Book Review: Real Estate Finance and Investments – The Ultimate Guide to the Industry?
Do you learn best by reading?
It’s a bit mixed for me.
While I do read a lot, sometimes video is a superior format: I couldn’t imagine trying to learn Excel or PowerPoint shortcuts from a book.
But text works quite well for overviews and introductions.
It’s tough to make commercial lease terms interesting in video format, but you can at least make them quick to get through in writing.
The book I’m reviewing today – Real Estate Finance and Investments: Risks and Opportunities by Dr. Peter Linneman – falls into that category: it’s a great introduction that works well as a book…
…but which doesn’t hold up quite as well if you’re preparing for detailed case study exercises.
What is This Book, and Why Should You Care About It?
This book is a standard reference and textbook used in real estate classes at universities and business schools, and people frequently recommend it as “The Real Estate Bible.”
You can read more about the author, Dr. Peter Linneman, right here, but suffice to say that he’s had a long and distinguished career in academia (professor at UChicago and Wharton) and real estate investment/development.
He also publishes a well-known quarterly newsletter on commercial real estate.
Real Estate Finance and Investments came to my attention when I was researching the new real estate private equity case studies we created this year.
I wanted to cover all my bases, so I decided to read one of the most common and highly regarded real estate references.
I approached it with one simple question: Is it a useful guide for answering case study questions in interviews and preparing for the job?
This review is based on Edition 3.1 of the book, the most recent one as of the end of 2015.
So What’s in It?
The book takes a “survey” approach, which is apparent if you review the Table of Contents.
There are chapters on commercial leases, financial modeling, due diligence, development and acquisition analysis, CMBS, REITs, RE PE funds, and yes, even ground leases; there are also supplements on finance basics such as NPV and IRR, careers in real estate, ARGUS, and sample case studies and exams.
No chapter is long enough to give extremely detailed information on the topic, but each one provides a good explanation of the fundamentals (e.g., the different components of leases and how you sum them to get the net effective rent).
Swipe Right: What I Liked
Just like a Tinder profile where the first photo looked good but the rest “varied in quality,” there was a lot I initially liked about this book.
Benefit #1: Range of Topics Covered
First and foremost, it covers a very broad set of topics.
For example, there’s an entire chapter on ground leases (common in mainland China and other regions where you can’t own land; you can only lease it from the government for a long time), which I’ve never seen much on in other books or courses.
There’s also a chapter dedicated to real estate exit strategies, which people tend to skip over in modeling tutorials.
So this book is probably the fastest way to get up to speed on the industry as a whole, and to understand the range of asset classes that relate to real estate.
Benefit #2: Back to the Fundamentals, Please
The author also does an excellent job explaining the fundamentals of real estate investing with several diagrams that show different scenarios.
The expected return in each scenario is 15%, but the outcome probabilities vary wildly: one scenario has an even distribution over a wide range of returns, one has a single outcome with a bell-curve distribution around 15%, and the others have multiple outcomes with different bell curves around each one.
It looks something like this, but with more varied distributions for each line:
He makes the point that no scenario is “the best”: it depends on your risk profile, your area of expertise, and the rest of your portfolio.
This same theme is present throughout the remainder of the book: numbers are merely a tool you use when making decisions.
Benefit #3: The Limitations of Numbers
A closely related theme is that numbers and financial models can only tell you so much.
My favorite chapters were the ones on Cap Rates and Financial Modeling, since he busts a few common myths there:
- First, Cap Rates are often problematic because of calculation discrepancies, changing markets, and changing cash flows; in some cases, it doesn’t even make sense to use a simple Cap Rate because the property is changing so much.
- Second, “sensitivity analysis” is often nonsense because people don’t consider how the assumptions are interrelated. Can rent fall by 10% even when the vacancy rate stays the same? No, probably not.
- Third, complex models are often worse than simple ones. If the math doesn’t work in a simple model, it won’t work any better in a more complex one, but you will spend a lot more time building it.
The chapter on Financial Modeling is great because he gives an example of a pro-forma model for an apartment complex, and then explains how and why different line items would change in different markets (decline, recovery, stable).
Most other training on financial modeling skips the meaning behind the numbers, which is what Linneman excels at here.
Swipe Left: What Wasn’t So Great
But as I kept reading, I realized there were also several difficult-to-overlook flaws – sort of like what happens when you keep flipping through someone’s photos and find the non-model-like ones.
