LEARNING MODULE #5

INVESTMENT AND PORTFOLIO MANAGEMENT

REAL ESTATE
Real estate has been a favorite long term investment vehicle because it appreciates in
value with the passage of time and as the saying goes “people come and go but the land is
always there”.

Real Estate Defined

Real estate refers to the land and all permanent improvements thereon including
buildings. It may be agricultural, industrial, commercial, residential, or in the form of rental
units. Real estate may also be in the form of raw land. Rental units include condominiums and
apartments.

Advantages of Real Estate

a. It is a hedge against inflation – the price of land in the Philippines , in general
increases steadily.

b. It is one of the few infinite investments – land available for development is limited

c. It is one of the basic necessities of man - Real estate includes housing and shelter is
one of the basic need of man.

d. It is tangible asset and can be directly controlled by the owners – as such, it

provides a visible evidence of the investor’s financial status.

e. It can provide periodic income when leased out.

f. It can be used in financing - it is generally acceptable as collateral in obtaining

loans.

Disadvantages Real Estate

a. It requires a number of years to realize profit on the investment – due to the long
holding period, the investors deprives himself of opportunities in the other forms of
investment.

b. It is immovable so that it is not easily transferred from one party to another

 c. Mortgaging real property requires certain procedures adopted by lending
institutions such as credit investigation, property appraisal and maintenance of
required deposits (in the case of banks.)

d. Upon death of the investor, real property automatically forms part of his estate
which is subject to inheritance tax.

e. It involves big amount so that it is impractical to dispose of it in case the investor is

in need of small amount of additional capital

f. Its price is adversely affected in time of crisis. In case of chaos or war, it cannot
easily be disposed of.

Carrying Cost of Real Estate

The cost incurred in holding on to an investment in real estate consist of costs incidental
to ownership thereof such as property taxes, cost of regular inspection of the property, cost of
normal maintenance and insurance. In decision making, opportunity cost of capital is included
in the computations.

Opportunity cost of capital – this refers to the earnings that could be earned in the
other forms of investment but which are foregone by the investor by choosing one form of
investment.

Factors Considered in Real Estate Acquisition

In acquiring or buying real estate, an investor should look into the factors that
contribute to increase in market value of property such as the following:
1. Location – this is the primary factor in real estate investment. Is the property near a
commercial area, school, or church? Is it near a cement factory, hospitals, cemetery
or squatters’ colony or other places with high incidents of violence? Is there a 24-
hour transportation service available?

2. Frontage and shape of land – the wider is the frontage, the higher is the market
value of land. The shape is preferably rectangular for flexibility in designing
improvements thereon.
 3. Drainage and sewerage system – this prevents pipe clogging and minimizes risk from
flood during the rainy season.

4. Width of streets – streets should be wide enough for smooth flow of traffic. There
should be provision for pedestrian lane

5. Elevation – adequate elevation minimizes risk from flood.

6. Possible expropriation – the prospective buyer should go to the engineer’s office to

determine if there is any planned road widening or other developments that would
result in the expropriation of a portion of the property.

7. Clean title – check with the register of deeds as to whether the property is covered
by clean title and if it is, what kind of title is it?

8. Encumbrances – these are liens or claims by third parties and are noted at the back
of the title. In addition to these, there may be unpaid real property taxes which have
priority over other claims. When property is mortgaged, the encumbrance and their
subsequent cancellation are noted at the back of the title by the office of the
register of deeds of the particular province or city where it is located.

9. Improvements – what are the improvements on the property and their possible use?
If the investor is not interested in the improvements, how much would it cost to
have them demolished?

10. Financing – how is the acquisition to be financed? If a loan is to be acquired, the

investor should make inquires as to the conditions imposed and the interest rates.

11. Prospects – this refers to the expected rise in market value due to current and future
improvements in the specific locality.

In buying real estate, it is always advisable to check with the Register of Deeds,
Treasurer’s office and Clerk of Court. These are done to check the validity of the title, the
encumbrances, unpaid real property taxes and any pending cases or legal questions related to
the property.
The importance of location in real estate investment can never be overemphasized. As a
matter of fact investors contend that the factors considered in real estate investment are
“location, location and location”. Location can affect the required holding period for real estate
because a commercial lot may be profitable disposed of within five years while a lot in a remote
undeveloped area may take twenty years or even more.

Real Property with Building or House

In case there are improvements included in the acquisition of real estate such as
building, house or warehouse, the buyer should consider the possible use thereof and
estimated cost of immediate repairs or even demolition. He should determine the quality of
material used, ventilation, layout and possible room for expansion.
When the properties available for investment vary in physical condition because of
varying degrees of maintenance, the investor should consider the cost of repairs and cosmetic
improvements and their expected effects on market values.

