Resarching Real Estate and the Factors affecting It

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.