1. Real Estate Investments David M. Harrison, Ph.D. Texas Tech University Accounting for Risk in DCF Analysis  Ex. #1: Suppose you are considering the acquisition of an income producing property. The building is currently leased for the next 5 years with annual (year-end) cashflows of $2,000,000. At the end of the current lease, you expect rents to increase to $2,500,000 (annually) for the foreseeable future. You anticipate selling the property ten years from today, at an expected multiple of 12 times the prevailing market rent. Market rates (OCC) are currently 8%, but given the uncertainty surrounding future rental rates a 2% risk premium must be added to interlease rates.

2. Real Estate Investments David M. Harrison, Ph.D. Texas Tech University Intra- and Inter-lease CF’s Revisited  What is the value of this property (to you) today?  Assuming this project is representative of other similar projects we may wish to evaluate in the marketplace, what “blended IRR” would be appropriate for analyzing these alternative instruments?  Confirm your answer:

3. Real Estate Investments David M. Harrison, Ph.D. Texas Tech University The Value of Certainty  Ex. #2: Now suppose we have the opportunity to extend our existing tenant lease for an additional two years (at the expected market rate of $2,500,000).  Would the tenant like this? Why/Why not?  How would this change the value of our investment?

4. Real Estate Investments David M. Harrison, Ph.D. Texas Tech University The Value of Certainty, cont.  At what rent would you be indifferent to locking in a two-year extension?  Verify your answer:

5. Real Estate Investments David M. Harrison, Ph.D. Texas Tech University Valuation Short-Cuts  Direct Capitalization  Advantages:  Disadvantages:  Gross Income Multiplier (GIM)  Advantages:  Disadvantages:

6. Real Estate Investments David M. Harrison, Ph.D. Texas Tech University Common Mistakes in DCF Analysis  GIGO –   Conceptual Errors –   Conclusion:

7. Real Estate Investments David M. Harrison, Ph.D. Texas Tech University Estimating Inter-lease Discount Rates  Ex. 10A: Suppose in a certain property market the typical lease term is 5 years, the cap rate (cash yield) is 7%, long term property value and rental growth rate is 1% per year, leases provide rent step-ups of 1% per year (per the expected growth rate), and the tenant borrowing rate (intralease discount rate) is 6%. What is the inter-lease discount rate?