©2015, College for Financial Planning, all rights reserved.

Session 16Real Assets – Gold, Real Estate, Property Valuation

CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAMInvestment Planning

Session Details

Module 9

Chapter(s)

1, 2

LOs 9-1 Explain the characteristics, risks, returns, markets, and valuation of tangible asset investments.

9-2 Evaluate the characteristics, risk, returns, financing methods, types, and forms of ownership of investment real estate.

9-3 Calculate net operating income and property value from real estate property information.

9-6 Analyze the effect of exchange rate changes on foreign security returns.

16-2

Investing in Tangible Assets

• No formally organized market – price quotes not readily available, no widely disseminated report of trades

• Markets for tangible assets and collectibles may be inefficient

• Little or no regulation • High degree of liquidity risk, and problems

associated with theft, fraud, and fire• Tangible assets can be

effective inflation hedges

16-3

Types of Gold Investments

• Gold coins (American Eagle – approved investment for IRA accounts)

• Gold bullion (reputation of dealer very important when buying and selling gold)

• Gold mining stocks and ETFs (more volatile than gold bullion price)

• Gold mutual funds (or grouped with precious metals, natural resources)

• Gold futures and options (provides leverage)

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Real Estate Investments

Types• Land – riskiest• Residential• Commercial• Industrial

16-5

Real Estate

16-6

Real Estate

Ways to InvestDirect investments:• Outright ownership • General partnership

Indirect investments:• Limited partnership• Corporation• REIT• REMIC

16-7

Real Estate Investment Trusts

Benefits of REITs

• Readily marketable, trade on stock exchanges

• Personal liability limited to the amount invested, and small sums may be invested

• Professional management of the properties

• REITs generally purchase many properties, providing diversification

• REITs are extremely popular, and provide the opportunity for many investors to include real estate as an asset class in their portfolio.

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Types of REITs

• Equity REIT – owns real estate property, appropriate as an inflation hedge (90.5% of market)

• Mortgage REIT – similar to a bond fund, invests in mortgages not in properties, income is higher than an equity REIT, not appropriate as an inflation hedge (9.5% of market)

• Hybrid REIT – invests in both properties and mortgages (in 2012, 0% of market)

Note: Since REITs distribute income (dividends) and the dividends are not taxed on the company level, REIT dividends do not qualify for the preferential capital gains rate―they are taxed as ordinary income.

16-9

Income Property Valuation

  Gross rental receipts (GRR)+ Nonrental income (laundry,

etc.)= Potential gross income (PGI)– Vacancy and collection losses= Effective gross income (EGI)– Operating expenses= Net operating income (NOI)

Net Operating Income (NOI)

16-10

NOI Capitalization

rateCap

NOIV

16-11

NOI Example

The following information applies to Spacious and Gracious Apartments:

What is the property’s net operating income based on this information? And what is the property’s value?

Gross rental receipts $750,000

Other income (parking) $22,000

Average vacancy rate 6% of PGI

Operating expenses $210,000

Mortgage loan payments $362,000

Depreciation expenses $131,000

Cap rate 12%

16-12

NOI Example Solution

$750,000 Gross rents (GRR)

+ 22,000 Other income

= $772,000 Potential Gross Income (PGI)

46,320 Average vacancy rate (6% of PGI)

= $725,680 Effective Gross Income (EGI)

210,000 Operating expenses

= $515,680 (NOI)

Property’s value: NOI/Cap rate

$515,680/.12 = $4,297,333

16-13

Gross Income Multiplier

IncomeGross

PriceSalesGIM

16-14

GIM Example

Green Mountain Apartments has $216,000 in gross rental income. It is similar to three other apartment complexes in the area that recently sold for the following prices. Their gross rents are shown.

Compute the fair market value of Green Mountain using the gross income multiplier approach. Use the average multiplier for the three comparable properties.

