Real Estate Value Drivers for Buying Decision

 

INVESTMENT IN REAL ESTATE

 

Real estate is known as best investment after gold. Those who are looking for long term investment with physical assets for them real estate remain best options. Before buying the assets one must look at the risk factor of the investment.

 

• Real Estate encompasses land and permanently affixed structures such as buildings, plants and machineries; Synonymous to real property;
• Technically, real property refers to ownership rights over real estate;
• In investment, real estate are acquired because of the cash flow that it generates ; REITS;

1.   CHARACTERISTICS OF REAL ESTATE

·         Physical

·         Economic

·         Legal

·         Others

 

1. Physical Characteristics:

 

Immobility  -       no physical market place;

                                -       Spatial fixity

                                        Huge in size;

 

Heterogeneous    -       unique, in terms of location, building, financing;

Differences in location, conditions, design, size, security of tenure;

 

Durability/ perpetuity   -       durable physically;

                                        -       land is durable and indestructible;

 

Long production time   -       construction of buildings may                                                consume years;

Property management -       management problems in owning property;                    

                                        -       Internal and external pressures;

                                        -       Landlord/ property owner appoints                                                         professional property manager;

 

 

 

b.  Economic Characteristics       :     

 

Interest and rights       -       ownership is all about interests and rights to its registered owner;

                                                -       title deeds is necessary;

                                        -       provide regular income;

 

Decentralized Market   -       bought and sold through agent’s familiar with a particular locality;

                               

Hedge against inflation -       better hedge against inflation than stock;

 

Large transaction costs -       cost much more;

-       Professional fees, valuation report, estate agency, legal fees, registration with local authorities, renovation;

-       Investments can be done                                             through acquiring property companies, property bonds or shares;

 

Supply lag                  -       market adjustment process subject to time delay due to time to finance, design and construct; adjustment mechanism tend to be slow; vulnerable to economic boom or  recession;

 

Cyclical values            -       responds to the ups and downs in the global economy and also the local market;

 

 

c.   Legal Characteristics:

 

Varying legislations and law   -       National Land code

                                        -       Contracts Act

-       Town and Country Planning Act                                     

 

Complicated Transaction Procedures-     transfer of interest;

                                        -       Registration of interest;

-       Preparation of legal documents;

-       Discharge of encumbrances; caveats;

Statutorily Charges      -       assessment, quit rent and premiums;

                                -       real property gain tax;

-       encompass large amount of money; high transaction   cost;

 

 

1. Other Characteristics:

 

Lack of publicly available information; asking price, transacted price, discounts, Access of information is through estate agents which require a professional fee; increase the transaction cost;

 

Ordinary goods, information on the goods are listed out in the forms of brochures, catalogues and price tags;

 

2.  PRICE DETERMINATION

Amount asked, offered or paid for; publicly disclosed or retained in private; price paid may or may not have any relation to the value of goods or services;

 

Price determined by the forces of supply and demand; supply of property relatively inelastic due to physical nature, planning laws and security of tenure;

 

Demand is also relatively inelastic; purchaser needs to have necessary funds or income or potential income to command a sufficient loan;

 

Motives for acquiring property:

                -       Occupation;

                -       Investment (long term);

                -       Speculation (short term);

                -       Development;    

 

Demand for property plays a major role in determining price and the factors affecting demand are as follows :-

                -       State of the general economy;

                -       Changes in the structure of the economy;

                -       Productivity of the property;

                -       Government intervention;

                -       Change in transport facilities;

                -       Alteration in the size and structure of the population;

 

Price determination mechanism revolves around the vendor and the purchaser; prime and final decision makers with professionals as advisors to achieve a reasonable value in the market;

 

Differential between ‘space markets’ (for functional terms) and ‘asset markets’ (for future cash flows);

 

a)      Open Market:

 

It is impossible to tell definitely whether the existence of supply will result in demand or vice versa; the parties will undergo a bargaining process to achieve an acceptable price to both parties;

 

Some of the important factors that affects the demand and supply of property are:

        -       Economic factors; regional or international;

-       Geographical factors; location, topography, climate, communications,         services;

-       Population; minimize price increase in areas where there are still ample supply of undeveloped land; real estate value will appreciate in mature/ established localities;

-       Physical aspects; every property possess varying identities; ever.

