Chapter 1 Flashcards
Definition of Investment
- Committing / sacrificing present resources for expected future benefits
- Necessitates release of capital in return for an anticipated return to be received
What is ‘present resources’ in investment?
equity + debt
what is ‘capital’ in investment
effort, money, ideas
what is investor is compensated for?
- resources committed
- expected inflation
- uncertainty of future payments
Expected Future Returns
- periodic payment such as monthly rentals, yearly dividends, interests etc
- accumulated sums such as capital gains
Shareholder vs Bondholder
Shareholder:
* invest in shares
* dividend paid to them
* owners
Bondholder:
* invest in bonds
* interest paid to them
* outsiders
Speculation
- acceptance of large risks & unsecured gambles often with borrowed funds for the sole purposes of fast returns
- risk of loss > expected return
expected return in speculation needs to be…
very appealing that ppl is willing to take risks
Characteristics of Real Estate
- Immobility & Heterogeneity
- Illiquidity & Information Inefficiency
- High Transaction Costs & Capital Outlay
- High Sensitivity to External Forces
- High Degree of Management
- Inflation Hedge
- Income Stability & Capital Appreciation
- High Financial Leverage
Immobile & Heterogeneous
- cannot be moved from one location to another
- each property is unique
- can lead to the delineation of sub markets according to property types and location.
Illiquid & Informationally Inefficient
- cannot be converted into cash readily.
- considerable time is often required to find a buyer, negotiate a sale, arrange financing, conduct title search & legal documentation.
- information on real estate transactions is not readily available or transparent.
- illiquidity exposes property investors to significant market risks. Therefore, real estate investments are viewed as longer term investments.
High Transaction Costs and Capital Outlay
- due to the complexity of property transactions, several intermediaries are usually involved
- fees incurred during a property transaction
- property is generally a big-ticket item
Highly Sensitive to External Forces
- highly susceptible to credit conditions such as interest rates movements and credit availability.
- government intervention over land use and introduction of cooling and heating measures etc., can significantly influence property values.
What does it mean by external forces?
OUTSIDE of the real estate market
High Degree of Property/Asset Management
- real estate is more durable compared to other goods
- STILL a physical asset and subject to depreciation
- asset managers incur capital expenditure on
property maintenance & asset enhancements to preserve or enhance the asset values
three forms of depreciation
(i) functional,
(ii) economic
(iii) physical obsolescence
Why make enhancements?
increase in value = make market value, still be in demand
Physical obsolescence
wear and tear of the building
examples of physical obsolescence
cracks in the roof and structure, peeling of paint and breakdown of
heating and cooling system.
Functional obsolescence
property is no longer able to perform the function it is originally designed to, often due to technological changes or changes in infrastructural requirements.
example of functional obsolescence
increase in the size and weight of storage goods mean that a warehouse with insufficient floor loading and floor plate size
Economic obsolescence
- loss of value resulting from external forces
- NOT curable & requires a change in the property use.
example of economic obsolescence
the decline of a ‘sunset’ industry.
Hedge against Inflation
- how much rents move w or exceed inflation rates
- uses fixed rate debt
Stability of Income and Capital Appreciation
- real estate generate regular rental income
- leases and contracts stipulate rent renewals
- stability of cash flows depends on the property type.
- values can appreciate over time and
commensurate with a growth in the ability to produce
income.
Alternative Forms of Real Estate Investment
- Shares in property companies
- REITs
- Land Banking
What is Land banking?
- Indirect ownership and holding of undeveloped land in areas where there are rezoning potentials
Example of Land Banking
conversion from agricultural land to residential land.
Types of Risks
- Business Risk
- Financial Risk
- Inflation Risk
- Liquidity Risk
- Market Risk
- Legal Risk
- Other Risks
Business Risk
risk of incurring income losses, could be due to changes in economic conditions, inefficient management
Financial Risk
risk on default on borrowed funds
* Interest rate rises
* Reduced income
* Increased operating cost
Inflation Risk
losses in real value due to changes in nominal prices of goods & services
Liquidity Risk
uncertainty with which an asset can be sold off quickly & at reasonable price
Market Risk
- associated with economic conditions
- social and political instability
Legal Risk
- Title becomes unsatisfactory
- eg. affected Zoning,
road widening
Other risk
Compulsory acquisition
Concept of Risk and Return
- Return is the reward for investing
- However, Investment cannot be evaluated on return alone
- Generally, higher risk, higher return
Risk Management Strategies
- Increased Knowledge of Outcomes
- Diversification
- Judicious choice of Property
- Transfer risk
- Good maintenance & management of property
Increased Knowledge of Outcomes
- Joint Venture with experienced developers
- use consultants
- proper feasibility studies
Diversification
- not putting all eggs in 1 basket
- investors facing budget constraints can form consortium to invest in local or overseas project
Judicious Choice of Property
invest in less risky project, go for projects in good location
Transfer Risk
- to insurers
- to tenants/buyers
e.g. Net Leases - makes tenants responsible for all expenses.
Good Maintenance & Management of Property
- regular building inspections, reduce danger of accumulated repairs
- keeping tenants satisfied, reduce likelihood of vacancy
Value of Company formula
Debt Value + Equity Value = Value of Company
Market Capitalization formula
No. of Shares x Market Share Price = Market Capitalization
