Description
The Assignment must be submitted on Blackboard (WORD format only) via allocated folder.Assignments submitted through email will not be accepted.Students are advised to make their work clear and well presented, marks may be reduced for poor presentation. This includes filling your information on the cover page.Students must mention question number clearly in their answer.Avoid plagiarism, the work should be in your own words, copying from students or other resources without proper referencing will result in ZERO marks. No exceptions. All answered must be typed using Times New Roman (size 12, double-spaced) font. No pictures containing text will be accepted and will be considered plagiarism).Submissions without this cover page will NOT be accepted.Chapter 20
Investments in
Real Assets
Objectives
◼
Understand the advantages and
disadvantages of real assets
◼
Discuss the various forms of investments
that real assets can take
◼
Explain the characteristics of investing in
real estate
2
Objectives continued
◼
Discuss the various forms of financing for
real estate investments
◼
Explain the traditional appeal of precious
metals as a form of investments
◼
Understand the factors that influence the
value of collectibles
3
Investments in Real Assets
Advantages and Disadvantages of Real Assets
◼ Real Estate as an Investment
◼ Valuation of Real Estate
◼ Forms of Real Estate Ownership
◼ Gold and Silver
◼ Precious Gems
◼ Other Collectibles
◼ Appendix 20A: A Comprehensive Analysis for
Real Estate Investment Decisions
◼
4
Real Assets
Real assets are tangible assets that may be
◼ Seen
Examples:
◼ Felt
• Real estate
◼ Held
• Gold and silver
◼ Collected
• Diamonds
• Coins, stamps, and antiques
Real assets during inflationary environments
have at times outperformed financial assets
5
Growth in Value: 1946-2006 ($1 of investment)
6
Real Assets – Advantages
An inflation hedge
◼ Hedge against unknowns, fears
◼ Effective vehicle for diversification
◼ Improves portfolio risk-return alternatives
◼ Low correlation with monetary assets
◼ May provide psychic pleasure
◼
7
Real Assets – Disadvantages
Lack of large, liquid, efficient markets
◼ Larger commissions & spreads compared
to securities
◼ No current income except from real estate
◼ Storage and insurance costs
◼ Unit costs may be high
◼ Cyclical hysteria or over-reactions
periodically occur (timing may be tricky)
◼
8
Real Estate As An Investment
About half of U.S. households own real
estate as a home or investment
◼ Brokerage and investment firms have
entered the market to
◼
• Buy
• Sell
• Finance
• Syndicate property
◼ Real estate has increased to 10% of pension
fund portfolios today
9
Real Estate As An Investment
Investments may include
◼ Homes
◼ Duplexes
◼ Apartments
◼ Offices
◼ Industrial buildings
◼ Shopping centers
◼ Hotels and motels
◼ Undeveloped land
10
Real Estate As An Investment
Methods investors may participate
◼ As an individual
◼ As part of a limited partnership R.E.
