Real Estate Investment

Real Estate Investment

Real estate has to do with land and buildings which is often referred to simply as property or landed property. Barlowe, 1978) said that the concept of land as property involves real estate and has legal connotations. The legal connotations are concerned with the traditional and/ or modern-day constitutional rights bestowed on individuals, families, communities or the states to own, develop and manage land and its resources without hindering the rights of others. The rights are granted to private or public institutions to utilize land efficiently.Land means different things to different people. It includes all the physical development carried out by man on the earth’s surface.These are man-made improvements onlandused to attain economic goals through the application of capital, labour and technology. It covers all economic crops and trees, buildings, structures and installations, roads, bridges, dams and all sorts of physical development on land. Agricultural resources include the fertile farmlands where economic crops, trees and vegetables are cultivated and arable farmlands used for cattle rearing. Economic trees include cocoa, rubber, cotton, oil palm, cowpea, maize, yam, fruits, vegetables and cassava; while livestock include cattle, goat, sheep, exotic poultry and local fowls.

 

Residential land includes the various houses that are built for the occupation of individuals and members of the family. It may be tenement houses, flats, bungalows, maisonettes and multi-storey apartment blocks. Residential land is classified into high density, medium and low density residential areas within a residential estate, and is usually the largest use of land within the urban areas as well as privately or publicly built as permanent or semi-permanent structures. (Barlowe, 1978)

 

            Forms of Real Estate Investment

These refer to all the options any potential real estate investor has in committing his resources in expectation of future benefits. Before embarking on any type of investment, certain qualities are expected from an investment that is attractive to the investor. Investment decisions are influenced by various motives. Some investors spend huge amount of money to establish a business where they sit as the Chief Executive Officers (CEOs) while others do so for the pecuniary motive of earning returns, both of which invariably represents the reward for undertaking such investment. Whatever the nature of investment, a rational investor seeks to maximize his returns while minimizing the risk undertaken. To earn reasonable returns, a prudent investor has to bear some risks which are determined through various ownership strategies. The various forms of real estate investment are categorized as follows:

 

    1. Construction: These include buildings constructed for various purposes including residential, commercial, industrial, and recreational, among others. The development process involves acquisition of suitable sites, formalization of relevant title documents, construction for occupation or letting, and management of the developed estate. Almost any works to a property or change in management or use of premises can have the effect of modifying its usefulness and hence its income-earning capacity to the investor,Emoh (2004).

    2. Acquisition: This involves acquisition of a freehold or leasehold interest in a developed property. This transaction enables the initial developer to realize the capital invested on an existing development for some other ventures. It has become a common trend by politicians, senior government officials and top business tycoons in major urban centres in Nigeria. Real estate investors, like other investors in stocksand shares, seek the highest rate of returns on their capital. In some transactions, they may accept a low initial yield because of the expectation of future growth of the investment. However, the yield is a reflection of thelevel of risk inherent in the investment.

    3. Mortgage Transaction: This is a transaction where investors relinquish their interests in real estate in order to obtain some credit facilities. The interest held in the property serves as collateral for the borrowed funds. Redemption is at the amortization or full discharge of the principal and accruable interest thereof. Mortgage transaction is the most important single source of funding property development in the developed world. The establishment of mortgage institutions in Nigeria for this purpose is a welcome development. It creates avenue for potential investors to raise funds for physical development purposes.

    4.    Sales and Leaseback Transaction:This arises because an owner-occupier wishes to raise capital for a certain purpose and in the cause of doing this he decides to dispose off his property to somebody (corporate or private) on an arrangement that the lessor immediately leases the entire property or part of it back to him, the lessee. The lessee then occupies the property as an inferior interest holder (tenant) rather than as the owner, and is able to invest the capital in the business.

    5. Shares Acquisition: This involves the acquisition of shares in the companies involved largely in real estate transactions. Purchasing shares in a property company enables the investor to have a share in the returnsarising from any development, expansion and management of property values arising thereof. Property company shares also tend to have high levels of volatility. This is largely because many property companies have high borrowing and gearing capacities thereby making their profits particularly susceptible to economic and market changes. Dubben and Sayce,1991.

