David M. Harrison, Ph.D. Real Estate Finance Texas Tech University Finance Theory and Real Estate Goal – Asset Valuation: Risk vs. Uncertainty.

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David M. Harrison, Ph.D. Real Estate Finance Texas Tech University Finance Theory and Real Estate Goal – Asset Valuation: Risk vs. Uncertainty

David M. Harrison, Ph.D. Real Estate Finance Texas Tech University Determinants of Value 1. Amount of after-tax CFs 2. Timing of CFs 3. Risk of CFs

David M. Harrison, Ph.D. Real Estate Finance Texas Tech University Risk in the Context of Real Estate Commercial Property – Real Estate Limited Partnership – Real Estate Investment Trust (REIT) – Residential Mortgage – Mortgage-Backed Security – Collateralized Mortgage Obligations (CMOs) – IO’s and PO’s – Servicing Rights -

David M. Harrison, Ph.D. Real Estate Finance Texas Tech University Leverage and Capital Structure Leverage Defined – Debt increases shareholder returns… Irrelevance of Capital Structure…

David M. Harrison, Ph.D. Real Estate Finance Texas Tech University Options in Real Estate Markets Call – Put – Intrinsic Value Market Value  Valuation considerations:

David M. Harrison, Ph.D. Real Estate Finance Texas Tech University Real Estate Options Residential Mortgages Prepayment – Default – Commercial Mortgage Ruthless Default – Protections – Explicit/Real Options –

David M. Harrison, Ph.D. Real Estate Finance Texas Tech University Key Concepts Financial Intermediation Portfolio Theory Asset Class Diversification Diversification Within Real Estate 

David M. Harrison, Ph.D. Real Estate Finance Texas Tech University Market Efficiency Efficient Market Hypothesis Levels of Market Efficiency  Conclusions?

David M. Harrison, Ph.D. Real Estate Finance Texas Tech University Agency Theory Agency Relationship Agency Problem:

David M. Harrison, Ph.D. Real Estate Finance Texas Tech University Agency Examples in Real Estate Property Management - Loan Officers – Appraisers – Agents -

David M. Harrison, Ph.D. Real Estate Finance Texas Tech University An Example Agency Problem  Suppose you’re considering undertaking a real estate development project. You plan to finance the construction of ________ with $25M (face value) of debt. Two methods/strategies exist for developing our __________. First, a safe method is available which produces profits (EBIT) of $40M if the economy is slack and $60M if the economy is robust. Alternatively, a risky process is available which produces profits (EBIT) of $0 if the economy is slack and $80M if the economy is robust. Assuming both states of the economy are equally likely to occur, which development strategy should the firm pursue?  Societal Perspective »  Creditors Perspective »  Owners Perspective » Conclusion:

David M. Harrison, Ph.D. Real Estate Finance Texas Tech University Mitigating Agency Problems Threat of Firing Threat of Takeover Managerial Labor Markets Proper Structuring of Managerial Incentives