Real Estate

Document Sample

```					Real Estate

Chapter 23
Students Should Be Able to:

   Calculate the real and nominal cost
of capital for real estate.
   Analyze the effects of changes of
different elements of cost of capital
on rental yields and real estate
prices.
Hong Kong Real Estate
   According to the planning department
rental yields on residential apartments
are more than 5%.
   Rental yields are the annual rent divided
by the price level.
   But interest rates on mortgage loans are
2.5%.
   Why don’t people want to borrow at 2.5%
to make 5.1% returns?
Real Estate
   Real Estate is an important type of
physical capital investment and a
special type of financial investment.
   Uniqueness- Each location of property
is unique, making it harder to value.
   Illiquid – Harder to sell than paper
financial assets, longer lead times for
building real property.
   Large share of the wealth of middle
income households.
Rental Yields & Cost of Capital
 Payoff to owning            Capital cost of real
property is rent, R.         estate includes
 Define rental yield,             Interest rate, i
y, as the ratio of               Depreciation/Maint
rent to property                  enance Costs δ
prices, PPE.                     Property Taxes: τ
   Other Costs: c RE
PMPK RE  R                                         P
   Capital Gains, g
R
y  RE
P
ck   RE
 (i    c  tw  g   PRE
)PRE
Cost of Capital Theory & Real Estate

   Constructing New Buildings has long
lead times. For a fixed stock of
buildings we can use cost of capital
theory (y = ckRE) to derive prices as
a function of rents.
1
R  ck  P RE                                           R
(i    c  tw  g        P RE
)
1

             
R
(i    c  tw        Pt RE
1
Pt RE
1 )
Ceteris Paribas
Curve PRE
R↑       →     ↑
i↑       ←     ↓
δ↑       ←     ↓
tw ↑     ←     ↓
c↑       ←     ↓
↑ →    ↑
RE
Pt 1
Real Estate Pricing

1
            )
R
(i    c  tw        Pt RE
1
Pt RE
1

45%

PRE
P*
Expectations

   A key determinant of the price of
real estate is the expected capital
gain.
   Expected deflation explains why
rental yields are so much higher in
HK than mortgage rates.
   Waves of optimism and pessimism
in property prices.
HK Property Prices
HK: Pro perty Capital Value: Residential: Medium
HKD/Sq ft

7000

6500

6000

5500

5000

4500

4000

3500

3000

2500

2000

1500
Dec-1988   Dec-1990   Dec-1992     Dec-1994       Dec-1996      Dec-1998   Dec-2000   Dec-2002
Credit Cycles: Real Estate
   Much of corporate collateral is real
estate.
   Real estate is good collateral
because it cannot be easily moved
and its value is relatively easy for
outsiders to derive.
   Fluctuations in property price have
effects on cost of capital and
investment.
The Financial Accelerator

Fire sales of commercial
Declining corporate net
property to pay back bank           worth
declines in prices

Lower investment and
reduced demand for real
Falling collateral values
estate
and worsening bank