Real Estate Investments I
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Real Estate Investments I
(Business 33450)
Winter Quarter, 2023
Instructor: . Pagliari, Jr.
Key Take-Aways:
• Real estate in three dimensions:
Property types,
Geographies, and
Life Cycles.
• Leases as a source of determining value.
• Supply & demand in commercial real estate.
Instructor’s Note: The key take-aways
represent the population of each
class’s testable topics. Moreover, if we
haven’t discussed a particular concept,
calculation, etc. in class, then it won’t
be on the mid-term or final exam.
Real Estate Investments I
Business 33450
Instructor: . Pagliari, Jr.
Class Notes – Week #1:
The Real Estate Investment Setting & Framework
Table of Contents
I. REAL ESTATE IN 3-D ……………………………………………………………………………….. 1
II. EXPANDED VIEW OF REAL ESTATE IN 3-D ……………………………………………….. 32
III. NATURE AND SCOPE OF INVESTOR/EQUITY MARKETS ………………………………. 38
IV. LEASES AS A KEY TO DETERMINING VALUE ………………………………………………. 48
V. INTRODUCTION TO INVESTMENT VALUATION ………………………………………….. 64
VI. SOME GENERAL NOTES ON INVESTOR DECISION-MAKING ………………………… 68
VII. CASE STUDY ON SUPPLY & DEMAND: APARTMENT INVESTING ……………………. 73
VIII. REAL ESTATE LAW ……………………………………………………………………………….. 106
IX. APPENDIX – LISTING OF SELECTED INSTITUTIONAL FIRMS ……………………….. 110
Note: Since not everyone has the same base of experience, let’s try
to provide a broad overview of commercial real estate (equity) investing.
I. Real Estate in 3-D
A. Real estate is not a commodity.
1. It is a heterogeneous (v. homogeneous).
2. The level of heterogeneity is a surprise for those first entering the commercial real
estate (CRE) field – particularly, the degree of nuance by property type.
B. An old real estate joke: “What are the three most important attributes of any real estate
investment? Location, location, location.”
1. I disagree: See below – an exhibit from “Real Estate in 3-D: See It Now!”
2. Three critical asset-level dimensions: property type, geography and life cycle:
REAL ESTATE IN 3-D
{each cell represents its own dynamic set of supply, demand, pricing and risk/return issues}
Life-Cycle Stage
Property Type
Family Industrial
Other Development
(To-Be Built)
Rehabilitation
Stabilized
Stabilized
Stabilized
Each cell (or cube) represents a set of risk/return characteristics:
Range of Potential Outcomes
Illustration of Potential Rates of Return
Average (µ )
+/- Standard Deviation (σ )
Through the midterm, we’ll be concerned with the return-generating
process for unleveraged assets (ka or simply k).
For our purposes, the most likely or average return will be indicated by:
Ex ante: E[ka]
Ex post: ak
[For a listing of other notations used throughout the quarter, please see the
Glossary on Canvas | Course Overview.]
C. Property Types:
1. Apartments:
(a) high-rise, mid-rise, or
garden (or walk-up),
(b) urban v. suburban, and
(c) tenant- v. landlord-paid utilities.
2. Retail:1
(a) regional v. super-regional malls (see site plan illustration),
(b) “strip” centers: community v. neighborhood shopping centers (generally,
grocery-anchored),2
(c) power centers v. outlet centers v. fashion center,
(d) life-style centers (mixed-use development: retail and multifamily –
a fairly recent development (last ≈15-20 years)), and
(e) in-line v. anchor tenants.
3. Office:
(a) Central business district (CBD) v. suburban,
(b) mid-rise v. high-rise, and
(c) (sometimes) medical office buildings (MOBs).
4. Industrial:3
(a) bulk v. regional distribution v. R&D/flex v. specialty, and
(b) bay width/depth, “clear span” (or height), truck court, etc.
1 This sector has been the focus of much of the market’s recent discussions about “disruptions” – particularly
with regard to malls. If interested, see the 2016 RE Lab project (prepared in conjunction with Washington Prime
Group (WPG)).
2 The International Council of Shopping Centers (ICSC) has ceased classifying (qualifying) retail properties as
“grocery-anchored centers.” Instead, they will be referred to as neighborhood or community centers (primarily
as f(square footage): neighborhood < 125,000 sq. ft. and 125,000 ≤ community ≤ 250,000 sq. ft.).
