TOPIC #1: Real Estate as an Investment
Explain how
real estate differs or mirrors (is the same as) other investments :
There are many different types of investing which all have
different characteristics that make them stand apart from one another but they
also all have certain traits that are common amongst them all. “All rational investors seek financial return
as a reward for committing resources and as compensation for bearing risk”
(Kolbe, Greer). This is an attribute
that is commonplace among all types of investing.
Investments can be made in Stocks, Bonds, Mutual Funds
(MFs), Exchange Traded Funds (ETFs), and Real Estate Investment Trusts (REITs). Comparing investments in real estate with
returns on other investments has proved to be difficult because “outcomes are
heavily influenced by the dates over which performance is measured” (Kolbe,
Greer).
http://www.wclibrary.info/moneysense/documents/mod5.pdf
This website describes different types of investments
including stocks, bonds, MFs, ETFs, and REITs.
The link states that stocks, bonds, MFs, and ETFs are technically
securities according to the federal securities laws. These securities are generally widely
available to be bought and sold on the market but they also bear a good amount
of risk. On the other hand someone can
invest in real estate and “add to [their] investment mix an asset with a low
correlation to stocks [and] bonds” which allows the investor to enjoy a higher
return on real estate when the securities market is down.
I found this link very insightful because it describes each
type of investment which lays the groundwork for analyzing the differences
amongst them all.
http://www.bakervaluation.com/re_investment.html
This article lays out the advantages and disadvantages of
each type of investment showing that there are some similarities between
investments in real estate and others.
Commodities and real estate have a sturdy hedge against inflation;
however, there is no complete commodities index fund which makes it tricky for
individuals to invest. When it comes to
real estate it is a good investment to make because it has a powerful inflation
hedge and therefore rarely ever has negative annual returns. Commodities and real estate are both tangible
investments which is another plus for both markets. Real estate and commodities have some
similarities but investing in real estate is safer because it has lower risk
and more steady high returns.
Both stocks and REITs are easy to invest in and possess an
efficient market. Investing in stocks
however does require more attention to detail due to the large number of
external factors that affect returns.
Once again real estate is a safer investment decision.
One way real estate investments differ from others is when
it comes to volatility and risk. Stocks
and commodities are highly volatile whereas investments in real estate are not.
http://seekingalpha.com/article/862191-investing-begins-with-education-top-12-investment-books
This topic analyzes how real estate differs or mirrors other
investments; however, this article looks into how investing begins with
education. The author provides a list of
different books he recommends to help one better understand investing. The other articles and website sources I
found detailed the differences, advantages, and disadvantages amongst the
various types of investments; however, they fail to acknowledge that
understanding the investment that you are incurring is the most vital part of
earning a positive return. If you don’t
understand the stock market than you will most definitely not make a positive
return except due to an extreme amount of luck.
In the world of investing you must understand the market that you are
dealing with and if you do then the differences between real estate deals and
bond deals become much less important.
You are then able to predict what is going to happen next in your market
and make a profitable decision.
TOPIC #2: Supply & Demand in a Real Estate Context and Basics of Urban
Development, Market Research
Explain
supply and demand factors for real estate.
What is Market Efficiency? Is a
real estate market considered efficient?
Was anything missed in the analysis of College Station?
Demand is seen as the association between the market price
and the amount of goods/services that will be bought during a time period. Some of the factors that affect demand in
regards to real estate include the variation in the number of prospective
tenants, changes in operating expense levels, yields available on other assets,
technology and customer taste or preference.
The supply of real estate is strongly correlated to relative
scarcity. Some facts that strongly
affect the supply curve include changes in the cost of construction and changes
in real estate developers’ optimism (Kolbe, Greer).
Market efficiency refers to a situation in which the top investors
earn the greatest value due to consumption.
A vital aspect of markets is that information is equally and adequately
available to all so that investors can make knowledgeable decisions. The amount of time that it takes for
information to be revealed in the market price is an important determinant of
market efficiency.
The real estate market is constituted by a number of inefficiencies
because this market tends to have a long lag time in portraying new and
relevant information in prices.
Transactions are not as frequent as are those in other investments and
therefore information tends to be outdated.
