1 1

The Real Estate

The Real Estate
Investment Decision
Investment Decision
LDM GROUP
LDM GROUP
Franklin Templeton Asset Group
Franklin Templeton Asset Group
2 2
State of the Investment
State of the Investment
Analysis Art
Analysis Art

Historically lagged behind

Historically lagged behind
mainstream finance and
mainstream finance and
investment thought; great
investment thought; great
strides recently
strides recently

Treats real estate as capital

Treats real estate as capital
asset desired for stream of
asset desired for stream of
benefits
benefits

Real estate investment as

Real estate investment as
special case of modern capital
special case of modern capital
budgeting
budgeting
3 3
Real Estate as an
Real Estate as an
Investment
Investment

Investors Passive or Active

Investors Passive or Active

Active investors
Active investors
acquire direct
acquire direct
title to real property; either
title to real property; either
oversee property themselves or
oversee property themselves or
hire management firms
hire management firms

Passive investors
Passive investors
place assets
place assets
with professional money
with professional money
managers who acquire interests
managers who acquire interests
in real property; may acquire
in real property; may acquire
shares in corporations or
shares in corporations or
partnerships that hold real
partnerships that hold real
property interests; make no
property interests; make no
operating decisions
operating decisions
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Real Estate as an
Real Estate as an
Investment
Investment

Investors take equity or debt

Investors take equity or debt
position
position

Distinction between investors in

Distinction between investors in
real assets and investors in
real assets and investors in
financial assets
financial assets

While both are investors, exclude

While both are investors, exclude
mortgage lenders from this study
mortgage lenders from this study
of investment analysis and
of investment analysis and
decision making
decision making
5 5
Figure 1.1
Figure 1.1
6 6
Who Are the Investors?
Who Are the Investors?

Private investors
Private investors

Institutions, such as REITs and

Institutions, such as REITs and
pension funds
pension funds

Small level of foreign holdings

Small level of foreign holdings

Concentrated in locales and

Concentrated in locales and
types of properties
types of properties

Surged during early 1980s and

Surged during early 1980s and
later moderated
later moderated

Level shifts with foreign

Level shifts with foreign
exchange rates
exchange rates

Level impacted by relative

Level impacted by relative
interest rates
interest rates
7 7
Figure 1.2
Figure 1.2
8 8
Real Estate Investment
Real Estate Investment
Performance
Performance

Data for investment comparisons

Data for investment comparisons
scarce, but frequently concluded
scarce, but frequently concluded
that real estate generates returns
that real estate generates returns
roughly comparable to common
roughly comparable to common
stock, with greater predictability of
stock, with greater predictability of
returns
returns

More data for investment return

More data for investment return
comparisons available recently, but
comparisons available recently, but
heavily influenced by period from
heavily influenced by period from
which data are drawn
which data are drawn

Brueggeman, Chen and Thibodeau

Brueggeman, Chen and Thibodeau
analysis
analysis
--
--
real estate funds
real estate funds
outperformed Standard
outperformed Standard

s and
s and
Poor
Poor

s 500 stock index and

s 500 stock index and
Ibbotson Associates bond index
Ibbotson Associates bond index
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Real Estate Investment
Real Estate Investment
Performance
Performance

Giliberto compared REIT yields

Giliberto compared REIT yields
with Standard and Poor
with Standard and Poor

s 500 stock
s 500 stock
index, 1978
index, 1978

1989; found
1989; found
advantage in common stocks
advantage in common stocks

Zerbst and Cambon (1984)

Zerbst and Cambon (1984)
analyzed earlier studies; found real
analyzed earlier studies; found real
estate tends to outperform stocks
estate tends to outperform stocks
during periods of inflation
during periods of inflation

Clayton and MacKinnon (2001) find

Clayton and MacKinnon (2001) find
REIT returns now closely
REIT returns now closely
correspond to returns on small
correspond to returns on small
capitalization stocks
capitalization stocks
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Concepts and
Concepts and
Definitions
Definitions

