Read Proverbs 31 and suggest what steps from Unit 5 the Proverbs 31 woman should do if she "considers" buying the field.

Unit 5: Techniques of Investment Analysis

LEARNING OBJECTIVES

When you have completed this unit, you will be able to accomplish the following.

• Describe how a market analysis leads to important data.
• List the attributes of a property analysis and how this information affects the real estate investor.

KEY TERMS

come out of the ground

deed restrictions

deferred maintenance

destination store

due diligence

Environmental Protection Agency (EPA)

feasibility analysis

innocent landowner defense

market study

minimum housing standards

overlay

Phase I, II, III, and IV

plat

pro forma profit and loss

remediation

rooftops

setback requirement

site selection

stabilized occupancy

subdivision restrictions

traffic counts

variance

INTRODUCTION

Many real estate investments are made in a relatively informal manner. A real estate broker offers a particular property to a client, who inspects it and briefly analyzes its income potentials using certain mathematical techniques to measure profitability. Usually, the services of an appraiser are sought to verify the market value of the property. If the investment meets the buyer's criteria, and the terms of the purchase can be arranged to satisfy the parties, the transaction is completed.

Under the responsibility of due diligence, a broker often recommends a more intensive analysis of the possible financial success of an investment to satisfy the requirements not only of the investor, but also of the financier and potential tenants. These formal feasibility studies are generally undertaken when large projects are contemplated, such as subdivisions, office buildings, shopping centers, industrial parks, and manufactured-home parks. They are also recommended for new investors with any size project until the investor develops better instincts and rules of thumb. Feasibility studies consist of three broad analyses: market analysis, property analysis, and financial analysis. This unit examines the first two.

MARKET ANALYSIS

The market analysis gathers data about the marketplace. It seeks to answer the questions, "What is the profile of the marketplace of potential customers, what properties are available for purchase, what competition is already in the market place, and what competition is likely to develop in the very near future?" The market analysis does not investigate economic viability of a purchase or development. That is the province of the financial analysis. The market analysis may reveal that spending time and money on a feasibility study will be fruitless. For example, a market analysis may show significant vacancy rates in luxury apartment units. One does not need a detailed financial analysis to conclude that a new luxury apartment project would be ill advised.

Market analyses include demographic data gathered from census studies and local chambers of commerce. It shows number of rooftopshouseholdsplus employment rates, ethnic and age profiles, and median disposable income. The location of major traffic arteries and feeder roads will be identified, with traffic count data and travel patterns obtained from local departments of transportation. Average home sales and rental rates are usually obtainable from local REALTOR associations. Chamber of commerce information, plus physical reviews of the area, will reveal location and sizes of competing properties or projects. Investigation of recent building permits or zoning variance requests will help identify competing projects about to come out of the ground in the near future. Many ill-prepared real estate developers have been surprised to discover four or five similar projects starting construction at approximately the same time, in a market that will support only one or two. All of this information will be necessary to evaluate market demand and possible near-future market competition.

Also important in the market analysis is the identification of interest groups that can affect an investment. These include location of a property within a local government's jurisdiction, which will determine what ordinances and zoning restrictions will apply. If specifically requested, the market analysis can also provide the identities and profiles of major competitors, lenders, and potential opposition groups.

An analysis generally begins with an on-site tour of the area. The investor obtains all available maps of the locale, zoning ordinances pertaining to the area, applicable building codes, and statistical data concerning the population. The investor then examines at least six major factors in the neighborhood: land usage, economic climate, occupancy rates, transportation and utility services, facilities, and community acceptance.

Neighborhood boundaries and land use

A neighborhood can be defined as an area within which common characteristics of population and land use prevail. There is no predetermined size for a neighborhood. In rural areas, it may consist of three square miles, while a city neighborhood may be five square blocks.

The investor must determine the boundaries of the area before a market analysis can be made. Rivers, lakes, mountains, parks, railroad tracks, or major highways help delineate the confines of a neighborhood. Particular note should be made of natural and artificial boundaries that may curtail the future growth of a neighborhood. Various types of land uses have differing neighborhoods. A major sporting goods retailer might be a destination store that draws consumers from a 75-mile radius. An all-you-can-eat buffet-style steak house would usually define its neighborhood as an area with a radius of five miles. Artificial boundaries, such as highways, might cut off part of the circle created by that radius.

In the absence of any obvious physical boundaries, an investor must determine the extent of land that is under common usage and that shares a similar population. Any variances or restrictions in zoning should also be noted. Depending on the type of property involved, these zoning regulations may have a positive or negative effect. Commercial and industrial enterprises are adversely affected by a zoning restriction that limits the area to residential or multifamily use. On the other hand, the desirability of a residential neighborhood could decline severely if a zoning ordinance favorable to industrial development were granted for the area. A prudent investor will also review any studies performed for the local planning commission or zoning board that might recommend future zoning changes.

Neighborhood economy

Various sources of statistical information are available to an investor for assessing the economic climate of a neighborhood. The local chamber of commerce accumulates data regarding the number and types of businesses in the area, the volume of their activity, and general trends in their growth or decline. A neighborhood with a well-diversified business sector is usually more economically stable than an area that depends on a single major industry for its support.

Information secured from local financial institutions also provides a reliable indication of the area's economy. The volume of mortgage loans outstanding and being issued reflects the overall confidence in the real estate market. Competitive rental prices currently charged for residential, commercial, and industrial space in the neighborhood also offer an accurate measurement of the area's economy. Low rents generally indicate an oversupply of rentals relative to a limited demand, whereas high rents generally indicate a shortage of rental space.

Occupancy rates

The occupancy rates for a particular type of property also reflect the relationship between supply and demand in the neighborhood. Occupancies constantly change, and vacancy rates fluctuate accordingly; this affects rents and values.

A high occupancy rate indicates a shortage of space and the possibility for rent increases. A low rate, as reflected by many For Lease signs posted in a neighborhood, results in tenant demands for lower rents and other concessions on the part of the landlord. The oversupply of space that results in low occupancy rates can be either technical or economic in origin. Technical oversupply occurs when there are more available units than potential tenants. Economic oversupply reflects asking prices beyond the purchasing power of potential tenants. Statistics on vacancy rates can be obtained from current housing reports, which are published by state departments of commerce and list vacancies by region. Local utility companies often provide information regarding vacancies, with the number of nonoperating meters corresponding roughly to the number of vacant apartments, stores, or offices, as the case may be.

The investor-developer must also be able to predict whether future occupancy levels will rise or fall and how quickly these transitions will take place. To answer these questions, existing competitive space must be inventoried according to building type,