Solved by verified expert :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