◼ Syndicate
◼ Via a real estate investment trust (REIT)
11
Real Estate in Recent Decades
and the Future outlook
The Tax Reform Act Of 1986
◼ Substantially increased wait time to take full
advantage of real estate tax deductions
◼ Severely restricted writing-off of paper real
estate losses by passive investors against
other forms of income
Made real estate
investment less attractive
12
Real Estate in Recent Decades
and the Future outlook, cont’d
Negative impact of tax reform on real
estate blamed for declining economic
conditions of late 1980s and early 1990s
1. Fewer new properties were developed
2. Gluts in office space/apartments shrank
3. Rents increased on existing properties
4. Eventual higher real estate evaluations
13
Valuation of Real Estate
The Cost Approach
◼ Comparative Sales Value
◼ The Income Approach
◼
In most cases, a final value may
be determined from a combination
of the three approaches
14
Valuation of Real Estate:
The Cost Approach
Cost to replace an asset at current prices
used as the value of real estate
Easy for new property
◼ Harder for older buildings
◼ Poor location makes building worth less than
its replacement cost
◼ Economic conditions influence value
◼
15
Valuation of Real Estate:
Comparative Sales Value
Find value using comparable property
prices in the neighborhood
◼
True comparables may be difficult to find
◼
Combine sale values of several comparable
properties to “average” out differences
16
Valuation of Real Estate (R.E):
The Income Approach
The stream of net earnings generated by an
income-producing property capitalized as a
measure of that property’s worth
Annual net operating income
= Valuation
Capitalization rate (Cap rate)
17
Valuation of Real Estate:
The Income Approach
Future realistic values of annual
rentals minus expenses such as
property taxes, insurance, …
Annual net operating income
Capitalization rate (Cap rate)
= Valuation
The rate of return required by
investors in similar-type
investments
18
Valuation of Real Estate:
The Income Approach
Example:
Projected annual net operating income = $17,500
Market capitalization rate = 10%
Value based on this approach:
$17,500
= $175,000
0.10
19
Valuation of Real Estate:
The Income Approach
Income approach helpful but overly simplistic:
▪ Annual NOI* changes over time
▪ Difficulty of choosing a capitalization rate
* NOI = Net operating income
20
Valuation of Real Estate
Benefits of combining the 3 approaches:
◼ Can use insights provided by each
individual approach
◼ Can overcome some limitations involved
in using only single approach
21
Financing of Real Estate
Types of Mortgages
◼
Fixed-Payment Mortgage
• Most frequently used
Adjustable Rate Mortgage (ARM)
◼ Graduated Payment Mortgage (GPM)
◼ Shared Appreciation Mortgage (SAM)
◼ Other Forms of Mortgages (equity
participation arrangement)
◼
22
Forms of Real Estate Ownership
Ownership of real estate can take many forms:
◼
Individual or Regular Partnership
◼
Syndicate or Limited Partnership
◼
Real estate investment trust (REIT)
23
Forms of Real Estate Ownership
Individual ownership or regular partnership
◼ Simplest way from a legal viewpoint
◼
Take advantage of personal knowledge of
local markets and changing conditions to
enhance returns
◼
Well-defined center of responsibility often
leads to quick corrective actions
24
Forms of Real Estate Ownership
Individual ownership or regular partnership continued
◼ Often lacks ability to pool adequate capital to
engage in large-scale investments
◼
Often lacks expertise to develop wide range of
investments
◼
Unlimited liability for the investor
25
Forms of Real Estate Ownership
Syndicate or Limited Partnership
◼ General partner forms partnership
• Unlimited liability
• Responsible for managing property
◼
Limited partners purchase participation units
• Liability limited to initial investment
• No responsibilities – merely investors
◼
Front-end fees to General Partner
• 5-25%
26
Forms of Real Estate Ownership
Syndicate or Limited Partnership continued
◼ Blind pool or are specific projects identified?
◼ Public offering
• Involves larger total amounts
• SEC registration
◼
Private offering
• Local in scope
• Maximum 35 investors
◼
Secondary (resale) markets exist but dealer
spreads and commissions high
27
Forms of Real Estate Ownership
Real Estate Investment Trust
◼ Similar to mutual funds or investment companies
◼ Trade on organized exchanges or over-the-counter