Problem #1: Insufficient for Completing Case Studies
First, I don’t think the coverage here is sufficient for completing case studies in interviews.
It does give you the required background information, and there are a few useful exercises at the end.
But these examples are not that close to what real estate firms ask candidates to complete in interviews.
Remember: I don’t have hobbies, interests, or friends, but I do collect case studies for fun:
There are some useful pieces that you could use for case studies.
For example, you could combine the chapter on the real estate pro-forma with the one on exit strategies and the one on calculating IRR, and get enough to complete a simple exercise (like our first RE PE case study).
But there’s no step-by-step walk-through that puts all those pieces together.
The author does provide a few good case study exercises at the end, but they’re simpler and less Excel-intensive than what you would receive in a real interview
Problem #2: Biases and Bizarre Tangents
Throughout the book, Linneman has a tendency to go off on tangents and show extreme biases on a few issues.
I’m not sure if these non-sequiturs were meant to be sarcastic, but they came across as a bit… odd.
For example, at one point he writes the following to explain the distinction between Capital Expenditures (CapEx) and Depreciation:
“Depreciation is a fiction created by Congress that governs how you are allowed to deduct [CapEx spending] for tax purposes. Depreciation is not a scientific exercise, but rather the result of a highly politicized tax collection process.”
This claim is sort of true in real estate because Depreciation affects only the taxes – but it seems like he doesn’t understand the accounting purpose of Depreciation in other industries: to allocate a capital expenditure over its useful life.
A few paragraphs later, he goes into the relationship between Depreciation and getting members of Congress re-elected.
This tangent stood out as particularly strange, but there are other, similar oddities throughout.
Similar to Damodaran, Linneman is also at odds with mainstream thinking on a few points.
For example, in one section he explains why IRR doesn’t apply to development projects: the risk profile, and therefore the appropriate discount rate, differs at each stage of the project, so “back-solving” for a single discount rate, as the IRR function does, doesn’t make sense.
From a finance theory perspective, yes, he is correct.
However, in case studies and on the job you’ll still be asked to calculate IRR for development projects since the terms of the deal, such as waterfall promotes, are often tied to IRR.
Problem #3: Heavy U.S. Bias
To be fair, the book does include coverage of markets outside the U.S., and two of the case studies are international: one in London and one in Tokyo.
But he has a very dim view of non-U.S. markets. Here’s an actual quote:
“A major problem is that most foreign property markets are not markets in any meaningful sense of the word. Properties rarely, if ever, trade; information is scarce, distorted, and self-serving; many properties are overtly manipulated by (often corrupt) governments; there are only a limited number of capital sources; and, the rules of the game frequently change, often in mid-play.”
These points might have had elements of truth a few decades ago, but they don’t hold up as well in 2015.
Also, I’ve collected dozens of real estate case studies from regions outside the U.S. – what exactly are investors putting their money into if the markets are dysfunctional in other places?
Analysis of Comparable Courses: This Book vs. Other Real Estate Courses
I’ve completed a number of online real estate courses in the past.
The biggest weakness of these courses – no names mentioned – is that they tend to focus too much on formulas and calculations and not enough on the why behind the numbers.
This book has much better explanations of the logic and rationale, even if it doesn’t go as in-depth into Excel as courses do.
Analysis of Comparable Courses: This Book vs. Our Real Estate Course
And then there’s our own Real Estate Financial Modeling course.
The main advantage of Real Estate Finance and Investments is that covers a much broader set of topics than we do.
Linneman also takes the time to cover topics, such as the time value of money and IRR, that we skip because of coverage in other courses on the site.
So his book could be a good prerequisite for the course we offer.
Overall: Nice Introduction and Overview, But…
You always have to be careful when “everyone” recommends one book as the best source for learning an industry.
I wasn’t disappointed with the Linneman book; parts of it were quite good, and offered clear, concise explanations of important topics.
If you have any interest in real estate, you should read this book as your first step.
But as with learning any industry, reading alone is not enough.
This book works best when you put it into practice with real, Excel-based case studies – however you find them.
Until you do that, this reference is “useful, but not sufficient” as you prepare for interviews, internships, and jobs.
You might prefer watching, listening, or reading for learning new concepts, but nothing beats doing.
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