Two warehouses on the same road can trade at very different prices. The difference is rarely the concrete. It is the lease, the tenant's credit, the pass-through clauses, and the debt stacked on top.
Real estate investments are heterogeneous assets in fragmented local markets, traded infrequently at high transaction cost. The features that matter for valuation are a property's current and potential economic use, its expected net cash flows, and its capital structure. Location, size, age, amenities, and the supply of comparable properties nearby set the rent a property can command.
Risk and return run along a spectrum. Senior debt (first mortgages, investment-grade commercial mortgage-backed securities) sits lowest. Core real estate holds stable income-producing properties and diversified public real estate investment trusts (REITs), behaving bond-like. Core-plus adds minor refurbishment and cash-flow stabilization. Value-add takes on vacant space, repositioning, and sub-investment-grade tranches. Opportunistic covers new development, mezzanine debt, and distressed situations, funded mostly privately and behaving equity-like.
Common mistakes
- Deducting debt service inside NOI. NOI stops before financing and tax. Subtracting the EUR220,745 payment produces EUR186,005, which is pre-tax cash flow, not NOI.
- Ignoring the recovery cap. A EUR24,150 cost overrun on a capped EUR102,500 recovery is fully absorbed by the owner. Fully passed-through items (tax, insurance) do not change NOI at all.
- Depreciating land. Land has infinite life. Using the full EUR3,750,000 base overstates depreciation by EUR25,000 a year and understates taxes.
Bottom line
- NOI = effective gross income − operating expenses − property maintenance allowance; before interest, principal, and tax
- LTV = mortgage outstanding / current value; DSC = NOI / total debt service including principal
- Equity dividend rate = (NOI − debt service) / initial equity; taxes = t × (NOI − interest − depreciation)
- Depreciable base excludes land; higher land value means less depreciation and lower after-tax cash flow
Exam shortcut
Build the income statement top down before touching the answers: gross rent, plus recoveries and other income, minus vacancy and concessions, equals effective gross income; minus operating expenses and maintenance allowance equals NOI. Vacancy always hits gross rent, never NOI directly; if a choice equals NOI times (1 − vacancy), it is the trap.
The full lesson (about 2,769 words, 18 min read) adds 2 worked examples, all 5 common mistakes, a self-check, free in the app.
Learning objectives
- real estate overview
Browse all free CFA Level II lessons or jump into free CFA Level II practice questions.