◼ Pool investor funds
◼ No minimum investment other than cost of share
◼ Most liquid type of real estate investment
◼ Large secondary market
28
Forms of Real Estate Ownership
Real Estate Investment Trust continued
◼ To qualify as REIT, must receive 75& of
income from real estate
• Rents
• Interest on mortgage loans
◼
Must distribute at least 95% of income as
cash dividend
29
Forms of Real Estate Ownership
Real Estate Investment Trust continued
◼ Equity Trusts
• Buy, operate and sell real estate as investment
◼
Mortgage Trusts
• Make long-term loans to real estate investors
◼
Hybrid Trusts
• Engage in activities of both equity and mortgage
trusts
◼
There are more than 400 REITS in existence
30
Gold and Silver
◼
Precious metals
• Most volatile of real asset investments
◼
Historically gold and silver
• Move up in value during troubled times
• Decline in value during stable &
predictable periods
31
Gold
Major factors that drive up gold prices are
◼ Fear of war
◼ Political instability
◼ Inflation
Different forms of gold ownership:
▪ Gold Bullion
▪ Gold Coins
▪ Gold Stocks
32
Movement in Gold Prices
33
Silver
◼
Many of same investment characteristics as
gold
• Hedge against inflation
• Potential safe haven for investment during
troubled times
Silver’s
1976
Price per ounce $5
1980
2006
$50
$12
34
Silver
◼
Used for
• Heavy industrial and commercial applications
• Photography
• Electronic
• Electrical manufacturing
• Electroplating
• Dentistry
• Silverware and jewelry
35
Silver
Different forms of silver ownership:
Silver Bullion
◼ Silver Coins
◼ Silver Futures Contract
◼ Silver Mining Stocks
◼
36
Precious Gems
Diamonds
◼ Rubies
◼ Sapphires
◼ Emeralds
◼ Gems appeal to investors because of their
◼
• Small size
• Easy concealment
• Great durability
37
Precious Gems
◼
Market knowledge is most important
◼
Must either be an expert or deal with
“honest” expert
◼
Better to buy higher quality, smaller carat
diamond than lesser quality, higher-carat
diamond
38
Other Collectibles
Art
◼ Antiques
◼ Stamps
◼ Chinese ceramics
◼ Rare books
◼ Psychic pleasure as well as opportunity
for profit
◼
39
Website
www.realtor.com
Comments
Has property search function,
mortgage evaluation function
moneycentral.msn.com
Has property valuation
function along with mortgage
financing calculator
www.quicken.com
Provides mortgage financing
info and payment calculator
www.nareit.com
Website for the industry trade
group and provides
information and data on
REITs
40
Website
www.hsh.com
www.realestate.com
www.gmacrealestate.com
www.housevalues.com
Comments
Contains database of current
residential mortgage rates
Provides information on
property listings and
mortgage financing and
reports on property values
and analysis
Provides property search,
valuation calculation, and
mortgage information
Will estimate residential
property values and provide
report for homes in cities in
its data base
41
Appendix 20A
A Comprehensive
Analysis for Real
Estate Investment
Decisions
Valuation of Real Estate:
A More Comprehensive Analysis
Any asset’s ultimate worth
is based on the present value
of its future cash flows
43
A More Comprehensive Analysis
Six steps to determine cash flow variables:
1. Determine purchase price, size of mortgage,
annual mortgage payment
2. Compute the net operating income for each year of
the anticipated holding period
3. Translate this to annual cash flow during the
holding period
4. Project the selling price of the property after the
holding period
44
A More Comprehensive Analysis
Six steps to determine cash flow variables:
5. Discount the annual cash flows and the anticipated
selling price after the holding period back to the
present to determine the present value of the future
benefits
6. Compare the upfront cash commitment to the
present value of future benefits to determine if the
property provides a positive net present value
45
1. Determine the Purchase Price & Financing
Assume:
▪ Six-unit apartment complex
▪ Purchased for $180,000
▪ Loan 80% of the value at 12% for 20 years
▪ The loan would be for $144,000 ($180,000 x 80%)
▪ Balance of $36,000 ($180,000 – $144,000) put up in cash
▪ From table below, annual mortgage payment
for..ARTChapter 20hir05159_ta20A1.jpg 20 years at 12% is
$19,280
46
2. Determine Net Operating Income (NOI)
for each year
Assume buyer intends to hold property for 4 years and then
sell it. We can determine the value each year from the table
below:
