Real Estate Investment

Introduction

There are many variables to be considered before an investor invests in income properties.
Among other things include the market factors, occupancy rates, tax influences, the level of risk , the amount of debt financing and methods of measuring returns on investment in real estates.

Similarly a lender would also be concerned with the same variables as they would also effect the value of the marketability of the properties being used as the collateral for the loan. In addition, the lender is also concerned about the sufficient cash flows generated from the properties to cover the loan payment.

CHARACTERISTIC OF REAL ESTATE INVESTMENT
As mentioned in the earlier chapter , investments in real estate involve in the following consideration:

1. Cash Outlay- real estate investment requires much larger initial outlays of cash than do other forms of investment

2. Liquidity-real estate investment is not liquid because it generally involves a long term commitment of investment funds

3. Management- real estate investment must be managed either by the investor itself or by a professional real estate management firm.In both cases ,it involves added cost , usually ranging from 5%-10% at the gross income depending on the types of building, the age of the building , the type of tenancy and location of the building

4.Risk- For investment properties ie: the properties required mainly for capital appreciation with little or no cash flow during the holding period, the risk would be in the form of loss in capital investment.

But for the income producing properties-i.e properties purchased primarily for cash flow, the level of risk depends on:

• the quantity of the income stream
• the quality of the income stream (refers to the sureness of its receipt) and
• the durability of the income streams(refers to the length of time the investment will generate an income)

5. Risk versus return

There is a direct relationship between the risk an investor undertake with the return he experts to get-i.e the higher the risk, the higher is the required rate of return.



TYPES OF RISK IN REAL ESTATE INVESTMENT

We mentioned risk as an element to be taken into consideration when investing in real estate. Let us look at the different types of risks involved.

1. Business Risk-Real estate investor are in the business of renting space. Its returns will be affected when economic condition changes that affect the demand for the rented space.

2. Financial Risk-The use of financial leverage magnifies the business risk. The financial risk increase as the amount of debt on real estate investment is increased.

3.Liquidity Risk-Real estate investment has a relatively high degree of liquidity risk,unlike investment in bonds or shares. It taken an average about 5 months to a year to liquidate a property.

4.Inflation risk-As mentioned earlier on, historically, capital appreciation in real estate can act as hedge against inflation, but during period of high vacancy rates where demand for space is week; income from real estate may lag behind the inflation rate.

5.Management Risk-The rate of return on real estate on the competency of the manager
that managers the building. Some properties may require a higher level of management expertise that others. Managing a shopping mall is an example.

6.Interest rate risk-Changes in investors rate affect the returns on any investment.
Since real estate tends to be highly levered, the rate of return earned by equity investors can be affected by the changes in the interest rates.

7.Legistative Risk-The value of real estate is affected by the changes in its environment which are hazardous to health and surrounding such as building materials, contamination by toxic waste etc.

All the above risk must be considered if we are interested in real estate investment.

What is Real Estate?

Definition of Real Estate

• Real Estate is often referred to as the physical land and improvements or structures constructed on the land such as buildings. Real Estate can also be defined as a business activity focuses on human activities concerned with land and its use or improvement which include professionals such as the appraisers, brokers, builders and planners.
• The ownership rights associated with the real estate are referred to as real property.Real property is different from personal property, which refers to the ownership rights in property and is not land or property permanently attached to the land such as fixtures.

Real Property Characteristic

Real property has many unique characteristic which make them different from the products.They can be divided into two distinct characteristics, classified as physical and economics.

Physical Attributes

Immobility or Fixity

Land cannot be moved physically.Through some of its substances, such as oil,minerals and oil, may be removed but the geographical location of the land remain fixed. Due to this immobility, the value of the land keep on changing, for better or worse in line with the changes in the environment surrounding it.Land also represents a primary source of income to support local government.

Indestructibility

Land cannot be destroyed or created.It continues to exist till the end of time.This attribute tends to popularize investment in land for its economic durability where the value of land will appreciate over time because of its scarcity and indestructibility.


Heterogeneity

It is most unlikely to have two parcels of land that are exactly identical. Each parcel of land has unique location and characteristics such as size, shape and topography. Even the structure is location-specific, giving rise to the vast differences in its values.Heterogeneity causes land to be legally declared as a non-fungible(not substitute) commodity,which requires specific contract involving its uses or sale unlike others commodities such as oil, rice and shares which are fungible or legally substitutable.
Economic Attributes

In addition to the physical characteristics, land also distinct economic attributes such as scarcity, fixed investment,location and improvements.

Scarcity:

Exist when land is required for specific purpose and at specific location, creating spiraling demand for land and thus pushing its value skyrocketing. however, the ability to construct higher building and highways, provide greater accessibility to more land and hence reduce its scarcity.

Fixed Investment

The second economic attribute of land is the fixed nature of the investment of fixity , which makes the investment in land long lasting. The value may changes surrounding the location or on the changes in people's preferences and life styles. Therefore, before you purchase or improve the land you must consider how long the land's usefulness will last.

Location

The location of parcel of land in relation to other internal land use activities is called situs.Similar pieces of real estate may have extremely different values because of its location. These vast differences are bought about by the personal preferences for natural attributes, such as schools, facilities or places of employment. All these factors affect the value of the property.

Improvements

Land in its natural state is called raw land. Land with improvements in it such as buildings, fences and others is called improved land. Improvements to the land (such as access roads, nearby schools, recreational facilities and other factors) often enhance the value of the land without modifying the sites.