Real Estate admin  

Some financial aspects of property and real estate investments

Properties or real estate are not considered truly liquid investment instruments since individual properties or real estate are not exchangeable. Therefore, identifying land or real estate in which to invest can require a great deal of time and effort, and much depends on how familiar investors are with the particular segment of the market corresponding to their interests. Real estate or land investors often use a variety of appraisal methods to make their lives a little easier by comparing prices. Sources of price information may include: public auctions, private sales, government agencies, stock listings, or real estate agents.

Real estate or land assets are much more expensive than bonds or stocks. Therefore, investors most often resort to a mortgage loan that can be guaranteed by the land or the property itself. Consequently, we generally use the terms *equity* or *leverage* with reference to the money paid by the investor as opposed to the amount loaned by the bank. Their ratio is called Loan-to-Value (LTV), which is considered to represent the risk assumed by the investor. Most banks consider 20% of the appraised value as a minimum capital requirement. A lot of pension funds and REITs, or real estate investment trusts, regularly buy land or real estate with *zero* leverage, which minimizes their risks, but also limits their return on investment (ROI).

If the purchase of the land or real estate is leveraged, the required monthly installments or “maintenance costs” can result in a negative cash flow for the investor immediately after the purchase. In addition to potential positive cash flow elements, such as those generated by depreciation, capital accumulation, and capital appreciation, investors may also partially or fully offset “carrying costs” through so-called Net Operating Income, or NOI. This technical term generally means *rents minus expenses* and in countries other than the US it is often referred to as Net Cash Flow. The *NOI/purchase price* ratio is called the Capitalization Rate. It indirectly indicates how many years the property or real estate will be amortized in a financial environment without interest.

For example, if an investor has purchased land or real estate for $800,000 that generates a positive net operating income of $40,000 per year, then the property’s capitalization rate is 5%. It shows the investor that the land or real estate property will pay for itself in 20 years in terms of net cash flows.

Leave A Comment