REAL ESTATE INVESTMENT

ADVANTAGES OF REAL ESTATE INVESTMENT

The basic element of real estate; land, cannot be destroyed, moved or lost and is less likely to suffer a loss in value through mismanagement compared with for example, a competitive business. Real estate defects are visible that is, more tangible and most people have knowledge of how a house works as they have lived in them most of their lives. Generally, as the economy increases in value (as the GDP or GSP rises) real estate increases in value. However, such increases should be measured in real terms (after inflation).The common methods of financing real estate purchases and developments are:


MORTGAGE

The most common method is by way of a mortgage. A first mortgagee has a first mortgage over the land and first claim on moneys realised on sale after government and local council if the mortgagor defaults on the mortgage repayments. Therefore, a fast mortgage is the safest real estate investment because:


MORTGAGE REPAYMENTS (INSTALMENTS)

In the 1960s and early 1970s it was common for mortgages to be at fixed interest rates that is, the interest charged remained level over the period of the loan. However today, mortgages over investment properties usually have the repayments tied to some index or formula such as the CPI or the gross income of the property.

CREDIT FONCIER MORTGAGE

A credit foncier mortgage is one where the interest part of the repayment reduces over the period of the loan because it is calculated on the balance owing. It is also known as a reducing balance mortgage.

See fixed interest mortgage

THE OWNER'S EQUITY

The amount borrowed by way of mortgage i5 usually less than the price of the real estate. For example, the borrower (mortgagor) may pay 20% of the sale price from his own funds (owner's or mortgagor's equity) and borrow the remainder (80%; lender's or mortgagee's equity) from a bank. The property is the security (collatera4 for the loan. The mortgagee has certain powers under the mortgage agreement (subject to legislation) if the mortgagor defaults on repayments. These are either the power to foreclose on or sell the property.

POWER TO FORECLOSE

Under this power the mortgagee takes control of the property to enjoy future rents and benefits until the mortgage debt and expenses incurred have been paid off. This power is seldom used as financiers' comparative advantage is in lending, not property management.

POWER OF SALE

The mortgagee is more likely to use this power on default of repayments by the mortgagor. The mortgagee is allowed to deduct all monies owing and the expenses of selling from the sale price but any residue goes to the mortgagor.

MORTGAGE VALUATIONS

The valuer when making a valuation for mortgage or security purposes determines the market value under the willing buyer willing seller theory unless otherwise instructed by the client. Valuation terms such as security value and mortgage value should be interpreted as meaning market value. The mortgagee should clearly state the type of value required for example, "fee simple in possession", "vacant possession" or "fee simple subject to existing tenancy" and these instructions should be included in the valuation report.

Generally, there is no difference in a mortgage valuation report for an existing building than that required for a normal market valuation (see Mortgage Valuation Practice Standard (1993) The Valuer and Land Economist, November 1993, p569).

There is no discount for a mortgage valuation as the ratio of borrowed money to market value is a matter for the mortgagee to decide and not the valuer. The API Standard states that the valuer should "..make a recommendation to the lender as to whether the property is or is not a suitable security" (part 1.3). However, the valuer is not an expert in banking as the mortgagee will take into account non valuation factors such as the credit worthiness of the applicant and the lending policies of the institution. For example, some institutions are "risk takers" while others are very conservative in their lending policy. Further, it can be argued that all property is suitable security at market value.

REQUESTS FOR NON VALUATION INFORMATION

As well as market value the valuer may be asked by the lender to supply other, usually economic information about the subject property. For example:


The valuer should stress that answers to such questions about the future are largely speculative and should point out that the market value has already taken into account such factors by the use of an appropriate capitalization rate. With regard the possible problem of resale, if there is some unusual factor that could affect resale it should have been covered in the valuation report and the market value is less because of it. For example, "bad" or ugly architecture.

The valuer should endorse his/her report to cover those matters which he/she is not expert in. There is an unfortunate trend towards long and verbose standard form reports by large lenders. Those modelled on American forms ask a large number of difficult and unnecessary questions. The valuer should try to avoid such forms wherever possible and instead use the Institute's PropertyProform.

See valuation reports.
See proposed developments


4