3 This sector has also been the focus of much of the market’s recent discussions about “disruptions” – but it
often (favorably) considered the “other side of the trade” (vis-à-vis retail), with issues relating to “last-mile”
delivery, autonomous vehicles, three-dimensional printing, drones, “on-shoring,” etc. If interested, see the 2017
RE Lab project (how might you invest $1 billion in domestic industrial properties).
When “stabilized”
(i.e., fully leased) =
“core” real estate
https://faculty.chicagobooth.edu/-/media/faculty/joseph-pagliari/docs/2016washingtonprimegroup.pdf
https://faculty.chicagobooth.edu/-/media/faculty/joseph-pagliari/docs/2017denovo.pdf
https://faculty.chicagobooth.edu/-/media/faculty/joseph-pagliari/docs/2017denovo.pdf
(a) types: luxury v. full-service v. limited service,
(b) price points: carriage-trade v. budget, and
(c) customers: business v. convention v. leisure/resort.
6. Specialty types (partial list):
(a) healthcare/senior living,
(b) self-storage,
(c) student housing,
(d) single-family rentals,
(e) data centers and lab space,
(f) infrastructure (cell towers, etc.);
(g) but, how far do we take it?
Non-core real estate
Not technically real
estate (as it’s not
fixed to the ground).
Despite this
technicality, this
example “feels”
more like real than
cell towers (also see
REIT discussion
(week #8), which
houses no people.
Core v. Non-core?
Most institutional
investors view this as
non-core real estate
(subject to the
Propco/Opco
discussion in
Appendix).
Potential career note:
The non-core real estate
sector might eventually
be were you “make
your bones.”
There a lot of
competition ahead of
you in the core sector,
but less so in the non-
core sector.
Additionally:
"The gift of a beginner is
fresh eyes. The longer you're
in a field, the harder it is to
perceive new truths. Your
mind is biased toward
refining what you're already
doing instead of exploring
fresh terrain..."
advice/habits guru
As cited by (SRQ #155)
https://en.wikipedia.org/wiki/Make_one%27s_bones#:%7E:text=To%20%22make%20one's%20bones%22%20is,achievement%2C%20status%2C%20or%20respect.
https://en.wikipedia.org/wiki/Make_one%27s_bones#:%7E:text=To%20%22make%20one's%20bones%22%20is,achievement%2C%20status%2C%20or%20respect.
Illustration of Common Shopping Mall Configuration
Aerial View of Site Plan
In-Line Stores
Food court
Anchor Stores
Surface Parking
Anchor Stores: (a) (b)
• JC Penney,
• Nordstrom’s,
• Nieman-Marcus.
They are typically
thought to “drive
traffic” to the mall
(i.e., prompt shoppers
to visit the mall).
(a) Department stores
account for ≈350
million sq. ft. Source:
, Property
Insights, November 29,
(b) Anchors frequently
own their own spaces,
(see next page) but
contribute towards
CAM (common area
maintenance).
In-Line Stores:
• Abercrombie,
• Chico’s,
• Jos. A. Bank,
• The Limited,
• Talbot’s,
They generally pay a
higher rent per square
foot than the anchor
Out Lots (or Parcels):
• local banks,
• movie theaters,
• restaurants,
The mix of retailers is important
• retailers must complement one another
(e.g., with Nordstroms), and
• retailers must complement the trade area
(e.g., Sears and JC Penny’s not located on Michigan Ave).
Because of the large in-fill tracts of land that suburban malls
occupy, they were sometimes referred to as “fortress” malls.
[However, malls can also be vertical; consider: Water Tower
Place – one of the country’s first urban malls.] But, now the
world has changed. Perhaps Tom Barrack (Colony Capital) best
summed it up: “reprice and reinvent”!
Per (1-27-22), ≈ ½ malls are owned by one of
the public REITs (Macerich, SPG, Taubman (but excludes
Brookfield’s take-private of GGP)), often in a joint venture
with a pension fund (CalPERS, Texas Teachers, etc.). [In other
property types, REITs own less than 15% of the sector.]
(or “end caps”)
Perhaps the retailer
type most damaged
by “disruptions.”
https://www.bloomberg.com/news/articles/2020-09-10/barrack-steps-back-from-colony-in-era-of-reprice-and-reinvent
An example of anchors owning their own spaces:
Typically, there is a reciprocal easement agreement
(REA) between the retailer(s) and mall owner. Though
the retailer may go bankrupt, the REA generally “runs
with the land” and, consequently, these REAs may be a
significant impediment to the mall owner which would
like to redevelop the vacating anchor’s site.
