Real Estate Investment - Case Study Example

REAL E INVESTMENT Risk Profile Generating a Risk profile is an integral part of any financial investment process. It is in fact an overall part of the overall investment strategy, which is used by an investor to arrive at a decision. The present section will discuss about the assessment of the various risks that can affect the value of a real estate property in Italy. First & the foremost, the resent boom in real estate investment is due to the fact that there euro has been trading strongly in comparison to the dollar. This has also been attributed as one of the prime advantages for getting a mortgage loan. But, the real danger lies in the fact that this situation will seem favourable only until the euro is able to sustain its lead. Once the situation changes the other way (as it always does), the higher rates of interest in Italy will become predominant & the boom in real estate may receive a setback. There are also several instances wherein the seller turns out to be a fraud, who goes absconding after having got the reservation money. The situation is particularly precarious in the case of costly deals where 20-30% amounts to a large amount of money. Therefore, proper verification of the credentials of the other party is a must in order to thwart such occurrences. It is absolutely true to say that a dollar invested today would have an enhanced worth say three years down the line. But, this case is true provided other factors remain fairly constant. For example, if the political situation or the law & order scenario of an area is not alright or gets worse at any time between these years, then concerns among the buyers or financiers would ultimately work towards the education in the value of the property. In worse cases, the property may become useless such as I the instance of war or ethnic strife. As Italy has been a fairly peaceful nation, this fear is not supposed to dampen the spirits of investors. But nevertheless, one must always take this aspect into consideration at the time of investment planning. The interest rates in Italy hover in the range of around 2%, which is a bit more than that in the US. Therefore, it is advised that anyone desirous of seeking a mortgage especially for costlier properties, conduct an efficient forecast abut his/her repayment options in order to avoid problems in the future. In spite of the boom in real estate in Italy, homeowners generally buy their property as something to live in rather than regard it as a form of investment. Therefore, when the need arises for selling that property especially after long periods of stay, the property value is set to fetch much lesser than the prevailing market due to any factors such as the age of the property, the amount of wear & tear, the forecast of the repairing costs that need to be undertaken by the buyer in advance etc. Another major disadvantage of investing in homes in Italy is that the majority of the mortgages are based on variable rates and as such, these interest rates keep changing fro area to area or company to company in particular. Therefore, the buyer may end up paying more while seeking a mortgage loan fro one company while there could be others offering it at reduced rates. Thus, this calls for a sense of responsibility on the part of the buyer to have an idea of the interest rates charged by the different mortgage companies. There is also an increasing trend towards direct purchasing through the phone or Internet. There have been instances in the past wherein investors have been duped by phony agents who pose as the real owners of a property or act as mediators. The reason has been attributed to the fault on the part of the investor to verify the authenticity of the property or it sellers. In most cases, the investor does not even inspect the site that is proposed to be purchased. The only solution is to verify the property & its seller either by himself or through trusted representatives, usually one's lawyers. In the case of a seller or in case the buyer wishes to resell the property subsequent to purchase, there is a potential risk that the property that has been purchased may turn out to be a bad deal. This is especially the case when one discovers that the property dos not have access to good infrastructure such as school, hospitals, roads etc. in order to prevent any such thing fro happening, the investor (the seller too) must ensure that there is adequate provision of proper facilities & basic infrastructure before providing ahead with the property purchase. The properties in some areas such as commercial districts are very costly and are much higher than the rates that are fixed by the government. This is an expected scenario, but there have been instances wherein properties have been sold behind the curtains for exorbitant prices. This is due to the commercial value & demand for the property in that particular area, which pushes the property rates to sky's limit. Therefore, one needs to put sense by making a forecast o the estimated value of the property I te years to come so that the investor may benefit fro the investment made in the long run. The decision mad in this case can also prove to be contrary to popular notion owing to the changing market & geo-political trends that affect that particular area. Therefore, this is something that needs to be worked out by the investor in advance prior to making any investments. In order to buy and maintain a property in Italy, one has to end up paying up numerous taxes to the government. Firstly, it is the 4% tax on stamp duty & registration expenses. The investor has to therefore, make sure that he has enough funds to pay for these expenses in addition to the expenses for the solicitor & the actual property itself. Next, the investor has to cough up a tax known as 'Value Added Tax (VAT)' that is in the range of 12.5% of the purchase price. This tax has the disadvantage that the taxes levied on the intermediaries have to be borne by the ultimate buyer. Therefore, this is a serious effect of the taxation regime in Italy. Then there is also the 'council tax' that is levied on the basis of the triple assessment of size, location & property value of the property. Obviously, owners of commercial & costly properties have to pay more as part of this tax. Moreover, properties near heritage monuments (something that is synonymous with Italy) are charged more taxes & their commercial values are similarly huge. Thus, this allows only the rich & the affluent to be able to purchase such properties. The end effect is that there is too much of tax that is levied on property in Italy for any property, bet commercial or residential & therefore, one has to get his finances right before proceeding ahead with purchasing any property. The only solution left for the common people desirous of purchasing a property seems to be the Italian countryside, which is known for cheaper residential properties. Recommending financing Here, it is to be considered that the corporate property under consideration will be an income generating property. Financing here means that the property will be mortgaged with any financial institution. The company that will be finance the purchase of the proposed property is ultimately interested in assessing whether the buyer would be able to repay the debt within the repayment period. This calls for the calculation of the repayment capability of the buyer, which is usually carried out by the company by taking the various incomes & expenses of the buyer into account. Such an analysis of the repayment capability is termed as the 'Cash flow analysis'. The cash flow analysis for the corporate property in Italy is performed as depicted below: The general procedure for the calculation of the repayment capability essentially comprises the Net operating income derived out of renting the premises. Therefore, this valuation obviously includes the evaluation of the consideration of the gross income as well as the net income. In addition, one needs to take into account the following aspects for the purpose of calculating the debt repayment ability (Marinus Dijkman & Andreas Schiller, 2005): Taxes Insurance Utilities Maintenance Landscape This is explained in the form an example as shown below: Cash flow analysis for prop 'A' in Italy Gross rental income------------------------------$100,000 (Less vacancies) ------------------------------ 5,000 Miscellaneous income--------------------------- 10,000 Effective gross income--------------------------$105,000 (Less operating expenses)------------------------ 20,000 (Taxes)---------------------------------------------- 5,000 (Insurance)------------------------------------------ 4,500 (Maintenance)-------------------------------------- 3,500 Net Operating Income----------------------------$ 72,000 Debt Repayment: Existing first mortgage---------------------------$ 50,000 Facility (prime+2%) -----------------------------$ 65,000 Total annual debt burden------------------------$115,000 The debt repayment ratio comes out to be in the range of 0.6. Debt repayment ratio= (net operating income)/ (total annual debt burden) = (72,000)/ (115,000) = 0.62. It can be seen that the income & the debt burden on an annual basis are not matching each other as the debt repayment ratio depicts (D.R.R Read More