Property Investment Decisions

A quantitative approach

S Hargitay, S. Hargitay, S-M Yu

• Publisher: Routledge
• Year: 2003
• ISBN:
  9781135829933
• Edition: 1
• Topic: Architecture
• Subtopic: Urban Planning & Landscaping

The importance of property as an investment medium continues to grow. Investors in property or those involved with the provision of expert advice to investors have had to improve the effectiveness and efficiency of their decision making. The aim of this book is to lay down the theoretical foundations of investment decision making, incorporating the techniques and procedures of modern management science, so that particular decisions regarding property investment can be made efficiently and rationally.

PART ONE

Property investment decisions

1

The rationale of investment and investment decision-making

1.1 Introduction

1.2 Principles of investment

1.3 The investment problem

1.4 Towards the management of the investment problem

1.5 Types of investment

1.6 The investors and market makers

1.7 Classification of investment decisions

1.8 The investment decision-making process

1.9 Summary

1.1

INTRODUCTION

This chapter reviews the fundamentals of investment as a wealth-generating activity. The investment problem and its management will be considered, together with the principal players, the decision-makers in this important economic activity. After the classification of the investment decisions, the investment decision-making process will be considered in detail.

1.2

PRINCIPLES OF INVESTMENT

The fundamentals of investment must be preceded by an attempt at defining investment as an economic activity. Investment is to do with the creation, enlargement and protection of wealth.

Investment involves the commitment of a capital sum for benefits to be received in the future in the form of an income flow or capital gain or a combination of both. As an economic activity, investment may be defined as follows: Investment is the utilization of capital resources for maximum possible reward.

Funds are committed to various ventures which promise attractive returns at the price of risking a partial or total loss of the funds without an absolute guarantee of the size or receipt of returns. Investment therefore represents certain sacrifices for uncertain benefits.

Investment has two principal aspects: anticipated return and risk. The return aspect is perhaps the easier one to perceive and measure. It is usually translated into money terms and its size is all-important. The risk aspect, on the other hand, presents serious conceptual and analytical problems. Risk is a difficult concept to perceive and define and its direct measurement is virtually impossible. In an ideal, rational world the investor is expected to live by the maxim: ‘Maximize returns whilst minimizing risk’.

Unfortunately, in the real world investors have difficulty in adhering to this discipline. In the first instance, investors do not always behave rationally as they are usually influenced by the vagaries of the markets in which they are active and are prone to follow fashion. Furthermore, the problems associated with investment risk cannot be totally eliminated, even in an ideal world.

Investments can be classified in many different ways and there is a wide spectrum of investment opportunities available to investors, all with different investment characteristics. This diversity creates the problem of choice, requiring the establishment of criteria and a rational basis for comparison. A rational choice is usually made on the basis of return—risk characteristics, provided they are measurable against some suitable standard.

The primary problem for an investor is the assessment of desirability of the acquisition or disposal of an individual investment proposition. In addition, he may have to face further complications:

1. When the funds available for investment are limited—he has a budget problem.
2. When surplus funds are to be invested but suitable investment projects are not readily available—he has a market supply problem.
3. When funds committed to certain projects cannot be realized and switched to other projects easily—he has a liquidity problem.
4. When the return-risk attributes of investment propositions must be considered in relation to the rest of the assets owned—he has a portfolio problem

1.3

THE INVESTMENT PROBLEM

The investment problem may be defined as a problem of decision-making in the presence of uncertainty and risk. The investment problem is a complex of the following three fundamental problems:

1. Problem of selection Choose the investment alternative which promises attractive returns at an acceptable level of risk. This implies the need of the quantification and measurement of the return and risk expectations.
2. Problem of allocation Decide the appropriate level of capital commitment, taking into account the degree of exposure to risk.
3. Problem of timing Decide the timing of the acquisition or disposal of investment projects, in attempting to achieve some return targets whilst minimizing the exposure to risk.

These problems are further complicated when the extra dimension of the interdependence of individual investments need to be considered in a portfolio setting.

1.4

TOWARDS THE MANAGEMENT OF THE INVESTMENT PROBLEM

At the core of the investment problem lies uncertainty which inevitably affects all future events. This problem of uncertainty can never be resolved completely as nobody will ever have a complete knowledge of the future. However, the problem of uncertainty can be managed as the consequences of the actions taken in the past, present and in the future are not completely random. Some consequences are not only foreseeable, but inevitable, barring some catastrophic event. On the other hand, the circumstances in which such consequences would be evaluated in the future are subject to random variations.

It is safe to assume that the primary aim of investors is to maximize the return on the capital committed. Whilst trying to safeguard their capital, in real terms, they wish to ensure the receipt and size of future returns, also in real terms. All rational investors would prefer higher returns to lower returns and lower risks to higher risks.

Throughout the ages, investors approached these problems in a number of different ways. Some of these approaches were wise and rational, others were quite irrational. The dictum ‘Do not put all your eggs in one basket’ appears amongst the proverbs of most languages. Some investors recognized the danger of the ‘all or nothing’ approach and saw the safety aspects of having a collection of investments. Other investors opted for another promising way to tackle the investment problem. Confidence in their experience, special skills and expertise has led them to the ‘single basket’ or ‘specialist approach’. Their strategy was formulated by Andrew Carnegie, whose maxim was: ‘Put all your eggs in one basket and then watch that basket.’

Only a few investors are in the position constantly to watch and manage their ‘basket’. In most cases, the sound, rational strategy is to diversify, as risks may be reduced by a trade-off with return. This risk-return trade-off may be illustrated through the case of investment in government securities where the investor accepts a lower return for the virtual freedom from risk.

Large institutional investors usually diversify their investment portfolios on three levels:

1. They diversify amongst investment media.
2. They diversify amongst the sectors of a particular investment medium.
3. They diversify amongst individual investment projects within a particular sector or a particular investment medium.

The investment problem demands continuing attention from the investor and its successful management remains the most fundamental task of investment managers and their expert advisers.

1.5

TYPES OF INVESTMENT

In all civilized societies money is the life-blood of the economy. It appears to be the most important commodity and its supply and allocation is extremely important. Business and industry need an increasing supply of this particular commodity and their requirements over the long term must be met by investors and—to obtain the necessary injection of money—they must sell stocks and shares to the public. There is also a demand for money supplied by investors to enable governments and local authorities to carry out their various activities. Although governments and local authorities raise funds by taxation, nevertheless, without the investor’s money, most of their schemes would encounter extreme difficulties.

The demand for investment to provide the flow of funds into various economic activities is usually satisfied by the individual investor and by large investing institutions. The following principal types of investments can be identified:

1. Money which is lent creating a debt. Such debt may be payable on demand, or at a specified date in the future.
2. Investment which transfers to the investor a part or share of a business enterprise.
3. Indirect investment in stocks and shares or in property through the purchase of an interest in a managed fund.
4. Investment in property interests.
5. Investing in non-yielding investments such as chattels, works of art or various commodities traded in commodity markets.

Most investments, particularly those made by institutional investors, would fall into the following categories:

1. Fixed-interest stocks representing marketable debt; government stocks, local authority stocks, company debentures and loans belong to this category.
2. Shares representing the acquisition of a part of a business enterprise; preference shares, ordinary shares and some of the means to acquire shares in companies such a...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Dedication
• Contents
• Acknowledgements
• Preface
• About the authors
• Introduction
• Part One Property investment decisions
• Part two Quantitative techniques for decision-making
• part three The measurement and assessment of investment performance
• part four Information needsÐProvision, Management
• part five Property Decisions in Practice: Examples
• Bibliography
• Appendice
• Index