Ajayi (1998), Bodie, et al, (1998) agreed that investment is the current commitment of money or other resources in the expectation of earning future benefits. Greer and Farrell (1984) opined that the nature of investment is that you sacrifice something of value now expecting to benefitfrom that sacrifice later. Okafor (1983) defined investment very specially as “economic activities designed to increase, improve or maintain the productive quality of the existing stock of capital”. From the above, it can be discerned that investment is a two way process. One parts with or sacrifices a valuable thing and in return receives a reward or benefit with both the sacrifices and the reward being potentially financial or non-financial. Financially, the sacrifice is money paid out to acquire an asset while the reward is the return receivable as a periodic income flow and/or a capital gain.

 

         The Characteristics of Real Estate Investment

The investment characteristics of real estate which distinguish it from most other investments flow directly from its physical characteristics, which are peculiar to its source, land. Wendth and Paul (1979) identified these as the uniqueness of each parcel of real estate, the immobility of real property, the large size and bulk of typical real properties; and the very long or permanent life of improvement to the land. Stemming from these peculiar real estate characteristics, they identified certain economic, financial and legal characteristics which tend to influence real estate as a medium of investment. Property is infinitely heterogeneous more than other investment media; it is frequently indivisible, and each indivisible unit has a relatively high cost. These and many other features distinguish it from another investment media (Enever, 1981). Lean and Goodal (1977) conception of real estate is that of “rights” rather than the land and building themselves. Consequent upon this, the ownership and right of use can be separated. In this wise, the owner can transfer the right to use to another person in return for a periodic sum (i.e. rental income). He could also convey the ownership in consideration for a capital sum. Traditional property investment was a means to obtain security and regular income; thus, decisions were often made based on intuition and experience (Ajayi, 1998). This argument may be valid and the practice quite acceptable in the past when economy was stable and there was a high rate of success, but not in the present complex, dynamic economic environment. With the huge number of funds being committed to real estate investment, there is the greater need for accountability. The need here is for comparative investment advice. Every unit of real property consists of income and capital elements which should be valued and appraised as investment options in the same way as any stock or bond” (Igboko, 1984).The investment markets are becoming increasingly competitive and, investment in property cannot be considered in isolation from other markets.

 

       Factors Influencing Investment Decisions

The decision to invest or not in any investment opportunity will be influenced by the motives of the investor, (G.A.ESSIEN and J.A.YACIM, 2018). Certain factors are fundamental to investment decisions. In making decisions, investors would consider the following factors:

    1.    Security of Capital: this is the most important factor; because few investors will want to place their money in an investment if the prospect of losing that money is high. Only the gambler, or the person who has so much money that he or she can risk losing some, will be prepared to put their money into a risky venture and, even then, only if there is some possibility of a large gain if all goes well. Most investors will only wish to place their money in an investment if there is a strong probability that they will be able to recoup their capital at any point in time should the need arise. The greater the chance of there being able to get their original money back at any point in time (or the greater the security of their capital), the greater will be their willingness to invest. If the chance of getting their original money is slight, then an investment will be considered insecure and relatively unattractive. 

(a)   Security of Income is another important consideration, and it must be remembered that, in investing money, an investor is giving up the immediate use of that money and is allowing its use to pass to some other party. In return for giving the use of money to someone else, he or she requires payment, and this payment will be the interest the money earns. It is the reward for forgoing the use of money, and before an investor is prepared to give it up he or she will wish to be reasonably certain that they will get adequate payment for such use, and that there is a high degree of certainty that the payment will in fact be made. 

    b. Regularity of income – Coupled with the certainty that adequate interest will be paid, will also be the wish in most instances to receive regular payments of interest.  If regular payments are made the borrower is less likely to get into arrears, while the receipt of interest at regular intervals enable lenders to phase such receipts to meet regular expenditure which they may be incurring, and this will assist their own budgetary control. 

         

        Growth Prospect – Inflation can have a significant effect on a business over the investment period. The effect of inflation on return on investment can be severe over the life of the project. Some investments lose their real value while others may well increase in real value as well as money value. To keep pace with the changing value of the Naira therefore, an investor will prefer to invest where capital and income will appreciate in real value.

        Liquidity – the concept of liquidity describes the ease, speed and cost with which an      investment can be converted into cash. Investors generally prefer investments which are capable of being into cash which may be needed in the event of better alternatives.

         The Implication of Taxation – investment decisions that in other respects might be the right ones may turn out to be unsound when the effects of taxation are considered. In investment appraisals, therefore, the effects of the following taxes must be considered.

 a.       Taxation on income

b.      Capital Gain Tax

c.       Value Added Tax

d.      Capital Transfer Tax.

The size and timing of tax payment is very important to successful operation of an investment.