UGBA 180 Lecture Notes - Lecture 11: Capitalization Rate, Aaron Peskin, Standard Deviation
25 Jun 2018
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Lecture 11: Risk Analysis
Types of Risk
1. Business
a. Driven by fluctuations in economic activity
2. Financia
a. Structure of debt
3. Liquidity
a. (un)availability of continuous market with frequent transactions
4. Inflation
a. Unexpected inflation can reduce investment’s real rate of return
5. Management Risk
a. Is the property adequately leased and maintained to preserve its value?
6. Interest Rate Risk
a. Changes in interest rates affect the prices of all securities and investments
7. Legislative Risk
a. Changes in government regulation can adversely affect an investment’s value
8. Environmental Risk
a. Unexpected changes or discovery of pre-existing problems
Due Diligence
●Investigation that should be undertaken before acquiring a property
○Rent roll analysis
○Lease agreement review
○Property survey
○Physical inspection
●*market conditions matter
Methods for Analysing Risk
●Sensitivity analysis
○Idea: quantify how investment performance changes if we change one or more
key assumptions
●Partitioning the IRR
○IRR determined by cash flows from
■Operations
■Sale of the investment
○What fraction of the investment returns is attributed to each?
○Method: calculate PV of both sources of cash flows and compare
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●Interpretation
○Annual cash flows can be projected with more certainty than the eventual resale
price
○The greater the proportion of the IRR that is attributable to future resale, the
greater the risk
○Consider 2 properties both requiring investment of 2.55M and with 20.08 IRR
■30% operations / 70% resale
■3% operations / 97% re-sale
Risk- Return Tradeoff
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
Types of risk: business, driven by fluctuations in economic activity, financia, structure of debt, liquidity a. (un)availability of continuous market with frequent transactions. Inflation: unexpected inflation can reduce investment"s real rate of return, management risk a. Interest rate risk: changes in interest rates affect the prices of all securities and investments, legislative risk, changes in government regulation can adversely affect an investment"s value, environmental risk, unexpected changes or discovery of pre-existing problems. Investigation that should be undertaken before acquiring a property. Idea: quantify how investment performance changes if we change one or more key assumptions. Method: calculate pv of both sources of cash flows and compare. Annual cash flows can be projected with more certainty than the eventual resale price. The greater the proportion of the irr that is attributable to future resale, the greater the risk. Consider 2 properties both requiring investment of 2. 55m and with 20. 08 irr. Common measures of risk is standard deviation around the mean return.