[Note: covenants, conditions & restrictions (CC&Rs)
can have a similar effect.]
Points to consider re: REAs:
• These documents may restrict the mall owner from various adaptive
reuses and/or restrain subleasing.
• It should not be assumed these types of restrictions are balanced and
bilateral, although they often are.
• It is important to know where ownership has freedom or leverage
over the department stores, and where the opposite might be true.
• The REA is often a 75- to 100-year agreement; so, the expiration (or
early termination) must be considered when evaluating residual value.
https://content.next.westlaw.com/2-507-2359?__lrTS=20210510211337196&transitionType=Default&contextData=(sc.Default)&firstPage=true#:%7E:text=An%20agreement%20that%3A,of%20the%20affected%20real%20property.
https://www.findlaw.com/realestate/owning-a-home/cc-r-basics.html
A Note on the Changing Composition of Mall Tenants:4
Source: “High-End Malls Get Boost From High-Tech Stores,” The Wall Street Journal, January 27, 2015.
4 And while the “disruptions” in the retail business (particularly in the mall sector) are, at this point, well known, something similar can now also be said about the “co-
working” business model (e.g., Regus, WeWork, etc.) in the office sector. For example, see: BMO Capital Markets, “WeWork – Partner and Disruptor,” June 27, 2018.
And something similar can be also said about the impact of Airbnb, Flipkey, etc. on the apartment and hotel sectors.
This evolution is part of the ongoing
“creative destruction” that is particularly
prominent in the retail sector.
Q: What’s the biggest issue facing old-line
retailers/tenants?
A: “Disruptions” → store closings →
financial viability (including bankruptcy)
mall valuations?!?!
Notable department-store bankruptcies:
• JCPenney,
• Lord & Taylor,
• malls used to be “long” fashion/apparel
(particularly, women’s) this has changed over time.
Industrial
Range of Expected Returns
Hypothetical Illustration of Differences in the Risk/Return
Characteristics of Various Property Types: Industrial v. Hotel
Industrial:
* long-term leases,
* few tenants,
* often "credit" tenants,
* tenant-paid operating expenses (NNN),
* low cap ex, and
* single line of business.
* short-term leases,
* many tenants,
* few "credit" tenants,
* owner-paid operating expenses,
* high cap ex, and
* multiple lines of business.
Q: What explains the dispersion in returns?
Q: What does the difference in risk (σ ) imply about expected returns [E(k)]?
[E(k Industrial)] =
= [E(k Hotel)]
“Triple Net” → tenant pays
all of the operating expenses.
Essentially, just the opposite of industrial.
COVID and Zoom have dealt this sector a
severe blow – particularly non-resort hotels.
“Investment
Grade” → if its
debts were
publicly traded.
7. The first four property types are considered the “core” property types:
(a) Depending on who you talk to, sometimes the first five (i.e., include hotels)
are considered core:
(b) The definition of “core” evolves over time – initially, apartments were
excluded (now, the fast-growing property type).
(c) NCREIF Index5 ≈ $950 billion ← approximately 10,600 (private,
institutionally held) properties.
(d) Property-type breakdown from NCREIF for the third quarter of 2022 (first
by property count and then by market value):
8. Here is a more a detailed delineation of core property types:
5 National Council of Real Estate Investment Fiduciaries (NCREIF) – represents the industry
benchmark (analogous to the S&P 500) for the private, institutional (core) real estate market place.
Data are as of third quarter (consider appraisal lag – see §VI.A).
As a matter of industry jargon, privately held real estate investments are sometimes referred to as
“direct” or “unsecuritized” investments, while publicly traded real estate investments (e.g., REITs and
REOCs – see the Appendix) are sometimes referred to as “indirect” or “securitized” investments.
We will often use this Index
to analyze historical returns.
D. Geography: The Evolution in Locational Considerations (as practiced by institutional
investors):
1. Regional parameters:
(a) Traditional (the first institutional approach):
(ii) West,
(iii) North, and
(iv) South.
