1. Alternative Investments
CFA二级重要知识点讲解
讲师：韩霄

2. Private property

3. Income Approach: DCF Method
In discounted cash flow method, the terminal value is
Relationship between discount rates and capitalization rates
The discount rate (r) : the required rate of return on the real estate investment.
The capitalization rate (R0 = r-g): the required rate of return less the expected growth in NOI (increase or decrease in value)

4. Income Approach: DCF Method
Relationship between discount rates and capitalization rates
The terminal cap rate is not necessarily the same as the going-in cap rate.
Going-in cap rate = PMT / PV
The terminal cap rate could be higher if interest rates are expected to increase in the future or if the growth rate is projected to be lower because the property would then be older and might be less competitive. Also, uncertainty about future NOI may result in a higher terminal cap rate.
The terminal cap rate could be lower if interest rates are expected to be lower or if rental income growth is projected to be higher.

5. Valuation with Different Lease Structure
In the U.K. the property is said to have reversionary potential when the contract rent expires
Method 1: Term and Reversion Approach
One way of dialing with the problem is known as the term and reversion approach, whereby the contract (term) rent and the reversion are appraised separately using different cap rates.
For example:
A single-tenant office building was leased six years ago at £200,000 per year. The next rent review occurs in two years. The estimated rental value (ERV) in two years based on current market conditions is £300,000 per year. The all risks yield (cap rate) for comparable fully let properties is 7%. Because of lower risk, the appropriate rate to discount the term rent is 6%. Estimate the value of the office building.

6. Term and Reversion Approach
Answer:
Step 1: Using the financial calculator, the present value of the term rent is:
N = 2; I/Y = 6, PMT = 200,000; FV = 0; CPT PV = £366,679
Step 2: The value of reversion to ERV is:
Step 3: The present value of the reversion to ERV is:
N = 2; I/Y = 7, PMT = 0; FV = 4,285,714; CPT PV = £3,743,309
Step 4: The total value of the office building today is:
PV of term rent
£366,679
PV of reversion to ERV
£3,743,309
Total value
£4,109,988

7. Valuation with Different Lease Structure
Method 2: Layer method
A variation of the term and reversion approach is the Layer method, one source (layer) of income is the contract (term) rent that is assumed to continue in perpetuity. The second layer is the increase in rent that occurs when the lease expires and the rent is reviewed.
For example:
Let's return to the example of the term and reversion valuation approach. Assume the contract (term) rent is discounted at 7%, and the incremental rent is discounted at 8%.

8. Valuation with Different Lease Structure
Answer:
Step 1: The value of term rent (bottom layer) into perpetuity is:
Step 2: The value of incremental rent into perpetuity (at time t = 2) is:
Step 3: Using the financial calculator, the present value of the incremental rent (top layer) into perpetuity is:
N = 2; 1/Y = 8 , PMT = 0; FV = 1,250,000; CPT PV = 1,071,674
Step 4: The total value of the office building today is:

9. Estimates and Assumptions
Using the discounted cash flow method requires the following estimates and assumptions, especially for properties with many tenants and complicated lease structures:
Project income from existing leases: to track the start and end dates and the various components of each lease
Lease renewal assumptions: the probability of renewal
Operating expense assumptions: be classified as fixed, variable, or a hybrid of the two
Capital expenditure assumptions: expenditures for capital improvements
Vacancy assumptions: how long before currently vacant space is leased
Estimate resale price: how long the initial investor will hold the property is important
Appropriate discount rate: some analysts use buyer surveys as a guide

10. Allocation of Operating Expenses
Example: Allocation of operating expenses
Total operating expenses for a multi-tenant office building are 30% fixed and 70% variable. If the 100,000 square foot building was fully occupied, operating expenses would total $6 per square foot. The building is currently 90% occupied. If the total operating expenses are allocated to the occupied space, calculate the operating expense per occupied square foot.
Answer:
If the building is fully occupied, total operating expenses would be $600,000 (100,000 SF×￥6 per SF). Fixed and variable operating expenses would be:
So, operating expenses per occupied square foot are $6.20 (558,000 total operating expenses / 90,000 occupied SF).
Fixed
$180,000 (600,000×30%)
Variable
$378,000 (600,000×70%×90%)
Total
$558,000

11. Compare direct capitalization and DCF methods
Compare the direct capitalization and DCF methods
Common errors made using the DCF method:
The discount rate does not adequately capture risk.
Income growth exceeds expense growth.
The terminal cap rate and the going-in cap rate are not consistent.
The terminal cap rate is applied to NOI that is atypical.
The cyclicality of real estate markets is ignored.
Direct capitalization
DCF
Numerator
First year NOI
Future cash flow
Inputs required
Less complex
Need to forecast what will happened in future.
Not doing a detailed lease-by-lease analysis.
Comparable transactions
Yes No
Choosing discount rate

12. Question—1
The Imperial office building has annual net operating income of $180,000. A similar office building with net operating income of $300,000 recently sold for $3,000,000. Using the direct capitalization method, the market value of Royal Oaks is closest to:
$300,000.
$1,800,000.
$3,000,000.

13. Question—1
Solution: B.
The cap rate of the comparable transaction is 10% (300,000 N〇I / 3,000,000 sales price). The value of Royal Oaks is $1,800,000 (180,000 NOI / 10% cap rate).

14. Question—2
Using the discounted cash flow method, estimate the property value of a building with the following information:
NOI for next five years $500,000
NOI in Year $600,000
Holding period years
Discount rate %
Terminal growth rate 4%
$8,104,607.
$8,350,729.
$9,024,472.

15. Question—2
Solution: A.
The terminal value at the end of five years is $10,000,000 [600,000 year 6 payment / (10% discount rate - 4% growth rate)]. The terminal value is discounted to present and added to the present value of the NOI during the holding period. You can combine both steps using the following keystrokes:
N = 5; I/Y = 10； PMT = 500,000； FV = 10,000,000； CPT PV= $8,104,607