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Running head: REAL ESTATE INVESTMENT 1

REAL ESTATE INVESTMENT 12

TOPIC: REAL ESTATE INVESTING

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Abstract

Real Estate Investment has gained significant attention among researchers, policy-makers, practitioners, and other stakeholders. Understanding real estate investing involving land and building is critical for real estate investors to decide on effective capital investment and possible returns in the business area. Several studies have provided critical concepts in investing in real estate as a major study for practical applications. According to the researchers, evaluating real estate investment is critical in realizing investment purpose, time, and return (Krulický & Horák, 2019). Moreover, the authors have submitted that Issues concerning the economic and physical properties of the estate that constitute its value are of great importance for prospective investors in the real estate market. (Klimczak, 2010). Furthermore, understanding the trend in investing in real estates such as bossiness environment, capital markets, business transformation, and city prospects is necessary for effective comprehension of investing in real estate (Pires et al., 2018). According to the previous study, there is a need to address critical challenges facing real estate investment and possible solutions to achieve investment gains and benefits. The study will accommodate a qualitative approach and value theory theoretical framework to establish factors and challenges in real estate investment and quantitative methods to assess numerical and statistical data on real estate investment and performance. The study outcomes will help researchers, policy-makers, practitioners, and other stakeholders to understand real estate investment challenges and solutions toward effective investment decisions.

Keywords: Real Estate, Challenges, value theory, and solutions

Introduction

Currently, there is an increase in the living standards of most people in the world. This has also increased the finances of most countries around the world. In the United States, the growth in household savings increases the urge to keep funds for the future until there is a need to use or invest. According to Prizzon and Cullino (2019), there are various ways in which households can free and use their funds. However, this depends on various factors such as the required liquidity, the approach to risk, and the required return. One of the most common strategies for household investment is the purchase of the real estate. Investment real estate is defined as real estate that is purchased specifically for commercial purposes. According to the value theory and economic theories, investment is defined as a process of sacrificing present values for future risks, uncertainties, and investments (Turner and Thomas, 2010). The investment cycle can be represented in figure 1 below:

Figure 1: Investment cycle

Source: Investment cycle

From figure 1 above, real estate investment can be determined by three key factors; the return expected, the risks identified, and the liquidity of the investment. In real estate investment, investors always expect higher returns from higher risks. Moreover, liquidity then expresses the ability to convert a given real-estate investment into a desired asset or money. As Giordano et al. (2018) state, the three characteristics are typical features of a real estate investment. Each real estate investment is made with a vision of future return.

Literature Review

Stages of a real estate investment

There are two main phases of a real estate investment. The first phase of real estate investment is the pre-investment phase. During this phase, the investor collects, analyzes, and evaluates all the documents that are related to the intended investment (Chen et al., 2018). First, the investor has to determine the cost of the investment and evaluate whether it fits into the budget. After thorough analysis and investment, the investor may decide to withdraw or continue with the project according to the visions and goals set. In the construction industry, various activities may be included in pre-investment planning. They include geological surveys, costs of various permits, and project and pre-project activities. Janeková et al. (2017) state that the second stage of real estate investment is the investment phase or the realization phase. This is the actual investment and subsequent collection of return on investment. The investment phase is often the longest period of all the investment stages. During this phase, the investor is always under threat of losing his properties or profits due to many unavoidable factors (Bad locations, negative cash flows, or lack of liquidity).

Real estate as an investment

Real estate is among the many options for household savings. As Sung et al. (2018) state, investing in real estate can be represented by real estate and how it generates the expected return to its owner. The demand for rental investment and housing is the most common form of investment in real estate investment. This is always typical for the majority of people in the countryside who chose to rent houses before purchasing their apartments after a while (Bradbury et al., 2019). In the United States, for example, the demand for housing units increased enormously between 2013 and 2018. This affected their subsequent costs and prices as indicated in the HB Index in figure 2 below.

Figure 2: HB index for housing units and prices in US (2013-2018)

Source: Prizzon and Cullino (2019)

Determination of the real estate open market value and rent

The best strategy for an investment property is investing in rental houses. In this type of investment, Bade and Hirth (2016) state that the owner has two main options. The first option is a lease option for long-term (according to the number of years) or short-term lease services (according to days or weeks). The long-term lease is mainly characterized by a long-term agreement between the investor and the tenant 

The open market value is the local rice that is agreed upon between voluntary independent sellers and buyers. However, there is no consideration for extraordinary effects such as price inflations. For comparison, the number of objects being compared is very crucial. However, this is always limited by the amount available in the local market segment (Gao et al., 2018). Hence, the number of objects being compared is limited from the top since the objects beings used for comparison must fulfill certain criteria. The comparative method can only be used in cases where a market with the same assets is fully developed. To measure the comparative value of a real estate investment, an example of six comparable real estates in the US was used. The six estates were offered for sale in Texas in the United States in a period between 1/9/2018 to 30/9/2018. All these real estate properties had close qualitative terms. As Fields et al. (2016) state, the reduction coefficient of the price was determined for individual real estate properties after consideration by the experts. This was regarding the bargaining power of the seller and the buyer with the final price. The selection of the co-efficient value for each comparable property is highlighted in the table below;

Table 1: Determination of the open market value of investment real estate property

Source: Prizzon and Cullino (2019)

Challenges of real-estate investment

One of the biggest challenges of this investment is its unpredictability. Krulický and Horák (2019) note that real estate has proven that it can become resilient to some economic factors that include pandemics and economic recessions. One of the basic assumptions from the experts is that if a property is bought today, it can still be sold some other time. Real estate values may rise over time but the market is still unpredictable. This means that a person’s investment can still depreciate. Several factors may lead to this depreciation. They include government policies, interest rates, demographics, interest rates, and the supply/demand curve (PWC, 2022). Another challenge is the investor choosing a poor location. When buying an investment property, location should always be the priority. As Eves (2012) states, location is the engine that determines other factors that may help to make profits. Location may influence the demand for your properties, rental rates, and the ability of your properties either to appreciate or depreciate. Poor location is likely to give lower returns while the best locations will give the best returns. Another challenge for real estate investment is the negative cash flows (Klimczak, 2010). In real estate investment, negative cash flows refer to the money that is left over after paying all the expenses, insurance, taxes, and mortgage payments. Negative cash flows happen when the money being invested is less than what the investor is getting. Some of the causes of negative cash flows include high vacancy rates, costly maintenance, and high financial costs on loans.

Conclusion and recommendations

To conclude, this paper aimed to evaluate real investment as a business, identify the possible challenges, and provide solutions to some of these challenges. It is established that real investment is a business that can return maximum profits to the investors if several factors are met. First, investors need to undertake a background check on the type of real estate to invest in the location and the effectiveness of customers within the localities selected. On the other hand, the paper also established various challenges that affect real estates such as negative cash flows, bad markets, and high vacancy cases. However, these problems can be avoided if investors chose the best locations for investment and also set the right prices for their properties.

References

PWC. (2022). Emerging Trends in Real Estate Road to recovery. https://www.pwc.com/gx/en/asset-management/emerging-trends-real-estate/assets/emerging-trends-in-real-estate-europe-2022.pdf

S. Sung, H. Cho, D. Ryu (2018). The Behavior of an Institutional Investor with Arbitrage Opportunities and Liquidity Risk. Emerging Markets Finance and Trade, 55(1), 1-12,

Y. Chen, M. Chiang, C. Weng (2018). Are investors always compensated for information risk? Evidence from Chinese reverse-merger firms. Review of Quantitative Finance and Accounting, 1-38,

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