CFA Level I Exam · Alternative Investment Performance and Returns

Real Estate, Infrastructure and Natural Resources Returns for CFA Level 1

Updated 7 October 2026 · Fact-checked

Real estate is valued by three approaches: income (direct capitalization or discounted cash flow), cost, and sales comparison. Direct capitalization gives value = NOI ÷ cap rate. Commodity futures return equals spot return plus roll yield plus collateral yield. Infrastructure, timberland and farmland are valued mainly with discounted cash flow or comparable sales.

Understand Real Estate, Infrastructure and Natural Resources Returns

Real estate, infrastructure and natural resources are real assets. Their returns come from income (rent, tolls, crop or timber sales) and from changes in value. Because they trade rarely, you cannot read a price from a screen. You must estimate value.

There are three real estate valuation approaches. The sales comparison approach adjusts prices of similar recent sales. The cost approach estimates what it would cost to rebuild the property, less depreciation, plus land value. The income approach values the cash flows. It has two forms: direct capitalization (value = NOI ÷ cap rate) and discounted cash flow (discount forecast NOI and the resale value at a required return).

NOI is net operating income: rental income and other income less operating expenses. It is before financing costs, depreciation and income taxes. The cap rate is the rate that links income to value. A higher cap rate means a lower value for the same NOI. In the terminal value of a DCF, the resale price is often NOI in the year after the final forecast year divided by a terminal cap rate.

Direct real estate gives control, but it is illiquid, needs large sums, and has high transaction costs. REITs are listed or unlisted pooled vehicles. Listed REITs are liquid and diversified, and they trade at market prices that can differ from the underlying net asset value (premium or discount). Their returns move more with equity markets in the short run. Appraisal-based direct indexes are smoothed, so they understate volatility and correlation with equities.

Commodity investors usually hold futures, not physical goods. The total return of a fully collateralized futures position has three parts. Spot return is the change in the spot price. Roll yield is the gain or loss from rolling to a new contract: positive in backwardation (futures price below spot), negative in contango (futures price above spot). Collateral yield is the interest earned on the cash that backs the position.

Infrastructure is valued mainly by DCF, since it has long, contracted cash flows. Timberland and farmland add a biological growth component: timber grows and can be held back from harvest when prices are low. Farmland returns come from crop sales or lease income and land value changes. Both are often valued with DCF or sales comparison.

Key formulas to remember

Direct capitalization value: Value = NOI ÷ Cap rate; Use the NOI that matches the cap rate definition, usually next-year or stabilized NOI.
Cap rate: Cap rate = NOI ÷ Property value; Cap rate is also called going-in yield. It moves inversely to value.
Net operating income: NOI = Rental and other income − Operating expenses; Exclude interest, depreciation and income taxes.
Terminal value in DCF: Terminal value = NOI(year n+1) ÷ Terminal cap rate; Use the NOI of the year after the last forecast year.
Commodity futures total return: Total return = Spot return + Roll yield + Collateral yield; Applies to a fully collateralized long futures position.
Roll yield sign: Backwardation → positive; Contango → negative; Backwardation means the futures price is below the spot price.
Cost approach: Value = Replacement cost − Depreciation + Land value; Used mostly for new or unique properties.

How to solve Real Estate, Infrastructure and Natural Resources Returns questions

Use this method for any question on real asset valuation or returns.

1Identify the asset and what is asked: value, cap rate, or return component.
2Name the approach: income (direct capitalization or DCF), cost, or sales comparison.
3Compute NOI correctly: income less operating expenses only. Drop interest, depreciation and taxes.
4Apply the formula and check that the cap rate and NOI are on the same basis (for example, next-year NOI).
5For commodities, split the return into spot, roll and collateral, and read the curve shape for the roll sign.
6For qualitative questions, compare liquidity, control, diversification, valuation method and smoothing.
7Check the direction: higher cap rate means lower value. Reject any option that breaks this.

Quickest way: NOI ÷ cap rate in three moves

When to use it: Use for any direct capitalization question with numbers.

Write NOI: income minus operating costs.
Divide by the cap rate as a decimal.
Sanity check: if the cap rate is 5%, value should be about 20 times NOI.

Common mistakes in Real Estate, Infrastructure and Natural Resources Returns

Subtracting depreciation or interest when computing NOI.
Students mix NOI with net income.
Fix: NOI uses operating items only. Exclude financing, depreciation and taxes.
Treating a higher cap rate as a higher value.
Students link higher yield with better outcome.
Fix: Value = NOI ÷ cap rate, so a higher cap rate lowers value.
Getting the sign of roll yield wrong.
Backwardation and contango are easy to swap.
Fix: Backwardation (futures below spot) gives positive roll yield. Contango gives negative.
Assuming appraisal-based real estate returns show true volatility.
Students take reported index numbers at face value.
Fix: Appraisals are smoothed, so volatility and correlation with equities are understated.
Calling REITs and direct property identical in liquidity.
Both own real estate.
Fix: Listed REITs trade daily and can trade at a premium or discount to NAV. Direct property is illiquid and has high transaction costs.

Worked examples

Example 1

A property earns rental income of $1,200,000 and other income of $50,000. Operating expenses are $450,000. Annual depreciation is $200,000 and interest is $300,000. The market cap rate is 8%. Using direct capitalization, the value is closest to: A) $8,000,000 B) $10,000,000 C) $15,625,000

Show the solution

NOI = 1,200,000 + 50,000 − 450,000 = 800,000.
Depreciation and interest are excluded.
Value = 800,000 ÷ 0.08 = 10,000,000.

Answer: B) $10,000,000

Example 2

A fully collateralized long commodity futures position has a spot price change of +3%, a roll yield of −2% and a T-bill yield of 1.5%. The total return is closest to: A) 1.5% B) 2.5% C) 6.5%

Show the solution

Total return = spot return + roll yield + collateral yield.
= 3% + (−2%) + 1.5%.
= 2.5%.

Answer: B) 2.5%

Exam tips

Check what is excluded from NOI first. Distractors often include depreciation or interest.
When you see backwardation or contango, decide the roll yield sign before calculating.
For REIT versus direct property questions, think liquidity, transaction costs, NAV premium or discount, and smoothed appraisals.
With three options, test direction: a higher cap rate must give a lower value. This often removes one option fast.
Numerical options run from smallest to largest, so a quick estimate usually isolates the answer.

Practice questions from Alternative Investment Performance and Returns

Real Estate, Infrastructure and Natural Resources Returns in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Real Estate, Infrastructure and Natural Resources Returns: frequently asked questions

What are the real estate valuation approaches in CFA Level I?

They are the sales comparison approach, the cost approach and the income approach. The income approach includes direct capitalization and discounted cash flow.

How do I calculate value with NOI and the cap rate?

Divide NOI by the cap rate written as a decimal. For example, NOI of 800,000 at an 8% cap rate gives a value of 10,000,000.

What are the components of commodity futures returns?

They are spot return, roll yield and collateral yield. Roll yield is positive in backwardation and negative in contango.

What is the difference between REITs and direct real estate investment?

REITs are pooled, often listed and liquid, and can trade at a premium or discount to NAV. Direct real estate gives control but is illiquid, needs large capital and carries high transaction costs.