47
3. Determine the Annual Cash Flow
Income from operations must be adjusted by
nonoperating factors such as
▪ Interest expense
▪ Depreciation
▪ Taxable income/losses
▪ Related taxes or tax shield benefits
▪ Repayment of the mortgage
48
3. Determine the Annual Cash Flow cont.
▪ Table 20A-3 Subtracts depreciation and interest expense
from net operating income to find taxable income or
loss for each year
49
3. Determine the Annual Cash Flow cont.
▪ To the extent the investor is actively involved with the
property, the losses during the first two years can be
used as a tax shield (shelter) for other income as
reflected in Table 20A-4
50
3. Determine the Annual Cash Flow cont.
▪ Net Operating Income is combined with annual tax shield
benefits or taxes owed & the annual mortgage payments
to determine the total annual value of cash flow in
Table 20A-5
51
4. Project the Sales Price
▪ Property purchased for $180,000
▪ Appreciates 6% per year over 4 year period
▪ Sales value: $180,000 x 1.262* = $227,160
Net proceeds from selling the property after subtracting sales
commission & fees of 7% →
= $277,160 – (0.07 x $227,160) = $211,259
*Appendix A – Compound sum 4 periods at 6% the factor is 1.262
52
4. Project the Sales Price cont.
To the extent that the net proceeds exceed the book value of the property, a
capital gains tax has to paid:
• Book value = Purchase price of
minus [4 years of depreciation: 4 x $5,096]
=
$180,000
$ 20,384
$159,616
=
$211,259
$159,616
$ 51,643
• Capital gain = Net proceeds of sale
minus book value
53
4. Project the Sales Price cont.
• Funds from sale = Net Proceeds
minus Capital gains tax [15% x $51,643]
$211,259
$ 7,746
= $203,513
• From the funds from the sale, the investor must pay off the mortgage balance
of $134,432 that exists after four years of repayments of principal:
Funds from sale
Payoff of mortgage
Net cash flow (from sale)
$203,513
– $134,432
= $ 69,081
54
5. Determine Present Value of All Benefits
If investor’s required rate of return on real
estate investments is 12%, the present
value of the future cash flows is $52,461
55
6. Compare Upfront Cash Payment to Benefits
The Net Present Value of the Investment:
$52,461 Present Value of future cash flows
– $36,000 Upfront cash investment
= $16,461 Net Present Value
Investment earns more than the required return
of 12% and is attractive, earning about 22%
Caveat: Real estate is illiquid investment and
almost the entire return here is based on the
assumption of a 6% yearly increase in value
56
Financing of Real Estate
An essential consideration in a real estate
investment analysis is the cost of financing
◼ Prior example
• Loan of $144,000
• Over 20 years
• At 12% interest
• Payments $19,280
◼ Table 20–1 page 563 the effects of various
interest rates on annual payments
◼
57
Managing Bond
Portfolios
Bodie, Kane, and Marcus
Essentials of Investments,
9th Edition
McGraw-Hill/Irwin
11
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
11.1 Interest Rate Risk
• Interest Rate Sensitivity
• Bond prices and yields are inversely related
• Increase in bond’s yield to maturity results in smaller
price change than yield decrease of equal magnitude
• Long-term bond prices more sensitive to interest rate
changes than short-term bonds
• As maturity increases, sensitivity of bond prices to
changes in yields increases at decreasing rate
11-2
11.1 Interest Rate Risk
• Interest Rate Sensitivity
• As maturity increases, sensitivity of bond prices to
changes in yields increases at decreasing rate
• Interest rate risk is inversely related to bond’s coupon
rate; low-coupon bonds are more sensitive to interest
rates
• Sensitivity of bond’s price-to-yield change is inversely
related to current yield to maturity
11-3
Figure 11.1 Change in Bond Prices as a Function of Change
in Yield to Maturity
11-4
Table 11.1 Annual Coupon Prices
Prices of 8% annual coupon bonds
*Equals value of bond at a 9% yield to maturity minus value of bond at (the
original) 8% yield, divided by the value at 8% yield.
11-5
Table 11.2 Zero-Coupon Bond Prices
Prices of zero-coupon bonds
*Equals value of bond at a 9% yield to maturity minus value of bond at (the
original) 8% yield, divided by the value at 8% yield.
11-6
11.1 Interest Rate Risk
•
11-7
Spreadsheet 11.1 Calculation of Duration of Two Bonds
11-8
11.1 Interest Rate Risk
•
11-9
Spreadsheet 11.2 Computing Duration
11-10
11.1 Interest Rate Risk
• What Determines Duration?
