Download - 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 FinanceTexas Tech University

Finance Theory and Real Estate

Goal –

Asset Valuation:

Risk vs. Uncertainty

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Determinants of Value

1. Amount of after-tax CFs

2. Timing of CFs

3. Risk of CFs


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 -


Leverage and Capital Structure

Leverage Defined –

Debt increases shareholder returns…

Irrelevance of Capital Structure…


Options in Real Estate Markets

Call –

Put –

Intrinsic Value Market Value

Valuation considerations:


Real Estate Options

Residential Mortgages Prepayment – Default –

Commercial Mortgage Ruthless Default – Protections –

Explicit/Real Options –


Key Concepts

Financial Intermediation

Portfolio Theory Asset Class Diversification Diversification Within Real Estate


Market Efficiency

Efficient Market Hypothesis

Levels of Market Efficiency

Conclusions?


Agency Theory

Agency Relationship

Agency Problem:


Agency Examples in Real Estate

Property Management -

Loan Officers –

Appraisers –

Agents -


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:


Mitigating Agency Problems

Threat of Firing

Threat of Takeover

Managerial Labor Markets

Proper Structuring of Managerial Incentives

Download - 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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