Gross

Rents

Sales Price

Property 1

$300,000 $2,700,000

Property 2

$200,000 $1,600,000

Property 3

$250,000 $2,000,00016-15

GIM Example Solution

Property 1: $2,700,000/$300,000 = 9Property 2: $1,600,000/$200,000 = 8Property 3: $2,000,000/$250,000 = 8Average:

Estimated value:

$216,000 x 8.3 = $1,792,800

3.83

25

3

889

16-16

Foreign Investments

Special Considerations

• Political risks• Foreign taxation• Fluctuations in

exchange rateso devaluation

(depreciation)o revaluation

(appreciation)

16-17

Exchange Rates

• Vary daily• Weak U.S. dollar boosts returns of

foreign securities• Risk reduction through hedging with

currency futures:o if long in a currency, short the

futureso if short in a currency, go long in the

futures

16-18

Exchange Rate Example

You are traveling in Europe and wish to purchase euros, and the current exchange rate is $1.49 U.S. for each euro.

How many euros would you receive for one U.S. dollar?

1/1.49 = 0.6711 euros, orHP10BII+: 1.49, SHIFT, 1/xHP12C: 1.49, 1/x

This will give you 0.6711, if you hit 1/x again it brings you back to 1.49.

16-19

Exchange Rate CalculationFrom our previous example: $1.49 for one euro or $1 for 0.6711 euros

Calculate how many U.S. dollars you would receive for one euro if:0.6600 euros per U.S. dollar 0.6800 euros per U.S. dollar

16-20

Exchange Rate Calculation (2)

10BII+: 0.66, SHIFT, 1/x = 1.515212C: 0.66, 1/x = 1.515210BII+: 0.68, SHIFT, 1/x = 1.470612C: 0.68, 1/x = 1.4706

Discuss the relationships:In the first example the dollar has gone down in value.In the second example it has risen in value.What are the implications for a U.S. investor in each scenario?

16-21

Module 10

• Mutual Funds – Open End and Closed End• Unit Investment Trusts (UIT’s)• Exchange Traded Funds (ETF’s)• Hedge Funds• Guaranteed Investment Contracts (GIC’s)• Dollar Cost Averaging• Selecting a Fund

16-22

Question 1

Which of the following combinations of risk is associated with art and other collectibles?a. regulation risk and purchasing power

riskb. liquidity risk and market riskc. market risk and business riskd. financial risk and reinvestment rate risk

16-23

Question 2

Your client is interested in purchasing gold as an inflation hedge. Which of the following describes advice you would give to this client?

I. Gold is a stable investment that has been gradually increasing over time.

II. Gold mining stocks have approximately the same volatility as the average U.S. large-cap stock.

III. Tangible assets, such as gold and silver, have traditionally been considered good inflation hedges.

IV. Gold mining mutual funds may be closed to new investors if there have been too many investment dollars flowing into the fund.a. I and II onlyb. I and III onlyc. II and III onlyd. III and IV onlye. II, III, and IV only

16-24

Question 3

Which of the following differentiate an equity REIT from a mortgage REIT?I. Mortgage REITs invest directly in properties.II. Equity REITs have the potential for higher

returns.III. Mortgage REITs provide income whereas equity

REITs participate in the capital gains of the real estate property.

IV. Mortgage REITs invest in mortgages that finance property purchases.a. I and II onlyb. I, II, and III onlyc. I, II, and IV onlyd. I, III, and IV onlye. II, III, and IV only

16-25

Question 4

Fritz Vanderbilt owns an apartment building that had the following financial results for the most recent year:

What is the net operating income (NOI) for the property?

a. $177,310b. $210,560c. $218,310d. $251,560

Rental income $340,000Parking fee income $2,000Vacancy and collection losses 7% of PGIDepreciation $33,250Interest expense on mortgage $41,000Other operating cash expenses $66,500

