1. Chapter 1
The Real Estate Investment Decision

2. Investment Analysis: Art and Science
Historically lagged behind mainstream finance and investment thought; great strides recently
Treats real estate as capital asset desired for stream of benefits
Real estate investment as special case of modern capital budgeting

3. Why Invest in Real Estate?
Investors take equity or debt position
Distinction between investors in real assets and investors in financial assets
While both are investors, exclude mortgage lenders from this study of investment analysis and decision making

4. Figure 1.1 7

5. Who Invests in Real Estate?
Private investors
Institutions, such as REITs and pension funds
Small level of foreign holdings
Concentrated in locales and types of properties
Surged during early 1980s and again in the 1990s
Level shifts with foreign exchange rates
Level impacted by relative interest rates

6. Figure 1.2
Source: Based on data from National Association of Real Estate Investment Trusts 4 4

7. How Have Real Estate Investments Performed?
Data for investment comparisons scarce, but frequently concluded that real estate generates returns roughly comparable to common stock, with greater predictability of returns
More data for investment return comparisons available recently, but heavily influenced by period from which data are drawn
Brueggeman, Chen and Thibodeau analysis--real estate funds outperformed Standard’s and Poor’s 500 stock index and Ibbotson Associates bond index

8. How Have Real Estate Investments Performed?
Giliberto compared REIT yields with Standard and Poor’s 500 stock index, 1978 – 1989; found advantage in common stocks
Zerbst and Cambon (1984) analyzed earlier studies; found real estate tends to outperform stocks during periods of inflation
Clayton and MacKinnon (2001) find REIT returns now closely correspond to returns on small capitalization stocks

9. Definitions and Concepts
Investment Value – Value of a property as an investment to a present or prospective owner
Most Probable Selling Price –
Probabilistic estimate of the price at which a future transaction will occur

10. Definitions and Concepts
Transaction Investment value from the present owner’s perspective sets the lower end of the range of possible transaction prices. Investment value from the perspective of the most likely buyer determines the upper end of the range.
To be motivated to sell, seller must conclude most probable selling price is greater than investment value
To be motivated to buy, buyer must conclude investment value is greater than most probable selling price
For transaction to be possible, investment value from prospective buyer’s point of view must be greater than from the prospective seller’s point of view
Market Value – the most probable price at which the property would sell in a competitive market as of the date of the appraisal, if it had been exposed to the market for a reasonable time. The estimate assumes reasonably informed parties, each acting in his or her own best interest and with neither subject to undue influence.

11. Figure 1.3

12. Figure 1.4

13. Figure 1.5

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

15. Estimating Investment Value: An Overview
Value of an investment property is sum of the debt and equity positions
Investment can be expressed as present value of the equity position plus the present value of debt position

16. Figure 1.6

17. Figure 1.7

18. Investors Disagree on Investment Values
Investors unlikely to arrive at same investment value conclusions as they differ on:
Future stream of rental revenue and operating expenses
Perceived levels of risks
Willingness to defer immediate consumption in interest of future benefits
Desire for precisely determinable future
Investors in higher-income brackets benefit more from tax-deductible losses

19. Investor Objectives and Risk
Seek financial return as reward for committing resources and as compensation for bearing risk
Emotional temperament plays a large role in an investor’s attitude
Relate expected return to risk; accept additional perceived risk only if accompanied by additional expected return
Tend to become increasingly averse to additional risk as total perceived risk increases

20. Figure 1.8

21. Figure 1.9