Most Probable Selling Price

Most Probable Selling Price

Probabilistic estimate of the

Probabilistic estimate of the
price at which a future
price at which a future
transaction will occur
transaction will occur

Investment Value
Investment Value

Value of a
Value of a
property as an investment to a
property as an investment to a
present or prospective owner
present or prospective owner
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Concepts and
Concepts and
Definitions
Definitions

Transaction Investment value from the Transaction Investment value from the
present owner present owner s perspective sets the s perspective sets the
lower end of the range of possible lower end of the range of possible
transaction prices. Investment value from transaction prices. Investment value from
the perspective of the most likely buyer the perspective of the most likely buyer
determines the upper end of the range. determines the upper end of the range.
To be motivated to sell, seller must conclude To be motivated to sell, seller must conclude
most probable selling price is greater than most probable selling price is greater than
investment value investment value
To be motivated to buy, buyer must conclude To be motivated to buy, buyer must conclude
investment value is greater than most investment value is greater than most
probable selling price probable selling price
For transaction to be possible, investment For transaction to be possible, investment
value from prospective buyer value from prospective buyer s point of view s point of view
must be greater than from the prospective must be greater than from the prospective
seller seller s point of view s point of view
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Figure 1.3
Figure 1.3
13 13
Figure 1.4
Figure 1.4
14 14
Figure 1.5
Figure 1.5
15 15
Estimating Investment
Estimating Investment
Value: An Overview
Value: An Overview

Investor who buys property buys set of Investor who buys property buys set of
assumptions about ability of property to assumptions about ability of property to
generate cash flows over the expected generate cash flows over the expected
holding period and likely market value of holding period and likely market value of
property at end of proposed holding property at end of proposed holding
period. Analysis: period. Analysis:
Estimate the stream of expected benefits Estimate the stream of expected benefits
Adjust for timing differences in expected Adjust for timing differences in expected
streams of benefits from investment streams of benefits from investment
alternatives alternatives
Adjust for differences in perceived risk Adjust for differences in perceived risk
associated with alternatives associated with alternatives
Rank alternatives according to relative Rank alternatives according to relative
desirability of the perceived risk desirability of the perceived risk- -return return
combinations they embody combinations they embody
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Estimating Investment
Estimating Investment
Value: An Overview
Value: An Overview

Value of an investment
Value of an investment
property is sum of the debt and
property is sum of the debt and
equity positions
equity positions

Investment can be expressed as

Investment can be expressed as
present value of the equity
present value of the equity
position
position
plus the
plus the
present value of
present value of
debt position
debt position
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Figure 1.6
Figure 1.6
18 18
Figure 1.7
Figure 1.7
19 19
Investors Disagree on
Investors Disagree on
Investment Values
Investment Values

Investors unlikely to arrive at

Investors unlikely to arrive at
same investment value
same investment value
conclusions as they differ on:
conclusions as they differ on:

Future stream of rental revenue

Future stream of rental revenue
and operating expenses
and operating expenses

Perceived levels of risks

Perceived levels of risks

Willingness to defer immediate

Willingness to defer immediate
consumption in interest of future
consumption in interest of future
benefits
benefits

Desire for precisely determinable

Desire for precisely determinable
future
future

Investors in higher
Investors in higher
-
-
income
income
brackets benefit more from tax
brackets benefit more from tax
-
-
deductible losses
deductible losses
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Investor Objectives and
Investor Objectives and
Risk
Risk
Seek financial return as reward for Seek financial return as reward for
committing resources and as committing resources and as
compensation for bearing risk compensation for bearing risk
Emotional temperament plays a large Emotional temperament plays a large
role in an investor role in an investor s attitude s attitude
Relate expected return to risk; accept Relate expected return to risk; accept
additional perceived risk only if additional perceived risk only if
accompanied by additional expected accompanied by additional expected
return return
Tend to become increasingly averse to Tend to become increasingly averse to
additional risk as total perceived risk additional risk as total perceived risk
increases increases
21 21
Figure 1.8
Figure 1.8
22 22
Figure 1.9
Figure 1.9