Finance Theory and Real Estate

1
Chapter 3

• Finance Theory and Real Estate

2
Chapter 3Learning Objectives
3-1

• Understand how basic finance principles can be
  applied to real estate
• Understand how finance principles can be applied
  to a wide variety of real estate topics

3
Issues In Real Estate
3-2

• THE ROLE OF RISK IN VALUATION
• Earn risk-free return for postponed consumption
• Earn risk premium based on risk exposure
• Optimal level based on degree of risk aversion

4
Issues In Real Estate
3-3

• VALUATION
• Market value versus book value
• Appraised value
• Amount and riskiness of cash flows
• FINANCIAL LEVERAGE
• The use of debt in financing
• Optimal mix of debt and equity

5
Financial Intermediation

• Intermediary stands between the supplier and user
  of credit
• Performs economic functions by assuming
• Liquidity risk (think savings account versus
  mortgage)
• Credit evaluation on borrower and property
• Interest rate risk

6
Issues In Real Estate
3-4

• MARKET EFFICIENCY
• Weak form efficient
• Semi-strong efficient
• Strong form efficient
• AGENCY THEORY
• Monitoring Costs
• Bonding Costs
• Structuring Costs

7
Issues In Real Estate
3-5

• OPTIONS IN REAL ESTATE
• Call Option - Right To Prepay
• Put Option - Putting The Property In Place Of The
  Debt
• Explicit Option - The Right To Purchase Property
  At A Specified Price Within A Specified Time