Property Targeting for High Returns
by Petros S. Sivitanides, Ph.D.
Property targeting and selection is the most important stage in the real estate investment process. If the selected property has poor economic fundamentals, and most importantly, poor income and value growth prospects, then the investment will not be successful, unless it was purchased at a price below market value. A typical real estate investor's objective is to maximize the return on his investment, or at least, achieve a satisfactory minimum target rate of return, while minimizing risk. These objectives form the framework of the property targeting process, which needs to account for all the factors that contribute to investment return. The return on real estate investments has two components: an income component, that is, the return from the income (mostly rental) the property is producing, and an appreciation component, which represents the growth in value from the time of purchase. For example, a property that is producing a Net Operating Income (NOI) that is 8% of its purchase price or value provides an 8% income return. In addition, if its value since the time of purchase increased at an annual rate of 5% then the appreciation component of the investor's return will be 5%. The investor's total return will be the sum of these two components, that is, 13%. Notice that if the appreciation component were 0 then the investor's return would be only 8% and if property value declined let's say by an annual rate of 3% the investor's return would be only 5%. Within this context, property targeting for high investment returns should focus on properties with strong value growth and appreciation potential. Typically, in a competitive real estate investment market the income component ranges from 6 to 10% depending on the type of property (apartments, office, retail or industrial/warehouse). These market realities reinforce the argument that investors targeting high returns, which I define as 15% and above, should focus their efforts finding properties with strong value growth potential. One category of properties that fit within this targeting framework includes properties with potential for significant improvement of their accessibility, visibility, and traffic exposure. Large urban transportation projects, such as new light transit systems, or the expansion of existing ones, new freeways, highways, and bridges change considerably urban traffic patterns, shifting heavy traffic from one street to another, and creating new heavy-traffic corridors and intersections. Properties found on either side of these new heavy-traffic corridors and intersections will experience a dramatic improvement of their accessibility, visibility, and vehicular traffic exposure. Thus, commercial properties or properties in other uses that can be converted easily and at low cost to commercial use, should appreciate considerably as they become exposed to heavy traffic and, as they become more accessible from every location in the metropolitan area. Be aware that residential properties about to be exposed to heavy traffic will lose value and should be avoided, unless they can be easily converted to commercial. The effect of newly created transportation corridors will be felt, not only by properties that are on the corridor, but also by clusters of uses and sites that are in close proximity to it. For example, office building clusters and vacant commercial sites that gain proximity to newly constructed freeways, major transportation arteries, and light rail system stations should also gain considerably in value, as their accessibility to clients and labor within the metropolitan area improves significantly. Jonathan (2002) reports that office rents at locations adjacent to Toronto’s light rail transit stations climbed 30% above the city average. Similarly, residential areas, whose broader access improves significantly as a result of close proximity to such new corridors, should also register significant gains in value. 1This is an excerpt from the book Profitable Real Estate Investing: A Value Growth Approach by Petros S. Sivitanides.
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