# Real Estate Finance and Investments

Real Estate Finance and Investments – Fall 2011

Homework 2

Question 1

The equity REIT A currently (current time is end of 2005) trades at \$120/share. In the past year, the realized rate of return on A has been 10%, and As cap rate at the beginning of year was 13%. REIT A distributed all of its NOI in the past year to its shareholders in the form of dividends. What was the trading price of A at the beginning of 2005?1

Question 2

Consider the following projected cash ows (including reversion) for Property

A and Property B for the following 10 years.

Annual net cash ow projections for two properties (\$ millions)

1

2

3

4

5

6

7

8

9

10

A

\$1.0000

\$1.0050

\$1.0100

\$1.0151

\$1.0202

\$1.0253

\$1.0304

\$1.0355

\$1.0407

\$12.7252

B

\$1.0000

\$1.0200

\$1.0404

\$1.0612

\$1.0824

\$1.1041

\$1.1262

\$1.1487

\$1.1717

\$14.7395

a. What is the annual growth rate in operating cash ows for each building during the rst nine years?

b. If both properties sell at cap rates (initial and terminal cash yields) of 9%, what is the expected annual return on a 10-year investment in each property?

c. If the 9% cap rate represents a fair market value for each property, then which property is the more risky investment (and how do you know)?

Question 3

You are considering investing in Property B in question 2. The listing price of the property is \$11 million. You know that the historical annual returns on this type of property has been 10%, and the historical risk premium on this type of property has been 5.5%. In alternative investments tools, the prices of zero coupon treasury bonds are as follows:

Prices of zero coupon treasury bonds (denomination = \$1,000)

Maturity(yr)

1

2

3

4

5

6

7

8

9

10

Price

\$971

\$934

\$889

\$839

\$784

\$725

\$665

\$604

\$544

\$485

How much is the property worth? Is this a good investment opportunity?2

1 Hint: Start with the denition of return. Write the return to REIT A in 2005. The answer will be staring at you …

2 Hint: You can calculate the risk free rates at di¤erent maturities from the Treasury bond

prices; i.e., Pt =

1000

:

(1+rft)

t

1

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