(v) see NCREIF’s breakdown by geographic region:
♦ four regions, plus
♦ breaks each region into two divisions:
Note the coastal preponderance (by market value):
Note: Institutional investors use various (property type and) geographic classification
schemes or systems to optimize their (real estate) portfolio allocations. Due to their
disappointment with the first geographic classification scheme, they looked for other
systems (in an attempt to improve the “efficient frontier” of portfolio choices):
Illustration of Anticipated Portfolio-Optimization Benefits
Strategy #1
Strategy #2
This coastal “tilt” is a matter of perceived risk. It is a
topic we will revisit in week #9:
• Coastal markets → “high-barrier” (to entry)
markets → less susceptible to supply-side risks.
• Non-coastal markets → “low-barrier” (to entry)
markets → more susceptible to supply-side risks.
(b) Nine Nations of North America by , 1981 (the second
evolution of the institutional approach):
(i) Quebec,
(ii) ,
(iii) The Foundry,
(iv) Dixie,
(v) The Islands,
(vi) MexAmerica,
(vii) The Breadbasket,
(viii) Ecotopia, and
(ix) The Empty Quarter:
Uses adjoining U.S. regions (but abandons
traditional state-by-state classifications)
which display similar socio-economic
characteristics. For example:
• Chicago has more in common with
Cleveland, Detroit, Milwaukee and
Pittsburgh, than it does with
Springfield (IL).
• San Francisco has more in common
with Portland (OR) and Seattle, than it
does with Los Angeles and San Diego.
(c) An aside (from the category of “the more things change, the more they stay
the same”), a proposal to update the Nine Nations of North America:
Source: , “A New Map for America,” Times, April 15, 2016.
(d) Economically similar markets (the third evolution of the institutional
approach):
(i) not physically contiguous,
(ii) markets sharing similar employment patterns;
(iii) for example:
♦ Austin (TX), Columbus (OH) and Madison (WI),
♦ , Philadelphia and Los Angeles.
(e) Edge City: Life on the by ,6,7 1991 (the fourth
evolution of the institutional approach → moving towards submarkets):
(i) Old downtowns/neighborhoods,
(ii) Edge Cities, and
(iii) Emerging Edge Cities.
(iv) The definition of an Edge City:
♦ has more than 5 million square feet of office space,
♦ has more than 600,000 square feet of retail space,
♦ has more jobs than bedrooms,
♦ is perceived by the population as one place, and
♦ was nothing like a “city” thirty years ago (now, 40-50 years ago).
6 Garreau has since written another book, Virtual Reality – but it has little to do with real estate (then
again, maybe it does!).
7 Garreau’s examples were “yeasty” Georgetown v. the drab suburbs of Washington, D.C. (Garreau
was previously a reporter for the Washington Post) which, in his view, all of suburbia pretty much
look like Houston’s suburbs.
Abandons the idea of
adjoining U.S. regions
and seeks similar
employment patterns.
Other examples:
• Denver, Houston &
Oklahoma City
“oil patch”
• Akron, Cleveland &
Detroit. “old
Very similar to
Schaumburg (formerly
an old, German farming
community).
Other Chicago-area
• Oak Brook,
• the O’Hare area.
Not officially a municipality
(f) More recently, institutional investors are looking to submarkets within major
markets which may share similar characteristics (e.g., income/education levels,
access to public transportation, proximity to cultural events, etc.):
(i) So, as examples within Chicago, consider various office submarkets:
♦ the “Loop”
♦ North Michigan Avenue,
♦ Streeterville,
♦ River North, and
♦ West Loop.
(ii) Chicago office market:
(iii) Chicago industrial market:
(g) “Wylies’ Map (while this is not a geographic classification system, the idea of
investing according to jobs flows is widely followed):
(i) an annotated U.S. map showing expected employment growth by
metropolitan area,
(ii) previously prepared by , (formerly) Global Director of
Research for DB/RREEF (now, rebranded as, DWS), and
(iii) now (sporadically) prepared by DB (Deutsche Bank):
Note: Job growth real estate returns.
However, they are often related; consider: Detroit v. Washington, D.C.
As an aside, CRE industry generally favors:
• simple explanations, and
• visual presentations.
2. Consider a few aspects of city/metropolitan area health, as cities/counties/states
compete with one another:
(a) Broadly, the Milken Institute periodically rates the top-performing (in terms
of job growth and job type) cities in the U.S. – see below:
Source: “Best-Performing Cities, 2022,” Milken Institute.
The magnitude of some of
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