University of Southern California School of Policy, Planning & Development. RED 542: Finance of Real Estate Development Fall 2009

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1 University of Southern California School of Policy, Planning & Development RED 542: Finance of Real Estate Development Professor: Jenny Office: RGL 224 Phone: Office hours: Monday and Thursday 2:00-3:00pm Class time: Thursday 6:00-9:30pm, VKC Room 111 Course description This course is designed to provide fluency in the tools of real estate analysis. Real estate is generally characterized as a long-lived asset whose value is derived from the stream of cash flows it generates over time. How these cash flows are forecast and interpreted defines an asset s value. RED 542 focuses on the various valuation techniques used in practice and on their strengths and weaknesses. Topics will include valuation techniques (especially discounted cash flow analysis) and the relationships between them, use of debt and equity, leases, taxes, the metrics of risk and return and how they are modeled. Other topics will be introduced as part of class discussion, but the primary focus is to develop mastery of the central tools of real estate analysis. Prerequisites Students entering RED 542 are assumed to have basic knowledge of finance fundamentals and some familiarity with Excel (or comparable spreadsheet programs). Course requirements Students are expected to attend all lectures and to participate in class discussions. Lectures are intended to prepare students to think critically and creatively about the essentials of real estate finance. If a student misses a class, or arrives late, it is his or her responsibility to ask the instructor or a classmate about any announcements that he or she may have missed and to obtain notes from another student. The tools of analysis are most likely successfully applied when they are understood both intuitively and technically. Problem sets are intended to help students master the technical skills of analysis. Materials for the problem sets (questions and/or sample spreadsheets) will be posted on the course Blackboard site. Homework assignments are due at the beginning of class on the dates listed. Late homework assignments will not be accepted. Students are encouraged to work together on the homework assignments (no more than 4 members to a group), and must list the names of all group members on the assignment. All group members will receive the same grade. There will be an in-class midterm and a final exam. There are no make-up exams. In case of an emergency (which stands for an extreme, sudden, and inevitable circumstance), the student 1

2 should notify the instructor BEFORE the exam, or he or she will receive a grade of zero for that exam. The weight of each requirement in the overall course grade is shown below. Problem sets (5) 20% Midterm exam 25% Final exam 40% Class participation 15% Total 100% Reading materials The required textbook for this course is Real Estate Finance and Investments, by Brueggeman and Fisher (13 th edition). Additional articles from the general media and industry journals will be posted on the course blackboard site throughout the semester. Disability Services Any student requesting academic accommodations based on a disability is required to register with Disability Services and Programs (DSP). A letter of verification for approved accommodations can be obtained from DSP. Please be sure that the letter is delivered to me as early in the semester as possible. DSP is located in STU 301; their phone number is Academic Integrity The use of unauthorized material, plagiarism, communicating with fellow students during an examination, attempting to benefit from the work of another student, allowing another student to benefit from one s own work, and similar behavior that defeats the intent of an examination or other class work is unacceptable. Where a violation has occurred, the student will receive an F in the class and may be subject to disciplinary action at the University level. Examples of violations include (but are not limited to) copying off another student, allowing another student to copy off your paper, using a cheat sheet in any form during an exam, and refusing to stop when time is called. 2

3 Course Outline and Readings Part I) Introduction to real estate finance (1 week) Introduction to real estate finance & course overview Motivation: real estate as cash flow generator Comparison of real estate and other asset types: implications for pricing Review of basic finance terms & math Overview of different valuation techniques Discussion of course topics and goals Reading: B&F Chapter 3 Part II) Valuation of real estate: framework and application (1 week) Valuing cash flows and real estate valuation techniques Discounted cash flow analysis Income or direct capitalization approach Market or sale comparison Cost approach Modeling irregular cash flows Readings: B&F Chapters 7 and 10. Focus especially on pp in Chapter 7, and pp in Chapter 10. Part 3) Leases: structure and modeling (1 week) Lease basics: Terms, mechanics, & modeling issues What are the economic rationales for and against it? Lease terms and types Basic types of leases Modeling the rent roll in a pro forma Readings: B&F chapter 9. Pay special attention to the nitty-gritty on leases (pp ). Part 4) Debt financing (3 weeks) Mortgages: concepts, mechanics and modeling Mortgage terms and mechanics Overview of mortgage types Modeling basic FRM Modeling ARMs and exotic mortgages Layering of debt Refinancing Underwriting concepts and mechanics 3

4 Default and foreclosure Readings: B & F chapters 2, 4, 5 and 6, 8 and 12 Additional readings from current media (to be posted on Blackboard) Part 5) Equity financing (2-3 weeks) Equity partners and & partnership structures Waterfall: concept, mechanics and modeling Equity partnerships Readings: B&F chapter 18 Other readings TBA Part 6) Taxes (1 week) Taxes: terms, mechanics and modeling Overview of taxes and real estate Income Capital gains Modeling before- and after-tax returns in pro forma Reading: B&F chapter 7, 11 Part 7) Introduction to development (1 week) Overview of development Highest and best use Estimating land values Participants, stakeholders and approvals Introduction to development finance Reading: B&F chapter 17 Part 6) More modeling and additional topics (1 week) As time permits, we will cover additional topics or more detailed modeling of prior topics. 4

5 Schedule of Classes and Assignments Class Date Topic of discussion Reading Assignments 1 27-Aug Introductions Course overview Ch Sep Valuation framework Ch 7 and 10 PS 1 due 3 10-Sep Leases Ch Sep Debt I Ch 2 and 4 PS 2 due 5 24-Sep Debt II Ch 5, Oct Debt III Ch 6, 8 Other readings TBA 7 8-Oct Equity I Ch 18 PS 3 due Midterm review 15-Oct MIDTERM EXAM 8 22-Oct Equity II Readings TBA 9 29-Oct Equity III/Taxes Ch 7, 11 PS 4 due 5-Nov NO CLASS - ULI meetings Nov Taxes/Development Ch Nov Topic and readings TBA 26-Nov NO CLASS - Thanksgiving 11 3-Dec Modeling risk & return Final review Ch 13; 15 PS 5 due 10-Dec FINAL EXAM, 7-9pm 5