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Benedetto Manganelli Real Estate Investing Market Analysis, Valuation Techniques, and Risk Management Real Estate Investing Benedetto Manganelli Real Estate Investing Market Analysis, Valuation Techniques, and Risk Management 123 Benedetto Manganelli School of Engineering University of Basilicata Potenza Italy ISBN 978-3-319-06396-6 ISBN 978-3-319-06397-3 (eBook) DOI 10.1007/978-3-319-06397-3 Library of Congress Control Number: 2014943417 Springer Cham Heidelberg New York Dordrecht London Ó Springer International Publishing Switzerland 2015 This work is subject to copyright. 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Violations are liable to prosecution under the respective Copyright Law. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. While the advice and information in this book are believed to be true and accurate at the date of publication, neither the authors nor the editors nor the publisher can accept any legal responsibility for any errors or omissions that may be made. The publisher makes no warranty, express or implied, with respect to the material contained herein. Printed on acid-free paper Springer is part of Springer Science+Business Media (www.springer.com) Contents 1 The Real Estate Market ................................ 1 1.1 Generalities on Property . 1 1.1.1 Economic Characteristics . 2 1.1.2 Land-Use Regulations and Economic Effects . 4 1.1.3 Extra-Economic Characteristics . 5 1.1.4 The Real Estate Operators . 5 1.2 The Nature of the Real Estate Market . 8 1.2.1 An Imperfect Market. 8 1.2.2 Segmentation . 9 1.2.3 The Short and Long Period . 11 1.2.4 Cycles in the Housing Market . 12 1.2.5 Supply Classification. 16 1.2.6 The Variables that Affect the Supply of Properties . 16 1.2.7 Demand Classification . 18 1.2.8 The Determinants of the Demand for Real Estate . 18 1.2.9 The Sales Market . 21 1.2.10 The Rental Market . 27 References . 30 2 The Market Research.................................. 33 2.1 The Usefulness of Research . 33 2.2 The Availability of Data and the Sources . 35 2.3 The Development of the Research . 38 2.4 Reliability of the Research . 42 2.5 Costs and Benefits of Research . 42 2.6 Defining the Market. 43 2.7 Analysis of Market Potential. 44 References . 51 v vi Contents 3 Financing .......................................... 53 3.1 General Information on Financial Markets . 53 3.2 The Leverage . 54 3.2.1 The Measure of Leverage . 56 3.2.2 How Much Finance? . 57 3.3 Financing Costs. 57 4 The Real Estate Investment ............................. 61 4.1 Features of the Property Investment. 61 4.1.1 Classification of Investments . 63 4.2 The Reasons for the Investment . 63 4.2.1 Advantages and Disadvantages of Investment Property. 64 4.2.2 The Value of Investments . 67 4.2.3 Comparison with Other Types of Investment . 69 References . 70 5 Investors and Investment Strategies ....................... 71 5.1 Classification of Investors. 71 5.2 The Behaviour of the Investor and the Risk Appetite. 72 5.3 The Real Estate Development Process . 74 5.4 Objectives and Strategy of the Investor . 76 5.5 Choice of Type of Intervention and Location . 79 5.6 The Decision-Making Process . 84 5.6.1 The Layout of a Pattern. 84 5.6.2 The Feasibility Study. 86 5.6.3 The Investment Value . 94 References . 96 6 Investment Evaluation ................................. 97 6.1 Introduction . 97 6.2 Cash Flow Evaluation . 98 6.2.1 Benefits and Future Building Value Evaluation . 99 6.2.2 Operating and Management Expenses . 102 6.2.3 Recovery Value . 104 6.2.4 Financing Management . 106 6.2.5 Evaluation of Construction Costs . 107 6.3 Traditional Techniques for the Analysis of Profitability . 109 6.3.1 Advantage Reports . 109 6.3.2 Financial Measures . 110 6.3.3 Measures of Profitability . 117 6.3.4 The Limits of the Traditional Criteria of Profitability . 120 Contents vii 6.4 Modern Techniques for the Analysis of Profitability . 121 6.4.1 Introduction to Discounted Cash-Flow Analysis . 121 6.4.2 The Net Present Value. 122 6.4.3 The Internal Rate of Return . 124 6.4.4 Other Indicators . 131 6.4.5 The Discount Rate . 133 References . 135 7 The Risk Analysis .................................... 137 7.1 The Variables and Risk Factors. 