2211 AFE Real Estate Finance
2211 AFE Real Estate Finance
Tutorial Questions and Answers
consequences of Borrowing- Extra maths Questions
e = (r i x M)
(1-M)
Effect of financial leverage on return on equity (e). Use the above equation, examples in Tables 4.1 to 4.3 of the text (Rowland) and the relevant examples in the lecture PPTs to compute the return on equity (e) in the following table. Show all workings clearly. To check your answers, the final answers have been provided. Workings will be provided in the tutes.
(a) (f) (g)
Property value 100000 100000 100000
Initial yield (r) 10% 5% 10%
LVR 50% 75% 75%
Loan interest rate (i) 8% 8% 6%
Loan amount 50000 75000 75000
Equity 50000 25000 25000
Net rental income 10000 5000 10000
Loan interest 4000 6000 4500
Cash flow 6000 -1000 5500
Return on equity (e) 12% -4% 22%
Effect of financial leverage on return on equity (e). With reference to Q1 above, now, use the equation e = CF/E, where CF = cash flow and E = equity, to compute the return on equity (e). Show all workings clearly. To check your answers, the final answers have been provided. Workings will be provided in the tutes.
2211 AFE Real Estate Finance
Workshop Questions and Answers
comparing property investments
Q only
What causes properties to suffer obsolescence even though they may be in good condition? Is a high vacancy rate a sign of obsolescence? [see pages 26-27]
What are the differences between gross and net leases? What are the differences between the net rent and the net income?
What characteristics do investors generally seek in tenants in shopping centres?
Estimate the annual net income from a house which is let at a gross rent of $450 per week. The Council rates are $850 per annum, the water and sewerage charges are $1,175 per annum and Land Tax is $740 per annum. House insurance is $180 per quarter. You estimate that maintenance on this older house will probably cost about $2,000 per annum. The management fee is currently $100 per month. The current 6 month lease was only signed 2 months ago but you consider it prudent to allow for 1 week loss of rent every 6 months to cover potential vacancies and leasing fees. [see pages 31-33]
Q&A
What causes properties to suffer obsolescence even though they may be in good condition? Is a high vacancy rate a sign of obsolescence? [see pages 26-27]
What is generally referred to economic obsolescence occurs when there is less demand for properties of a particular style or in a particular location. Some design features (such as the examples in the right column of Table 2.2 on page 27) may be out of fashion in homes or may not be suitable for current business operations. When new areas are developed, existing neighbourhoods may be relatively less attractive or less accessible; tenants may only be found at lower rents and/or vacancies may increase.
High vacancy may be a sign of obsolescence but it may also be caused by overbuilding across the market or limited demand in times of economic downturns.
What are the differences between gross and net leases? What are the differences between the net rent and the net income?
Under a gross lease, the tenant pays the (gross) rent from which the landlord pays the property expenses (being the statutory charges and the operating expenses). Under a net lease, the tenant pays the net rent plus an amount to cover the property expenses (which are calculated each year). In Australia, almost all residential properties have gross leases and most commercial and industrial properties, except some of the smallest, have net leases.
The net rent is the rent under a net lease, whereas the net income is the total rental and other income from the properties, less a vacancy allowance and operating expenses. The differences between the net rent and the net income are the unrecovered property expenses (arising from the terms of the lease and vacancy) and the vacancy allowance. [see pages 31-33]
What characteristics do investors generally seek in tenants in shopping centres?
Investors investigating potential tenants for any income-producing property consider their ability to continue paying the rent. For non-residential properties, this requires the tenants business should earn an adequate, stable and preferably growing income to more than cover the rent. This should minimise the risk of default and permit rent to grow when the lease allows.
In shopping centres, it is most important that the mix of tenants generates the most shoppers. For this, the trades should complement one another (sometimes this requires many tenants of one type, such as fashion labels, and sometimes this requires the greatest variety of goods). There may also be some tenants that are well known and act as a draw to the centre. Can students think of examples of such trades and tenants? [see pages 25, 27-28]
Estimate the annual net income from a house which is let at a gross rent of $450 per week. The Council rates are $850 per annum, the water and sewerage charges are $1,175 per annum and Land Tax is $740 per annum. House insurance is $180 per quarter. You estimate that maintenance on this older house will probably cost about $2,000 per annum. The management fee is currently $100 per month. The current 6 month lease was only signed 2 months ago but you consider it prudent to allow for 1 week loss of rent every 6 months to cover potential vacancies and leasing fees. [see pages 31-33]
per annum
Gross potential income $450 per week for 52 weeks $23,400
Vacancy allowance 2 weeks rent per annum $900
$22,500
Statutory charges Council, Water and Land Tax $2,765
Operating expenses Insurance - $180 per quarter $720
Maintenance $2,000
Management - $100 per month $1,200
Total property expenses $6,685
Net (operating) income $15,815
2211 AFE Real Estate Finance
Workshop Questions and Answers
Properties as investments
Q only
Distinguish between private and institutional investors.
What might some reasons be for becoming a landlord?
Distinguish between direct and indirect property investments.
Do you think that investors should research and select properties before, at the same time or after researching and arranging for their financing?
How efficiently do you think residential property markets absorb public information? Does the level of efficiency alter the way that you might research the purchase of a typical residential property?
An investor has equity of $156,000 available to buy a property. She can borrow 65 per cent of the price but must allow for buying costs of 4 per cent of the price. What price can she afford?
Additional Qs
What is finance? What is REF?
Why might property markets be more imperfect compared to most financial markets? What is the implication of the above?
Q&A
Distinguish between private and institutional investors [Rowland, 1.20]
Private: households who own rental properties and units in property funds
Institutional: institutions such as superannuation funds, insurance companies
What might some reasons be for becoming a landlord?
Secure LT investment, rental income, negative gearing, possible future home, potential capital gain, retirement investment. Others??
Distinguish between direct and indirect property investments. [Rowland, 1.30]
Direct: investor becomes owner of properties, not securities that give rights to returns from properties
Indirect: investment via intermediaries/institutions such as property funds
Do you think that investors should research and select properties before, at the same time or after researching and arranging for their financing?
Although much finance theory suggests that investment assets, including properties, should be selected independently of their financing, this is never entirely practical. Both the availability of debt finance and the investors willingness to take on debt determine the price range in which investors should search for properties. Whilst it is true that favourable debt finance cannot make a poor property a good investment, investors must be aware of their sources of finance when selecting, researching and pricing properties. Selecting properties and their financing are related decisions although the property purchase is negotiated prior to any application for finance. see pages 8-10
How efficiently do you think residential property markets absorb public information? Does the level of efficiency alter the way that you might research the purchase of a typical residential property?
It would be difficult to prove whether any particular residential property market correctly prices information when it becomes publicly available. However, one would expect residential markets with many transactions of similar properties to be reasonably efficient. Residential markets with few transactions and few similar properties (probably expensive homes or those in small communities) are likely to be less efficient.
If the market is correctly using public information about homes and/or blocks of land, investors should not expect to find under-priced properties. In these efficient markets, research and analysis will confirm whether the price of a property is reasonable, given current information and may confirm the suitability of a property for a particular investor. In inefficient markets, research and analysis may reveal details about the property that are not widely known and this may minimise the chance of paying too much for an unusual property.
see pages 11-13
An investor has equity of $156,000 available to buy a property. She can borrow 65 per cent of the price but must allow for buying costs of 4 per cent of the price. What price can she afford?
P = E / (1 + T M)$156,000 / (1 + 0.04 0.65) = $400,000
