Property Investments

Real Estate Investors

A real estate investor is someone who actively or passively invests in real estate. An active investor may buy a property, make repairs and/or improvements to the property, and sell it later for a profit. A passive investor might hire a firm to find and manage an investment property for him. Typically, investors choose real estate for several reasons: cash flow, appreciation, depreciation, tax benefits and leverage.

A cash flow investor might opt to put 5% or 10% down when acquiring a property. This may allow the investor to obtain favorable financing terms and a lower mortgage payment. This will often result in positive monthly cash-flow, crudely derived by subtracting the monthly debt service from the monthly rent.

Appreciation occurs over time, generally, though an investor may "force the equity" in a property by making enhancements to it or the surrounding environment to increase its value. In general, residential real estate is valued by the "comparable sales" method which estimates the value of property under the principle of substitution. The method estimates property values by comparing a subject property to similar properties sold in similar locations within a recent period of time.

Depreciation is one of the many benefits afforded to real estate investors. Though the property is actually increasing in value, the government allows owners to systematically depreciate the property over its projected useful life span. Depreciation is an allowable tax deduction. In addition to depreciation, an investor will usually claim the interest portion of his monthly mortgage payment as a tax deduction.

Leverage is a powerful reason for investing in real estate. If an investor used 100% cash to acquire a house worth $100,000, and the house increased in value by $5,000 in one year, then the investor made a return of 5% (assuming no other costs in this case). However, if the investor obtained 95% financing, only $5,000 cash would be required at the closing table, and a bank or other lender would loan the remaining $95,000 to acquire the property.

Assuming the same $5,000 increase in value, the investor's cash contribution of $5,000 would yield an increase in equity of $5,000 in one year, a 100% return. Of course, leverage works in the opposite manner as well. A $1,000 decrease in value would produe a negative 20% return on the $5,000 investment.

Real estate investing has become quite popular in recent years due to rising property values and low interest rates. Deflation in property values or a sharp increase in interest rates would dampen the market considerably, however.

Types of Investment

The difference in the use of the term investment between the economics field and the finance field is that economists refer to a real investment (such as a machine or a house), while financial economists refer to a financial asset, such as money that is put into a bank or the market, which may then be used to buy a real asset.

Business Management

The investment decision (also known as capital budgeting) is one of the fundamental decisions of business management: managers determine the assets that the business enterprise obtains; these assets may be physical (e.g. buildings or machinery), intangible (e.g. patents, software, goodwill), or financial (see below). Whatever the type of asset, the manager must assess whether the net present value of the investment to the enterprise is positive; the net present value is calculated using the enterprise's marginal cost of capital.

Economics

In economics, investment means the production per unit of time of goods which are not consumed but instead to be used for future production. Examples include tangibles (such as building a railroad or factory) and non-tangibles (such as a year of schooling or on-the-job training). In measures of national income and output, gross investment I is also a component of GDP, given in the formula GDP = C + I + G + NX. I is divided into non-residential investment (such as factories, machinery, etc.) and residential investment (new houses). Net investment deducts depreciation from gross investment. It is the value of the net increase in the capital stock per year.

Investment, as production over a period of time ("per year"), is not (yet) capital. The time dimension of investment makes it a flow. This is in contrast to capital, which is a stock, that is, an accumulation measurable at a point in time (say December 31st).

Investment is often modeled as a function of income and interest rates, given by the relation I = f(Y, r). An increase in income will encourage higher investment, whereas a higher interest rate may discourage investment as it becomes costlier to borrow money. Even if a firm chooses to use its own funds in an investment, the interest rate represents an opportunity cost of investing those funds rather than loaning them out for interest.

Finance

In finance, investment means buying securities or other monetary or paper (financial) assets in the money markets or capital markets, or in fairly liquid real assets, such as gold, real estate, or collectibles. Valuation is the method for assessing whether a potential investment is worth its price.

Types of financial investments include shares or other equity investment, and bonds (including bonds denominated in foreign currencies). These financial assets are then expected to provide income or positive future cash flows, but may increase or decrease in value giving the investor capital gains or losses.

Trades in contingent claims or derivative securities do not necessarily have future positive expected cash flows - so are not considered to be assets, or strictly speaking, securities or investments. Nevertheless, since their cash flows are closely related to (or derived from) those of specific securities, they are often studied as or treated as investments.

Investments are often made indirectly through intermediaries, such as banks, mutual funds, pension funds, insurance companies, collective investment schemes, or even investment clubs. Though their legal and procedural details differ, an intermediary generally makes an investment using money from many individuals, each of whom receives a claim on the intermediary.

Personal Finance

Within personal finance, money used to purchase shares, put in a collective investment scheme or used to buy any asset where there is an element of capital risk is deemed an investment. Saving within personal finance refers to money put aside, normally on a regular basis. This distinction is important as investment risk can cause a capital loss when an investment is realized, unlike saving(s) where the more limited risk is cash devaluing due to inflation.

In many instances the term saving and investment are used interchangeably which confuses this distinction. For example many deposit accounts are labeled as investment accounts by banks for marketing purposes. To help establish whether an asset is saving(s) or an investment you should consider where your money is invested. If the answer is cash then it is savings, if it is a type of asset which can fluctuate in value then it is investment.

Investment Management

Investing can be a complex activity and there have been countless books about investing that have been written over the years though certain books are considered classics because of their enduring principles that have stood the test of time. Many of the books on investing, including some of the seminal texts were written by investment managers and or famous investors.

Real Estate Investment

Within real estate, money used to purchase property for the sole purpose of holding or leasing for income and where there is an element of capital risk is deemed a real estate investment. Real Estate investment is distinct from other forms of economic or financial investment in that a real estate is purchased.

Appreciation

Appreciation is a term used in accounting relating to the increase in value of an asset. In this sense it is the reverse of depreciation, which measures the fall in value of assets over their normal life-time. Appreciation is a rise of a currency in a floating exchange rate.

In times of high inflation, appreciation will be common to all balance sheet assets. Generally, the term is reserved for property or, more specifically, land and buildings. In any viable modern economy, such property tends to increase in value over the years - if only because of the scarcity of usable land forces its price in a competitive situation. However, this belief has often caused speculative bubbles to arise.

There are considerable difficulties in assessing the increase in value of any particular asset. This is principally because of the variety of interpretations that can be attached to the word value itself and due to the various instruments and methods used in the valuation process. Appreciation is also a term meaning an expression of gratitude.