137 7.2 The Analyst’s Task . 142 7.3 Risk Control . 144 7.4 Traditional Methods for the Treatment of Risk . 146 7.4.1 Risk-Adjusted Discount Rate . 146 7.4.2 Certainty Equivalents . 147 7.5 The Probabilistic Analysis . 150 7.5.1 Partitioning and Sensitivity Analysis . 151 7.5.2 Decision Tree Analysis . 155 7.5.3 The Monte Carlo Simulation . 160 7.6 Mathematical: Statistical Criteria. 162 7.6.1 The Average-Variance Approach . 177 7.6.2 The Expected Utility Theory . 179 7.6.3 The Approach of Stochastic Dominance . 183 7.6.4 Evaluation Based on Differentiated Assumptions . 185 7.6.5 Mathematical Programming . 185 7.7 Limits and Perspectives of Evaluation Techniques. 186 References . 188 8 The Theory of Real Options in Real Estate.................. 189 8.1 Investment as a Generator of Real Options. 190 8.2 The Development of the Process . 193 8.3 Risk Analysis . 193 8.4 The Process of Strategic Analysis . 194 8.4.1 Identification of Areas of Managerial Adaptability . 194 8.4.2 Identification of Options and Their Parameters . 195 8.4.3 Verification of the Operating Conditions . 200 8.4.4 The Process of Quantitative Analysis . 203 8.4.5 The Calculation Models for Extended NPV . 203 References . 210 Chapter 1 The Real Estate Market Abstract This chapter introduces the basic features of the real estate market. This is an imperfect highly segmented market. The segmentation is derived from the characteristics of traded goods. In order to understand the trend in the different submarkets, the following paragraphs analyse the trend patterns of stakeholders involved in the sale or purchase of property or in the use of a property. A clas- sification of demand and supply is developed, identifying the main macroeco- nomic factors that affect these two functions and the interpretation about how they interact, is given. 1.1 Generalities on Property The ownership and control of a building or any part thereof have always been considered fundamental actions of an individual’s life. They fulfil a primary human need: that of their home or shelter for property, machines or animals. However, changes in social habits have reduced the significance and impor- tance always attributed to the dependence of people on the ownership of the land and of what artificially permanently insists on it. It occurs, in fact, that today an individual frequently decides—for cultural, social and especially economic rea- sons—to rent the apartment in which to live thereby giving up the possibility to get full control through the purchase of the property. In addition, the individuals often work in offices, factories and stores that do not belong to him. The changing balance between primary needs and the way in which people manage to satisfy them, the new requirements that accompany the change in the lifestyle of people, have changed the attitude towards the control of the real estate. It is true, however, that a building offers a very wide range of services and benefits, and the current primary needs mentioned above represent only a portion of those needs that individuals feel and that the building can meet. Therefore, the purpose for which many individuals, have the financial capacity, purchase real Ó Springer International Publishing Switzerland 2015 1 B. Manganelli, Real Estate Investing, DOI 10.1007/978-3-319-06397-3_1 2 1 The Real Estate Market estate, in some cases does not depend on personal satisfaction of primary needs but instead responds to the need to preserve capital and make a profit. In principle, there are thus two reasons that impel the economic player, household or company, to purchase an urban property: • Benefit from a flow of services derived from the self-consumption of the property, when the building is used as a dwelling or is instrumental to production; • Ensure a flow of future income when they consider the purchase of property as an investment. Because of personal qualifications and aptitudes of the operator who exerts the demand for real estate, the reasons and the weight of the factors that determine the purchase of goods, change. Economic reasons certainly influence consumer behaviour: income, the interest rate on loans, the level of taxation on transfer and possession.

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