Library/CFA (Chartered Financial Analyst)/JuiceNotes 2024: Alternative Investments - CFA Level I/Real Estate and Infrastructure

Real Estate and Infrastructure

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Real Estate Investment Features and Structures5 min

Real estate investments are broadly categorized into residential and commercial properties. Residential property primarily includes single-family homes, while commercial property encompasses income-producing assets such as office buildings, malls, and hotels. Mortgages and whole loans represent debt investments in this sector, which can be pooled into Mortgage-Backed Securities (MBS) or Commercial Mortgage-Backed Securities (CMBS) for indirect investment. Real Estate Investment Trusts (REITs) offer a liquid, publicly traded alternative to direct ownership. REITs invest in mortgages or properties and are distinct because their income is used to pay dividends, which are often tax-exempt.

Key Points

Residential properties include single-family homes.
Commercial properties produce income (e.g., hotels, offices).
REITs trade like stocks and offer liquidity compared to direct investment.
MBS and CMBS are securitized pools of real estate loans.

Performance Measurement and Indices5 min

Measuring real estate performance involves specific indices, each with unique characteristics. The Appraisal Index relies on periodic value estimates, resulting in the lowest standard deviation among methods due to the smoothing of data. The Repeat Sales Index tracks price changes for properties sold more than once. REIT Indices reflect actual stock market trading prices. Notably, REIT indices show a strong correlation with global equities due to shared business cycle sensitivities but maintain a low correlation with global bond returns, providing diversification benefits against fixed-income portfolios.

Key Points

Appraisal Index has the lowest standard deviation (volatility).
Repeat Sales Index uses prices of properties sold multiple times.
REIT indices correlate highly with global equities.
REIT indices have low correlation with global bonds.

Real Estate Valuation Methods6 min

Valuation is conducted using three primary approaches. The Comparable Sales Approach values property based on recent transactions of similar assets. The Cost Approach estimates the replacement cost of the property. The Income Approach is critical for commercial real estate, calculating value by dividing Net Operating Income (NOI) by the Capitalization Rate (Cap Rate). NOI is calculated as rental income plus other income, minus vacancy losses and operating expenses. The Cap Rate is theoretically the discount rate minus the growth rate (k minus g).

Key Points

Comparable Sales Approach uses recent transaction values.
Cost Approach is based on replacement cost.
Income Approach Formula: Value equals NOI divided by Cap Rate.
NOI approximates EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).

Infrastructure Investments5 min

Infrastructure assets are essential public facilities divided into economic and social categories. Economic infrastructure includes transportation (roads, airports), utilities (electric grids, waste disposal), and communications (broadcast assets). Social infrastructure includes schools, hospitals, and prisons. Investments are also classified by development phase: Brownfield investments involve existing, operating assets providing stable cash flows and high yields. Greenfield investments involve new construction projects, carrying higher risk and uncertainty but offering greater potential for capital growth.

Key Points

Economic infrastructure: Transportation, Utilities, Communications.
Social infrastructure: Schools, Hospitals, Prisons.
Brownfield: Existing assets, stable cash flow, high yield.
Greenfield: New construction, high growth potential, higher uncertainty.

Questions

Question 1

Which of the following best describes a characteristic of Real Estate Investment Trusts (REITs)?

Real Estate and Infrastructure

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