• Zero-coupon bond’s duration is time to maturity
• Time/yield to maturity constant, bond’s duration
and interest-rate sensitivity higher when coupon
price lower
• Coupon rate constant, bond’s duration and
interest-rate sensitivity generally increase with
time to maturity; duration always increases with
maturity for bonds at or above par
11-11
11.1 Interest Rate Risk
•
11-12
Figure 11.2 Duration as Function of Maturity
11-13
Table 11.3 Annual Coupon Bond Duration
Durations of annual coupon bonds
(initial bond yield = 6%)
Coupon Rates (% per year)
Years to
Maturity
4%
6%
8%
10%
1
1.000
1.000
1.000
1.000
5
4.611
4.465
4.342
4.237
10
8.281
7.802
7.445
7.169
20
13.216
12.158
11.495
11.041
Infinite
(perpetuity)
17.667
17.667
17.667
17.667
11-14
11.2 Passive Bond Management
• Immunization
• Strategy to shield net worth from interest rate
movements
• Rebalancing
• Realigning proportions of assets in portfolio as
needed
11-15
Table 11.4 Terminal Value of Bond Portfolio after Five
Years
11-16
Figure 11.3 Growth of Invested Funds
11-17
Table 11.5 Market Value Balance Sheets
11-18
Figure 11.4 Immunization
11-19
11.2 Passive Bond Management
• Cash Flow Matching and Deduction
• Cash flow matching
• Matching cash flows from fixed-income
portfolio with those of obligation
• Deduction strategy
• Multi-period cash flow matching
11-20
11.3 Convexity
•
11-21
Figure 11.5 Bond Price Convexity
11-22
11.3 Convexity
• Why Do Investors Like Convexity?
• More convexity = greater price increases,
smaller price decreases when interest rates
fluctuate by larger amounts
11-23
11.4 Active Bond Management
• Sources of Potential Profit
• Substitution swap
• Exchange of one bond for bond with similar
attributes and better price
• Intermarket swap
• Switching from one segment of bond market to
another
• Rate anticipation swap
• Switch made in response to forecasts of
interest rate changes
11-24
11.4 Active Bond Management
• Sources of Potential Profit
• Pure yield pickup swap
• Moving to higher yield bonds, usually with longer
maturities
• Tax swap
• Swapping two similar bonds to receive tax benefit
• Horizon analysis
• Forecast of bond returns based largely on
prediction of yield curve at end of investment
horizon
11-25
11.4 Active Bond Management
• Example of Fixed-Income Investment
Strategy
• Key features
• Firms respect market prices
• To have value, information cannot already be
reflected in prices
• Interest rate movements extremely hard to
predict
11-26
College of Administrative and Financial Sciences
Essay assignment
Deadline: 25/11/2022 @ 23:59
Course Name: Investment
Student’s Name:
Course Code: FIN403
Student’s ID Number:
Semester: first
CRN: 13436
Academic Year: 1444/1445 H
For Instructor’s Use only
Instructor’s Name: Dr. Muath Alolayan
Students’ Grade:
/ 10
Instructions – PLEASE READ THEM CAREFULLY
•
The Assignment must be submitted on Blackboard (WORD format only) via allocated folder.
•
Assignments submitted through email will not be accepted.
•
Students are advised to make their work clear and well presented, marks may be reduced for
poor presentation. This includes filling your information on the cover page.
•
Students must mention question number clearly in their answer.
•
Avoid plagiarism, the work should be in your own words, copying from students or other
resources without proper referencing will result in ZERO marks. No exceptions.
•
All answered must be typed using Times New Roman (size 12, double-spaced) font. No
pictures containing text will be accepted and will be considered plagiarism).
•
Submissions without this cover page will NOT be accepted.
Questions
Write an essay with the range of 500 to 1000 words explaining what did learn during the
semester. Mainly, you need to forget the point that you are a student and you are now a
professional investor. Each part of investment you choose need to be clarified why you selected
that. Thus, you can
–
explain some investment strategies that you will follow.
–
Resources you can get information for your investment.
–
What kind of financial assets and real assets (you can exclude real assets if you want with
some explanations why you think so); the assets you would like to invest should be precise
meaning you can’t just say government bonds (need to specify what country). Also,
general stock need to be specified like Apple, Microsoft …. Etc and why you think it is
profitable.
–
Mainly, you need to construct a portfolio of different financial assets and if you would
like real assets.
–
What factors that might affect your portfolio?
Purchase answer to see full
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