Real estate deals are a negotiation between the buyer and seller and the
seller is unaware of prices that others may be offering on the property. Some main sources of inefficiency include
that information is expensive and hard to gather because the market is
differentiated. Another inefficiency is
the high transaction costs associated with real estate contracts as well as the
fact that products in this market are significantly differentiated.
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/invemgmt/effdefn.htm
This website explains market efficiency and states that
markets may not always be efficient for all but that it also depends on the
investor group. This website mainly
focuses on the stock market; however, market efficiency relates to each market
in similar ways so it is a good basis to learn about efficiencies and how
efficient one market may be in relation to another. It also reinstates that efficiency is
strongly based on “what information is available” and how long it takes for the
information to be reflected in market prices.
http://ideas.repec.org/a/jre/issued/v15n11998p41-58.html
This article “Further Evidence on Real Estate Market
Efficiency” provides an abstract on exactly what the author focuses on. The abstract makes it clear that the real
estate market has “strong evidence against market efficiency” due to “lagged
annual returns” and “deviation[s] of price from fundamental or intrinsic
value.” The information found in this
article directly parallels the information I found in the textbook for my
Finance class entitled “Investment Analysis for Real Estate Decisions.” Real estate decisions are based on uncertain
predictions which lead to a change in future prices that may turn out to be
outdated by the time they are utilized.
http://www.thetruthaboutrealty.com/real-estate-supply-and-demand/
Housing supply is always changing and according to this
article “new construction should hover around 3% of current housing supply” or
else the housing market could take a huge hit.
Good determinants of supply are the amount of new construction in real
estate as well as restrictions placed on the housing market by certain
jurisdictions such as the Federal Clean Air Act. This article implies that demand is the most
important factor in real estate because without customers interested in buying
property, there is no market. Some
demand factors stated to be important in regards to real estate include
population as well as purchasing power of potential homeowners.
TOPIC #3: Operating Statement & Forecasting; Forecasting
Cash Flow, Deriving Value, Capitalization Rates
What is the
convention for preparing the analysis of income producing real estate? Forecasting Cash Flow is an art. Why?
How do discounted cash flow and direct capitalization analysis
differ?
In order to determine the future benefits and income that
may be generated from a real estate property you must analyze the “operating
history.” Forecasting is extremely
important in determining what rent should be in the future and how much
expenses will increase. These depend on
various factors such as inflation and other factors due to economic, political
and social changes. You begin the
process by determining the potential gross income of the property and then
subtract vacancies and collection losses to arrive at effective gross
income. You then estimate operating
expenses for the year and subtract these from the effective gross income to get
the net operating income. Further
calculations will yield the before tax cash flow and you can also derive the
after tax cash flow.
Forecasting cash flows is a skill and it must be
learned. It is considered an art because
there are a multitude of factors that come into play to ultimately determine
cash flows. Some of these factors
include variations in a facilities’ efficiency, declining physical durability,
environmental issues, changes in transfer costs, etc. There is such a wide range of factors to be
considered, that it is a very specific and detail oriented method of
determining cash flows.
Direct capitalization solely deals with income
that is generated and accounted for at the beginning of the first year of
operations. The method of discounted
cash flows involves estimating what a cash flow would have been worth a number
of years before. In essence, discounted
cash flow determines the net present value of a property.
http://incomepropertyanalytics.com/direct-capitalization-vs-yield-capitalization/
This article details what
exactly direct capitalization is. From
this article I learned that direct capitalization regards only the first year
of operations at the beginning of that year.
It disregards anything that happens outside of that first year of
operations and focuses on the factors and changes that go on during that year.
http://macabacus.com/valuation/dcf/overview
This informative website
involves an in depth description of the discounted cash flow method. The discounted cash flow method provides the
net present value of a future cash flow by using discount rates and inflation. You may also arrive at a future cash flow for
a certain period.
http://www.tisbooks.com/cash-flow-forecasting.htm
This website describes a book
called “Cash Flow Forecasting – A Hands On Approach” and lays out exactly what
is discussed in the book. One section of
the book is dedicated to describing why Forecasting is an art. The author states that it is an art because
you have to dedicate a good amount of time to learning about the various
interactions between different financial structures. If you spend an adequate amount of time
analyzing these interactions then you will complete a relevant forecast of cash
flows that may be used to make vital financial decisions.
