploring A Sales Analysis
Industrial
8 Williamson Road, Ingleburn
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
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individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Exploring a sales analysis – 8 Williamson Road, Ingleburn
- Key return metrics:
- WALE figures:
- Lease Expiry Distribution:
- Tenant composition:
- Comments upon sale:
- What role does this asset play in the investor’s strategy/portfolio?
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Capital Value Decomposition
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Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
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individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Important Note
- We are decomposing the asset’s capital value across two periods.
- Another type is “capital growth” decomposition which is very different.
- The latter incorporates capital expenditure into the decomposition.
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Capital Value Decomposition - Pictorially
Rent $/psm
R1
1/Y1 1/Yield
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Capital Value Decomposition – Example
Conduct a capital value decomposition analysis.
- Change in CV brought about by change in rent:
- Change in CV brought about by change in yield:
- Exercise for you: Complete the row for 2023.
Year (R) Yield
(Y)
−1 (CV) Δ Δ Δ −1 Δ(−1) Δ −1 Δ −1 Δ
2021 $232 6.25% 16.00 $3,712.0
2022 $235 6.125% 16.327 $3,836.7 $124.70 $3 0.327 $48.00 $75.76 $0.98
2023 $240 5.50%
=
$48.00
$124.70
= 38.49%
=
$75.76
$124.70
= 60.75%
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Capital Value Decomposition Analysis
Source: Author’s calculations when employee of JLL Research.
Market Sector Sample
Period
Income
Component
Yield
Component
Sydney CBD Office 4Q10-1Q18 77.3% 21.5%
Canberra Office 3Q07-3Q17 53% 47%
Parramatta Office 3Q07-3Q17 63.6% 36%
South Sydney Industrial 4Q10-1Q18 64.5% 34%
Melbourne West Industrial 4Q10-1Q18 21.4% 76.8%
Outer Central West Industrial 4Q10-1Q18 49.1% 49.5%
Sydney Regional Centres Retail 3Q07-3Q17 62% 38%
Sydney Sub-Regional Retail 3Q07-3Q17 55% 45%
Sydney Neighbourhood Retail 3Q07-3Q17 24% 76%
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Rees, D – Discount Rates in Commercial Property –
A User’s Guide
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Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Discount Rate – Understanding the basics
- The basic discounted cash flow (DCF) formulation is expressed as:
=
0
(1 + )0
+
1
(1 + )1
+
2
(1 + )2
+ … +
1 +
Where is the discount rate (%) and CF is the cash flow indexed by time.
For the purposes of illustration, we will treat the rent (here being represented as
CF) as being paid annually and in arrears. Note that this is NOT the case in
practice.
- If the rent is constant and the stream of payments is perpetual then (1)
simplifies to:
= 0 +
(1)
(2)
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Discount Rate – Understanding the basics
- Since the rent is treated here as being paid in arrears Equation (2) simplifies
further to:
=
- Thus, the yield formula we use in real estate embodies the assumption of
rental payments in arrears. Again this is not industry practice!
- Rents do increase per annum at a fixed positive rate . Given that this is the
case, the cash flows per year will be expressed as:
2 = 1(1 + )
and so on and so on.
(3)
(4)
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Discount Rate – Understanding the basics
- This rental growth can be extended to a perpetual context. Thus equation (3)
becomes:
=
(1 + )
−
- The link between Equation (3) and Equation (5) is given by:
1 + = 1 + (1 + )
where is the required rate of return (or capitalisation rate) and is also called
the _____________
- Expanding and re-arranging Equation (6) gives us:
− = (1 + )
(5)
(6)
(7)
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Discount Rate – Understanding the basics
- Suppose that is the expected inflation rate, then should rise by a
commensurate amount to keep constant. Why?
- Substituting Equation (7) into Equation (5) gives us:
=
(1 + )
(1 + )
=
- What does this imply?
(8)
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Discount Rate – Understanding the basics
- Suppose now that is NOT the expected inflation rate.
- In other words, the growth in the cash flows (rent) is from sources other than
the rate of expected inflation.
- What would be one example of this?
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Discount Rate – Understanding the basics
- What is the implication of this? In the scenario where, > expected rate of
inflation, then Equation (5) tells us that:
=
(1 + )
−
=
(1 + )
- What else did we have to assume for this to hold?
- What are the ensuing results?
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Discount Rate – Understanding the basics
- On a cyclical basis, rents may increase faster than the rate of inflation. This
indicates real rental growth, but there is no corresponding change in .
- Why?
- What does Equation 8 tell us?
- Note that cyclical events are temporary and hence NOT permanent, by
definition.
- Thus, we cannot use Equation (3) and Equation (8) to explain cyclical trends.
Only permanent effects.
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Discount Rate – Understanding the basics
- What else could explain the change in capitalisation rates?
- Finance theory indicates that the perceived risk associated with each asset
class is one key variable.
- Vacancy rates are a possible explanatory variable of risk given they indicate
the difficulty in attracting a tenant.
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Discount Rate – Understanding the basics
- How do we determine discount rates?
- Any factor that influences the correlation of a particular property with the
overall market returns should be accounted for in the bottom line (that is the
denominator of Equation 1).
- What are some of these factors? (property classes’ specific features, tenant’s
financial characteristics).
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Discount Rate – Understanding the basics
- What then goes in the top line (that is the numerator of Equation 1)?
o Lease expiry costs
oRefurbishments
oCapital Expenditure
oMaintenance
In other words, anything specific to the property being valued.
- Discount rates are specific to asset classes (and not to specific assets).
Which of the two risks then is being reflected in the discount rate?
Systematic risk or non-systematic risk?
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
way, shape or form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or
individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
A Basic Valuation Model
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individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Conclusion of the basic valuation model
- In a zero-inflation rate world with no debt financing and a 100% payout ratio
we must have the following:
- Yields in commercial real estate are not nominal but rather expressed in real
terms.
- In other words, yields in real estate are not affected by the expected rate of
inflation in all periods.
Note: These lecture notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS5533 Real
Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
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individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Group Formation for the Group Assignment
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Estate Finance & Investment for Term 3,2023. Reproduction, distribution and re-use of these lecture notes outside the scope of the course, in any
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individual, however defined, if these lecture notes are used in valuations or providing investment advice for private or commercial purposes.
Lecture 2 – Readings
- [Required] – Rees, D. (1997), ‘Discount Rates – A User’s Guide’.
- [Optional] – Mourad, M (2020), ‘The WALE by income: Insights for investors
and practitioners in commercial real estate investments and valuations’.
Unpublished.