Real Estate Investment Analysis

Real Estate Investment Decision

• Real estate investment analysis has lagged behind mainstream finance, but recent years have shown progress.
• Modern analysis treats real estate as a capital asset, focusing on future benefits. This aligns with capital budgeting.

Who Invests in Real Estate?

• Real estate investment is often spurred by federal regulations:
  • REITs (Real Estate Investment Trusts) are exempt from corporate taxation on distributed income. In 2018, 184 member REITs controlled over $960 billion in real estate assets.
  • ERISA (Employee Retirement Income Security Act of 1974) directed pension funds to diversify, leading many to heavily invest in real estate. In 2016, pension fund capital in real estate equities exceeded $3.1 trillion.
• Foreign direct investment in US real estate fluctuated, with significant increases in the early 1980s and the early 1990s. Foreign ownership is often concentrated in specific geographic areas and types of properties.
• Key factors influencing foreign investment include foreign currency exchange rates (a lower cost of dollars in foreign currency makes US real estate more attractive), and differences in interest rates (high US interest rates tend to depress real estate prices).

Why Invest in Real Estate?

• Investors can be classified as either passive (hire professionals to manage the property) or active (directly manage the property).
• Investors also take either an equity or debt position in real estate (owning part or all of an asset or lending money to own an asset.)
• A clear distinction exists between investing in real assets (property) and financial assets (mortgage-backed securities).

How Have Real Estate Investments Performed?

• Reliable yield data for real estate is scarce. Initial findings suggest that returns were comparable to equities, with greater predictability.

• Recent institutional involvement and reporting requirements have provided more accurate comparisons between real estate returns and other investment types. Specific findings critically depend on the time period of analysis.

• One study (1972-1983) found real estate funds outperformed the S&P 500 index and bond index (Ibbotson Associates). Another (1978-1989) found that similar periods favored common stocks.

• Some analysis in 1984 implied that real estate and common stocks yields were similar, but real estate tended to outperform in inflationary periods.

• Subsequent research highlighted a less strong relationship between returns on real estate investment trusts (REITs) and large capitalization stocks. Similar returns exist but are more associated with smaller capitalization stocks.

Definitions and Concepts

• Investment Value: The worth of a property from an investor's perspective (considering factors like future cash flows, holding period, selling price, risk, and financing). It's subjective.
• Most Probable Selling Price: The predicted price at which a property could be sold (a range bound by the buyer and seller's perceived values). This range considers the various considerations involved in the actual transaction.
• Transaction Range: The likely range of transaction prices bound by investment value from various participants (buyer, seller).
• Market Value: The most likely price at which a property would sell in a properly functioning market, given a reasonable time frame, with rational and involved market participants.

Estimating Investment Value

• Estimating investment value involves estimating future cash flows, factoring in time differences, assessing risk, and comparing different alternatives.
• Financial analysts widely recognize investment value as the sum of the value of outstanding debt and equity, representing the asset's overall worth.
• Present value(s) of future cash flows during the estimated ownership period and disposal proceeds help determine investment worth.

Investor Objectives and Risk

• Investors are diverse and seek a balance of return and risk.
• Emotional aspects influence risk tolerance and investment decisions. Rational investors prefer higher returns with appropriate levels of risk considered.
• Investors tend to avoid increased risk as total perceived risk increases.

Explore the evolution of real estate investment analysis as it increasingly aligns with capital budgeting principles. This quiz delves into the factors influencing real estate investment, including federal regulations and the role of REITs and pension funds. Understand who invests in real estate and the dynamics of foreign direct investment.