16-26

Question 5

Charles is considering the purchase of an office building that has a net operating income of $520,000, depreciation expense of $54,000, and vacancy and collection losses of $66,000. The building is financed by an 8% mortgage loan, and interest payments for the past year were $73,000. Charles has done an analysis of other properties in the area, and has arrived at a capitalization rate of 9%. What is the maximum that Charles should pay for the property?a. $4,444,444b. $5,044,444c. $5,777,777d. $6,500,000

16-27

Question 6

Jacqueline is doing a preliminary analysis of investment property in her city, and has come up with the following recent sales:

Jacqueline is considering the purchase of a 45-unit complex, Morning Vistas, with monthly rents of $500. Morning Vistas is similar and near to the properties shown in the chart. Morning Vistas is being offered for $2,300,000.

Which of the following statements is true?

a. Based upon the comparable sales, Jacqueline should only pay up to $2,160,000 for this complex.

b. Based upon the comparable sales, Jacqueline should consider paying the $2,300,000 offering price for this complex.

c. Based upon the comparable sales, Jacqueline should act quickly since an offering price as high as $2,600,000 would still be reasonable.

d. There is no reliable way to determine whether the $2,300,000 offering price may be reasonable based upon the information provided.

Number of units

Monthly rent

Sales price

Serenity Pointe 35 $700 $2,058,000

Village Pines 40 $600 $2,592,000

Whispering Meadows 55 $550 $2,904,000

16-28

Question 7

Robert is in the market for a small office building to purchase. He has researched recent sales of similar properties in the area and has determined that the average sales price of the properties is $2,100,000 and that the average gross rents for the properties is $280,000. He has narrowed his choices of properties to buy to Building A, which is listed for $1,750,000 and has gross rents of $225,000, and Building B, which is listed for $1,400,000 and has gross rents of $200,000. The cap rate for properties in the area is 10%.

Which one of the two buildings is the best investment option for Robert and why?

a. Either, because the gross rents divided by the cap rate give values for both properties in excess of the listed prices.

b. Building A, because its gross rent multiplier of 7.8 is greater than the gross rent multiplier of 7.5 for the recently sold properties.

c. Building B because its value ($1,500,000) is greater than its listed price ($1,400,000).

d. Either, because gross rents divided by the listed price give a cap rate in excess of 10%.

16-29

Question 8

Which of the following statements is true?a. Single country closed-end fund standard

deviations are higher than the standard deviations of broadly diversified international funds.

b. The variability of returns in developed markets is similar to the variability of returns in emerging markets.

c. Because of tax treaties, taxes may not be withheld on dividends paid on foreign securities.

d. A rise in the value of the dollar would benefit a U.S. investor who has purchased international stocks.

16-30

Question 9

If a Japanese investor buys U.S. Treasury bonds for his portfolio, which one of the following scenarios would result in the greatest capital gain?a. U.S. interest rates fall and the yen

strengthens against the U.S. dollar.b. U.S. interest rates rise and the U.S.

dollar weakens against the yen.c. U.S. interest rates fall and the U.S.

dollar strengthens against the yen.d. U.S. interest rates rise and the yen

weakens against the U.S. dollar.16-31

Question 10

You took a trip to Europe and exchanged U.S. dollars into euros when the exchange rate was $1.51 (U.S. dollars) for each euro. Upon your return you exchanged the euros back into U.S. dollars when the exchange rate was .68 euros for each U.S. dollar.

What has transpired concerning exchange rates between the beginning and end of your trip?

I. The dollar has strengthened, and you will only receive $1.47 for each euro.

II. The dollar has weakened and you will only receive $1.47 for each euro.

III. The euro has strengthened, and you will now receive less U.S. dollars for each euro.

IV. The euro has weakened since it will take .68 euros for each U.S. dollar at the end of the trip, compared with .66 euros for each U.S. dollar at the beginning.a. I onlyb. II onlyc. I and IV onlyd. II and III only

16-32

©2015, College for Financial Planning, all rights reserved.

Session 16End of Slides

CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAMInvestment Planning