Fundamentals of Real Estate Lecture 7 Spring, 2002 Copyright © Joseph A. Petry

2 Exam one week from today, 2/13 MC, questions, similar to homework, class examples. Exam will cover ch. 1-4 & 6. No office hours today. Office hours: Monday, 4-5, Tuesday 9:00-11:00. Web-board questions checked Sunday, Monday & Tuesday with all questions answered by 5:00pm each day. Homework for this week has been posted. It includes Chapter 4 and Chapter 6. As usual, homework is due on Monday. All HW is due Monday—however, as we will not finish Chapter 6 today, I will only verify that Chapter 4 is included in determining whether credit is to be given. Housekeeping Issues

3 Variability of Returns Real Estate, like any other form of investment, should be evaluated on the basis of return relative to the risk of the investment. Unfortunately for the real estate investor it is more difficult to properly evaluate historical returns and risks in this market, than in most other financial markets. – Assets are not frequently traded – No central clearinghouse of information such as the SEC, or stock markets Risk & Real Estate Investment

4 Variability of Returns This forces real estate investors to rely on “Subjective Probability Distributions” as opposed to “Probability Distributions”. – Probability Distributions define the likelihood of certain events occurring, and are based on long and rigorous statistical testing (likelihood of successful infertility treatment) or on provable theorems (likelihood of heads on a coin toss). – Subjective Probability Distributions are educated guesses about the likelihood of an event occurring. Less precise methodology & less accurate. Risk & Real Estate Investment

5 Variability of Returns An example of subjective probabilities that would impact the expected returns of a real estate investment might be the possible states of the economy over the first few years of the investment horizon. We will use mean (expected return), variance, standard deviation and coefficient of variation to evaluate the return and risk of each investment alternative. Rational investors are risk averse, preferring higher returns with lower risk. Risk & Real Estate Investment

6

7 Variability of Returns Risk & Real Estate Investment

8 Variability of Returns Risk & Real Estate Investment

9 Variability of Returns Risk & Real Estate Investment

10 Variability of Returns Risk & Real Estate Investment