Market Conditions for Real Property

The market conditions for real property vary depending on the demand and supply.
A. Buyers’ Market – this exists when buyers are at an advantage. Demand is low so
that the buyers are able to avail of discount s and deferred payment plans for
extended periods. This exists in times of economic crisis and in localities that are not
yet developed. When an investor is in need of cash so that he intends to sell
property, he may negotiate for a second mortgage thereon instead of selling it a low
price.

B. Seller’s Market – this exists when sellers are at an advantage. Demand exceeds
supply so that the sellers can charge high prices often on cash basis or for shorter
terms. This exists during times of prosperity for well developed properties and for
those that can be self-liquidating. when the market conditions indicate that it is
sellers’ market, the investor may wait for the market conditions to change before
they buy.

C. Buyers’ or Sellers’ Market – in determining market conditions, an investor may

consider the trend in construction, occupancy rates, loan availments for real
property acquisition and interest rates. It is always advisable to invest in real
property in a buyers’ market and sell during times of prosperity.

Diversification in Real Property Investment

A wise investor spreads his investable funds for real estate among the different classes
under this category. This is done to be assured that he realizes profit from the sale of some of
them and in case of rental units, to be assured of a steady source of cash inflow.
Conformity
Conformity as applied to real estate refers to whether the property conforms to what is
normal or standard in a specific locality. It includes conformity to city or municipal
requirements and zoning policies. It can enhance the value of property. It contributes to the
realization of the expected cash inflow or the expected gross margin upon sale.

Occupancy Rate
Occupancy rate refers to the proportion of real estate that brings in revenue based on
the total capacity. It may be expressed in terms of number of units, months, revenue or income
producing area.

Appraisal of Real Estate

Upon receipt of application for a mortgage on real estate, the lender subjects the
property to an appraisal or an estimate of its market value to determine the amount that may
be granted as loan. This is done to be assured that said loan would be fully secured in terms of
the market value of the property.

Estimating Market Value Based on a Study of the Market

In estimating market value based on a study of the market, the appraiser takes into
consideration conformity or how the property fits with other properties in the same
neighborhood, the recent selling price for similar property in the locality, and the physical
condition of the subject property. Thus, if a similar unit was recently sold for 2M and it fits with
the type of properties in the same neighborhood, the subject property may be assigned the
value or more or less 2M also.

Financing Real Estate Acquisitions

An advantage of real estate investment is that it can easily be financed by long-term
loans from financial institutions. This is due to the fact that real estate is the most acceptable
collateral for bank loans due to their immovability and appreciation in value. When the real
estate to be acquired is used as collateral for loans to be obtained, it is called leveraged
acquisition. In some cases, the investors obtain a bridge loan. A bridge loan is one that is
temporarily granted using another property as collateral so that upon consummation of the
purchase of the second property, the latter becomes the collateral and the first property is
freed of the lender’s lien

Refinancing
Refinancing refers to obtaining a new loan to cancel an old one. This is usually done to
take advantage of a lower rate of interest on the new loan and /or a longer term.
Payment Acceleration
Payment (or mortgage) acceleration refers to making additional payments in order to
reduce balance of the principal, increase the borrower’s equity and shorten the payment
period.

Advantages of Payment Acceleration

a. It reduces the total interest charges and consequently, the real acquisition cost
of the property.
b. It enables the borrower to take hold of the title to property earlier and
subsequently make use thereof in raising additional capital to finance other
ventures.

Disadvantages of Payment Acceleration

a. By reducing interest charges, the borrower forfeits himself of the tax benefit
therefrom inasmuch as interest is deductible for income tax purposes.
b. It increases the borrower’s opportunity cost, that is, the benefits he may derive
from the use of the amount involved in other forms of investment.
c. Equity in the mortgaged property cannot be sold nor can it be withdrawn.

Net Income; Net Cash Flow

Net income from real property refers to the excess of periodic rental income over the
related operating expenses and periodic interest charges. The operating expenses that are
deducted include charges even if they do not require cash outlay such as depreciation. Net cash
flow is the difference between periodic collections and the related periodic cash outlays.

Payback Period and Time Adjusted Rate of Return

Payback period is the length of period it takes to recover investment. Thus it is based on
purchase cost and annual cash inflow from the particular investment. Time adjusted rate of
return is the rate at which an investment is earning or the rate which equates the present value
of net cash returns with the investment.