Course Content
Alternative Investments Vs. Traditional Investments
This topic is covered under LOS A of Reading 58
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LOS A
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LOS A
Categories of Alternative Investments
This topic is covered under LOS B of Reading 58
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LOS B
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LOS B
Benefits of Alternative Investments
This topic is covered under LOS C of reading 58, which requires you to 'describe potential benefits of alternative investments in the context of portfolio management'.
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LOS C
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LOS C
Hedge Funds, Private Equity, Real Estate, Commodities, Infrastructure, and Other Investment – Explained
This topic is covered under LOS D and E of Reading 50, which requires us to: a. describe hedge funds, private equity, real estate, commodities, infrastructure, and other alternative investments, including, as applicable, strategies, subcategories, potential benefits and risks, fee structures, and due diligence; b. describe, calculate, and interpret management and incentive fees and net-of-fees returns to hedge funds; and c. describe issues in valuing and calculating returns on hedge funds, private equity, real estate, commodities, and infrastructure.
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Hedge Funds
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Private Equity
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Real Estate
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Commodities
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Infrastructure
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Others
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LOS D and E
Risk Management
This topic is covered under LOS G of Treading 58, which requires us to 'describe risk management of alternative investments'.
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LOS F
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LOS F
Alternative Investments – Question Bank
Some questions to test your level of preparation for the exam.
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Question Bank
Alternative Investments
About Lesson

1.  Investments in real estate can be both direct and indirect, either through debt or equity.

2.  Some of the important characteristics of real estate are:

    a.  It provides the better potential for total return in form of capital appreciation and regular income.

    b.  It provides greater stability of cash flows, especially when leased.

    c.  It provides a sort of hedge against inflation.

    d.  The real estate assets are usually indivisible, unique, and fixed.

    e.  They often require operational management.

1.  Forms of Real Estate Investment

The real estate investment could be in the form of:

a.  Private-Debt. This occurs when the investor provides debt against real estate property as a mortgage or lends for construction.

b.  Private-Equity. This is direct ownership of the real estate property.

c.  Public-Debt. All the residential mortgage-backed securities (RMBS), commercial mortgage-backed securities (CMBS), and collateralized mortgaged-backed obligations (CMO) are publicly traded debt-based real estate investments.

d.  Public Equity. All the shares in the real estate-based companies and real estate investment trusts (REITs) are examples of public traded investment in real estate.

2.  Categories of Real Estate Investments

2.1.  Residential Properties

These are the owner-occupied, single residences, held for capital appreciation.

2.2.  Commercial Real Estate

1.  These are non-owner-occupied, income-generating properties.

2.  It could be residential, office, retail, or industrial property. So, even if a property is for the purpose of residence, if it is let out for the purpose of renting, it would be recognized as a commercial property.

3.  These properties require active and experienced operating management.

2.3.  REIT Investing

REITs could be both mortgage-based as well as equity-based. The biggest advantage of investing in real estate through the REIT is that it provides expert management, plus there is no tax at the trust level if it pays-out more than ninety percent of its earnings.

2.4.  Mortgage Based Securities

MBS is the asset-backed securities that are backed by the mortgage in form of real estate properties.

2.5.  Timberland and Farmlands

1.  These are the properties of natural resources.

2.  The timberlands provide a return in the form of biological growth that can be sold in the market at the commodity prices and the increase in land prices. It functions as both factory and a warehouse.

3.  Farmlands are the land where the farm products grow. They provide returns in the form of harvest quantities like raw crops and permanent which can be sold as commodities, and also land price appreciation.

3.  Measuring Performance of Real Estate

The performance of real estate investments can be measured with the help of the following indices:

a.  Appraisal Index. This index uses the estimates of value based on comparable sales and cash flow techniques; thus, it is likely to understate the degree of volatility.

b.  Repeat Sales Index. This method uses changes in the sales price of the real estate properties to construct the index.

c.  REIT Index. This method uses the prices of publicly traded shares to construct the index.

4.  Benefits and Risk

The biggest benefit of investing in real estate is a low correlation with the traditional investment options, thus providing diversification benefits.

But, such a low correlation may be due to the limitation of index construction.

The other risks of investing in real estate are the asset risk (resulting due to economic conditions and interest rates), and operational risk (resulting due to management’s operational and financial ability, and ability to generate finance and refinance, when needed).

5.  Real Estate Valuation

The real estate property value needs to estimate, till the time they are sold. These can be estimated using one of the following approaches:

a.  Comparable Sales Approach. Here the valuation is done using the comparable figures recent sales of similar properties having the similar condition, age, location, and size.

b.  Income Approach. Under this approach, the valuation is done by dividing the net operating income by the capitalization rate. Net operating income is the expected property income minus the expected operating expense. And, capitalization is the discount rate reduced by the growth rate.
Otherwise, under this approach, the valuation can be done by discounting all the net expected cash flows, including the income can resale value, like in the case of the discounting model.

6.  REIT Valuation

For REITs the valuation can be done using any of the following approaches:

a.  Income-Based Approach. Under this approach, the valuation is done by discounting the operating cash flows at the cap rate.

b.  Asset-based approach. Under this, the valuation is done based on the net asset value, i.e. estimated market value of the asset minus the estimated market value of liabilities.

 

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