This document outlines key concepts related to real estate investment valuation including time value of money, internal rate of return, risk, cost of equity, discounting cash flows, and appraisal. It discusses how real estate investment involves costs now for future benefits which are uncertain. It also explains how to calculate an investment's internal rate of return and how appraisal estimates a property's most probable selling price.
3. Investment and risk: A classical view
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Investment is about involving costs (cash outflows)
now for the sake of future benefits (cash inflows).
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Investment risk is about uncertainty. This
uncertainty comes from two possible sources: (1)
costs can be uncertain, and (2) benefits can be
uncertain.
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Examples of uncertain costs: (1) renovating an aged
house frequently leads to cost overrun, and (2)
developing a subdivision may be surprised by soil
contamination.
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Question: should high costs, in equilibrium, lead to
high benefits (returns)?
5. Calpers loses big on land deal
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“Calpers, a $244 billion fund, did its first
undeveloped land deal in 1994 and today has 7
partners for such deals and investments in more
than 12 states.”
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Some deals filed for bankruptcy.
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“Land can loss value quickly because there are fewer
other ways to generate income form it.”
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Source: WSJ, May 01, 2008.
10. 2 notions of RE values
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Investment value: value to a particular individual
(e.g., NPV): Chapters 18 & 19.
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Appraised value: value to a “typical” investor, or
probable selling price: Chapters 7 & 8.
13. Internal rate of return
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In addition to fundamental value, practitioners often
obtain estimates of the internal rate of return (IRR).
The IRR is also known as the “investment yield” or
the “total yield” in the RE industry.
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If the IRR is higher than the required IRR (the
benchmark), the investment project is accepted.