Overview of Types of Real Estate Investment: formula sheet

Key formulas

Investment grid

Private equity | Public equity | Private debt | Public debt

Classify first by owner or lender, then by private or public trading.

Liquidity and pricing ranking (typical)

Public (REITs, MBS) > Private (direct, whole loans)

Public forms have market prices and small unit sizes; private forms rely on appraisals or negotiated values.

Equity vs debt payoff

Equity return = income + value change after debt; Debt return = contractual interest + principal

Equity is residual and unlimited on the upside. Debt has priority claim and a capped return.

Leveraged equity return

Equity return = property return + (D ÷ E) × (property return − cost of debt)

D and E are the market values of debt and equity, so D + E is the property value. Property return, cost of debt and equity return must be on the same basis: total returns (income plus value change) over the same period, measured on beginning values. The property return is before financing costs and the equity return is after them. On that basis this is an identity, not an approximation. Leverage magnifies gains and losses. Use it when the question gives D, E and the borrowing cost.

Net operating income (NOI)

NOI = Rental income + other income − vacancy and collection loss − operating expenses

Operating expenses exclude depreciation, interest and income taxes. Under a gross lease the landlord bears more expenses, so NOI is more exposed to cost increases.

Gross lease vs net lease

Gross: landlord pays operating costs. Net: tenant pays some or all of them.

Single net, double net and triple net leases move more costs to the tenant, in that order. Triple net passes taxes, insurance and maintenance.

Percentage rent

Rent = Base rent + % × (Tenant sales − breakpoint sales)

Common in retail. It gives the landlord upside from tenant sales but ties income to consumer spending.

Occupancy rate

Occupancy = Occupied space ÷ Total leasable space

Vacancy = 1 − occupancy. Compare it with the market, not in isolation.

Premium or discount to NAV

Premium (discount) = (Market price per share − NAV per share) ÷ NAV per share

Positive means the share trades above NAV. Negative means below NAV.

NAV per share

NAV per share = (Market value of assets − Liabilities) ÷ Shares outstanding

Use estimated market values of properties, not book values.

Funds from operations (FFO)

FFO = Net income + Depreciation and amortization + Losses on property sales − Gains on property sales (and other one-off items)

Depreciation is added back because property values often do not fall as book depreciation implies.

Adjusted FFO (AFFO)

AFFO = FFO − Non-cash rent adjustments (straight-line rent) − Recurring maintenance capex and leasing costs

Closer to sustainable cash flow available for distribution.

P/FFO and P/AFFO

P/FFO = Price per share ÷ FFO per share; P/AFFO = Price per share ÷ AFFO per share

The real estate version of P/E. Lower multiple is cheaper, other things equal.

Unsmoothing appraisal returns

r*(t) = [r(t) − (1 − λ) × r(t−1)] ÷ λ

r(t) is the observed appraisal return, r*(t) the unsmoothed estimate, and λ the smoothing weight on current true return, between 0 and 1. Lower λ means more smoothing. Use the form given in the vignette.

Smoothing relationship (model behind it)

r(t) = λ × r*(t) + (1 − λ) × r(t−1)

Observed return is a weighted average of the current true return and last period's observed return.

Effect on volatility

σ(unsmoothed) > σ(smoothed) when 0 < λ < 1

Unsmoothing raises standard deviation. The mean return is roughly unchanged.

Sharpe ratio

Sharpe ratio = (Rp − Rf) ÷ σp

Understated σ from smoothing gives an overstated Sharpe ratio. Unsmoothing lowers it.

Quick revision

• Four forms: private equity, public equity, private debt, public debt.
• Direct private ownership gives control but is illiquid and needs large capital.
• Public real estate equity, such as REITs, is more liquid and easier to diversify.
• Private debt is mortgage lending; public debt includes mortgage-backed securities.
• Different property types have different lease terms, demand drivers and cycle sensitivity.
• REITs trade on exchanges, so their prices move with equity markets in the short term.
• Check the exact REIT rules in your curriculum for distribution and tax features.
• Appraisal-based indexes smooth returns, so they understate volatility.
• Smoothing can also understate correlation with other asset classes.
• Transaction-based indexes use actual sale prices but depend on sales volume.
• REIT indexes reflect market prices and so are timely but more volatile.
• Always match the index method to the question: appraisal, transaction or REIT.

Common mistakes

• Treating REITs as direct property ownership with the same risk profile. Fix: Remember that REIT shares trade on stock exchanges, so they are liquid and move with equities in the short term, and the investor has little or no direct control over assets.
• Treating REOCs as if they had the same traits as REITs. Fix: REITs have tax-advantaged structures with income distribution requirements. REOCs reinvest earnings, have more flexible activities and are taxed as ordinary corporations.
• Saying a gross lease protects the landlord from expense inflation. Fix: In a gross lease the landlord pays operating costs from a fixed rent. Net leases pass costs to the tenant.
• Treating all property sectors as equally cyclical. Fix: Rank by lease length. Hotels and apartments reset fastest and are most cyclical. Long-lease industrial and net-leased property are steadier.
• Saying a REIT pays no tax at all. Fix: Say distributed income is generally not taxed at the REIT level; investors are taxed on distributions. Rules vary by country, so use the vignette.
• Treating a REOC as paying high dividends. Fix: A REOC has no payout requirement and retains earnings for growth, so yields tend to be lower.
• Saying appraisal smoothing raises volatility. Fix: Smoothing averages across periods, which damps swings. Reported volatility is too low; unsmoothing raises it.
• Treating REIT indexes as smoothed. Fix: REITs trade on exchanges with observable prices, so there is no appraisal smoothing. Their issue is equity market and leverage effects.

Exam tips

• Classify the investment on the equity/debt and private/public grid before reading the answer options.
• If a question mentions smooth returns or low correlation for private real estate, think appraisal smoothing.
• Match liquidity needs and horizon in the vignette to the form. This is the most common reason an option is wrong.
• For REIT versus REOC questions, think tax and income: REITs distribute income under a tax-advantaged structure; REOCs reinvest and are taxed as corporations.
• For debt, focus on collateral, default, prepayment and capped returns, not property appreciation.
• There is no penalty for wrong answers, so always answer, and eliminate options that mix up traits across forms.
• Expect vignettes that describe a property in two or three sentences. Underline lease length, lease type and tenant mix before reading the options.
• Questions often ask who bears a cost or risk, landlord or tenant. Answer from the lease wording.