Property Investment Analysis The internal rate of return is the most comprehensive and most commonly used measure of evaluation of real estate investment performance but other indicative measures of other aspects of investment performance can be also calculated such as Gross Income or Rent Multiplier, Net Income Multiplier, Return on Equity, Cash-on-Cash Return etc., when a thorough property investment analysis is performed. The formulas and examples for the estimation of the internal rate of return, and many other measures of investment performance are presented and discussed in the 46-page e-book titled Real Estate Investment Mathematics. Market analysis is a very important element of the whole property investment analysis process. This focuses on the analysis of the local market examining demand and supply conditions, as well as vacancy rates, rents and prices, for the particular property type the investor is interested. The purpose of the market study is to assess whether the market is tight or soft; whether prices and rents are rising; how much space is planned and under construction; what is the most likely outlook for demand given economic trends and prospects, especially for economic sectors that are most relevant to the type of real estate examined; the outlook for supply given the planned and under construction projects; the outlook for vacancy and rents given the outlook for demand and supply; and the outlook for prices given the outlook for rents and capitalization rates. Ideally, if there are long enough historical data for demand, new construction and rents, the market study should include econometric forecasts of these variables, as a means for describing the most likely future state of the market, that will be used as the base case for carrying out the investment analysis for the particular property examined.
Highest and best use analysis is another component of property investment analysis, especially in the case of vacant land or deteriorated property that needs to be redeveloped. Highest and best use is defined as the most profitable use at which a site can be developed. Thus, highest and best use analysis is usually carried out for land sites that are acquired for development purposes. A site’s highest and best use will depend on a number of factors including site physical characteristics, its location, make up and purchasing power of the population in its area of influence, competitive projects in its area of influence, market conditions and prospects at the time of analysis, and other factors. If the land site is zoned in an urban use, the highest and best use analysis will focus on the feasibility and profitability of developing the alternative allowable uses. If there is a good chance for obtaining re-zoning of the site to some other uses then these uses should be also included in the highest and best use analysis. The highest and best use analysis will take into account all costs and expected revenues from a particular use in which the site can be developed and estimate the expected return for the investor. Major components of feasibility studies for real estate include: Analysis of Proposed Site in terms of location, broader and closer accessibility of the site, visibility, drive-by traffic and local exposure, topography, building layout and design, and the property’s overall suitability for the use analyzed.
Demographic Analysis of the population within the project’s area of influence or catchment area, including population breakdowns by age, income, sex, household income, spending patterns, etc. Urban growth and suburban growth trends should be also taken into account in assessing the demographics of the project's potential area of influence.
Analysis of Competition focusing on planned, existing and under construction projects that are expected to compete with the project under consideration. This analysis typically includes for each project size in square feet or units, quality, asking or selling prices or rents, features, major tenants the case of commercial projects, map with location of each project, etc.
Demand Analysis, which focuses on recent trends in terms of absorption of rental space or sales rates of units expected sales rate or lease up rates taking into account the project’s strength and competitive position, the performance of existing competing projects, the expected additional competing projects to enter the market by the time of project completion. In case of retail projects demand analysis will derive estimates of expected visitation/capture rate from primary and secondary market area of the project, estimates of sales potential along different lines of retail spending, and supportable square footage by line of trade.
Financial Analysis, which includes estimates of the rent/prices that the particular project will command upon completion given its competitive position in the market, lease up timing, cash flow estimates net present value and return projections over a particular holding period, typically 5-10 years. In small projects, the time horizon of the analysis may be shorter. The most commonly used model for analyzing the financial feasibility of real estate investments is the discounted cash flow (DCF) model. It is advisable when assessing the financial feasibility of a project to run different scenarios regarding the value of critical inputs that affect project returns in order to assess its sensitivity to some critical assumptions. Such an exercise is necessary in order to assess the risk of the investment. Financial analysis is one of the most crucial components of property investment analysis, because it incopropates the conclusions and implications of the other studies in terms of the profitability of the investment, and provides the final assessment as to whether the investment is worth pursuing or not. One of the best books on property investment analysis for commercial real estate is the book written by Geltner and Miller, two of most distinguished minds in the real estate academic community. Their book bridges the gap between mainstream finance and the current cutting edge of professional real estate practice.
Besides analyzing and evaluating each property separately on its own merits, in the case of investors that own more than one property, a comprehensive property investment analysis process must also include an analysis at the portfolio level. Such an analysis will result in the determination of additional acquisition criteria that will help the investor achieve an optimal portfolio composition, which will maximize potential returns and minimize risk, given the anticipated market and investment environment over the holding period of the portfolio. Such optimal portfolio composition may be defined through asset allocation models that use modern portfolio theory and the Markowitz model. Furthermore, additional property selection criteria may be stipulated based on broader property portfolio strategies. Within the context of a portfolio strategy, property investment analysis needs to examine whether the property under consideration fits the investment criteria of the portfolio strategy in terms of property type, location, size risk level and any other parameter stipulated by such strategy.
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Return from Property Investment Analysis to Property Investing