-       demanding purchasers led developers to churn out more creative designs which inevitably vary the prices of property;

-       technological/ building method; adopting varying construction technologies invites the involvement of foreign expertise and in turn     increase cost which will be transferred to the purchaser;

       

-       Fashions and trends; better built up properties will incur higher building costs; decrease amount of vacant land for new development will also increase price;

-       Occupancy status; high occupancy evolves a seller’s market in which owners have ultimate choice of tenants; with low occupancy rate;  the buyer’s market will prevail;

-       Development approvals; will lead developers to invest in vacant parcels of land and come up with new development; provision of sufficient public facilities will be a plus factor for the value of     properties to increase;

-       Tenure and title conditions/restriction; freehold and leasehold;   freeholder entitled to perpetual right and leaseholder entitled to        limited tenure; there are legal binding endorsements or restrictions which might reduce the desirability of owning properties;

-       Parties involved; valuers or property consultants; real estate agents; 

 

b)      The Controlled Market:

        -       Government Policy; 30 percent of affordable housing; controlled selling price;

-       New Economic Plan; quota on ethnic group purchasers; discount;      

 

3.  Methods of Valuation

-       The Comparison Method; based on direct market evidence and is very much dependent on the skill knowledge and experience of the valuer; in comparing         properties differences will appear in terms of position, plot size, floor area,         design, number of rooms, age and condition; ideal when properties compared are similar, in the same area and market relatively stable;

-       The Investment Method; Net Income X Years Purchased =Capital Value

-       The Cost Method; known as depreciated replacement cost method; used for properties which come onto the market for special usage

Capital Value = Site Value + Building Cost + Professional Fee – Depreciation

       

        -       The Residual Method

                Current Value Of Land = (Development Value –                               Development Cost) PV to      develop land

 

 

4.     REAL ESTATE CYCLES

 

(a)    Mechanism of Real Estate Market Cycle:

 -      Starts with population growth and industrial development; facilitated by public         works and other government services; increase demand eventually surpassing supply;

-       Time required for the supply; rents and land values will rise; rate of increase         rises; increase in real estate prices;

-       The peak of the real estate cycle is characterized by a high volume of real estate transfers;

-       Soon after the peak, the real estate market enters a slow phase; prices are no         more escalating;

-       During the downswing, the net income of real estate plunges due to falling         rents and increased vacancies, while mortgages and other operating costs         remain rigid in the short term; widespread defaults; foreclosure rate increases;    unemployment and lower real wages reduce demand for real estate;

        -       Intervention of government during peak or low;

(b)    International Influence:

-       Real estate is cyclical in nature owes its affiliation to the economy;

-       open to the influence of international economics; when it is slow, the general outlook is dreary and current exchange rate becomes unfavorable; high inflation rates shrink purchasing power of consumers;

(c)    Regional Influences:

-       encompass level of local establishment and political stability;

 

5.  RISK ELEMENTS

(a)    Economic Investment Risk

• International; risk of speculation causing economic downturns; e.g George Soros attack on the currency market in the 1990s;
• Regional; stable political environment greatly enhance the market outlook; invites the inflow of foreign funds; accelerate the growth of the economy; regional political cooperation is also a vital factor;
• Cycle of supply and demand; we can predict based on past trends but one will never known when the market is at its peak or is low;
• Government Policy; alternation in the government policies would expose different kinds of risks to real estate;
• Value Depreciation; inevitable; off set by the appreciation in land value; when property are located out of the development concentration area, value of properties might depreciate resulting in monetary loss;

(b)    Buildings:

Normal wear and tear;

Nature’s Act;

Lack of Maintenance / low construction Quality;

(C)    Legal

Acquisition;

New zoning causing the value to drop;

(d)    Government Policy: