FIN 591 Week 1 Real Estate Markets and Investment Example

Why a Family Office Is Looking at 120 Apartments in San Antonio: The Space Market, the Capital Market, New Supply and What Makes Real Estate a Different Kind of Investment

[Student Name]

University of Phoenix

FIN/591: Real Estate Investment

Week 1 Assignment

[Instructor Name]

[Date]

The family office, Mission Oaks Apartments and all figures are composites written for a model paper; market concepts and research findings come from the sources listed and are stated generally.

A composite family office in Dallas, managing about $180 million for the heirs of a regional grocery chain, holds mostly stocks and bonds. Its investment committee wants to add direct real estate for income and diversification. A broker has offered Mission Oaks, a composite 120-unit garden apartment community built in 2004 on San Antonio's north side, at $16.8 million, or $140,000 per unit. The broker's package shows net operating income of about $965,000, a cap rate of about 5.75 percent. Before deciding whether the price is right, the committee needs to understand the markets that set both the income and the price. This paper explains them.

The Property and Its Income

Mission Oaks has 120 one- and two-bedroom units averaging 870 square feet in ten two-story buildings around a pool and leasing office, with average rent of about $1,350 a month. Gross potential rent is about $1.94 million a year. After a 7 percent allowance for vacancy and unpaid rent and about $90,000 of other income from fees and laundry, effective gross income is about $1.9 million. Operating expenses of about $932,000, nearly half of income because Texas property taxes are high, leave net operating income of about $965,000.

Two Markets, Not One

DiPasquale and Wheaton (1992) described real estate through four linked quadrants. In the space market, the supply of apartments and the demand from renters set rents. In the asset market, investors decide what they will pay for a stream of rent, expressed through cap rates, which depend on interest rates, expected rent growth and risk. Values then determine whether new construction is profitable, and construction changes the stock of space, which feeds back into rents. A property's value can fall even when its rents rise, if cap rates rise faster.

The San Antonio Space Market

San Antonio's population and job growth have been steady for more than a decade, supported by military bases, health care and a growing logistics sector. Renter demand has been solid. But developers, encouraged by low interest rates and strong rent growth in 2021 and early 2022, started many projects, and an unusually large number of new apartments opened in the city in 2023 and 2024. New buildings competed with older ones through concessions, often a month or more of free rent, slowing rent growth and pushing vacancy up. Mission Oaks, older than the new buildings, competes on price; its rents are about 20 percent below new properties nearby.

The Capital Market

In 2021, apartment buyers accepted cap rates near 4 to 4.5 percent in many Texas cities because borrowing was cheap and rent growth was strong. As the Federal Reserve raised rates in 2022 and 2023, borrowing costs rose and buyers demanded higher yields. Cap rates rose by roughly a point or more, which at constant income lowered values by a fifth or more. Plazzi et al. (2010) found that variation in commercial real estate cap rates reflects changes in expected returns and in expected rent growth, which is why a rise in interest rates and a cooling rent outlook together pushed cap rates up.

Where Mission Oaks Sits

At 5.75 percent, the asking price assumes a cap rate somewhat below what recent sales of similar older properties suggest. Either the seller expects buyers to believe in strong rent growth as new supply is absorbed, or the price is high. The following weeks test which.

The Investor's Alternatives

The family office could gain real estate exposure in other ways: buying shares of apartment real estate investment trusts, which trade daily and hold hundreds of properties, or committing to a private apartment fund managed by a specialist. Investment trusts offer liquidity and diversification but move with the stock market day to day. Private funds offer professional management but charge fees and lock up capital for years. Direct ownership offers control, tax benefits passed straight to the owners and the chance to add value through management, at the cost of concentration and effort. The committee chose to evaluate a direct purchase because it wants control and expects to hold for a decade, but the alternatives set a benchmark the property must beat.

Renter Demand in More Detail

Demand for older, moderately priced apartments like Mission Oaks comes mainly from working households earning roughly $45,000 to $75,000 a year: nurses' aides, warehouse supervisors, airmen from nearby bases, retail managers. Their rents rise with wages, which in San Antonio have grown steadily, and many cannot afford the newest buildings or a home purchase at current mortgage rates. High mortgage rates since 2022 have kept more households renting longer, supporting demand even as new supply rose.

What Makes Real Estate Different

Each property is unique, so prices come from negotiation and appraisal rather than continuous trading. Transactions are slow and expensive, with closing, financing and selling costs of several percent. Properties need active management, from leasing and repairs to collecting rent and handling disputes. Most buyers use substantial debt, magnifying gains and losses. Income is taxed in distinctive ways, with depreciation deductions sheltering much of it. Markets are local, so a family office in Dallas must understand San Antonio. Case and Shiller (1989) found that housing prices show momentum over short periods, evidence that property markets are less efficient than stock markets, which creates both opportunities and traps.

Why Investors Hold It

Investors hold real estate for income, inflation protection over long periods, tax benefits and diversification, since property returns have historically moved only partly with stock returns. Apartments in particular offer short leases that let rents adjust to inflation each year, though expenses such as insurance and taxes can rise quickly too, as Texas owners have found.

The Investor's Fit

The family office can hold property for ten years or more, does not need the cash quickly and can tolerate illiquidity. It lacks property management staff, so it would hire a third-party manager, whose fee is included in the operating expenses.

Questions for the Weeks Ahead

The committee's questions follow from the markets. What is Mission Oaks worth by the main valuation methods? How should the purchase be financed, and how would debt change returns and risk? What tax and legal issues come with ownership? What could go wrong, and how does the property fit the family office's portfolio? And, finally, should the committee bid, and at what price?

Conclusion

Mission Oaks' value depends on rents set in a San Antonio space market absorbing heavy new supply and on cap rates set in a capital market that repriced as interest rates rose. Real estate's local, illiquid, managed and debt-financed character distinguishes it from the securities the family office already holds. Understanding both markets turns a broker's asking price into a set of questions the committee can test.

References

Case, K. E., & Shiller, R. J. (1989). The efficiency of the market for single-family homes. The American Economic Review, 79(1), 125-137.

DiPasquale, D., & Wheaton, W. C. (1992). The markets for real estate assets and space: A conceptual framework. Real Estate Economics, 20(2), 181-198. https://doi.org/10.1111/1540-6229.00579

Plazzi, A., Torous, W., & Valkanov, R. (2010). Expected returns and expected growth in rents of commercial real estate. The Review of Financial Studies, 23(9), 3469-3519. https://doi.org/10.1093/rfs/hhq069