The Objective of Investment - Essay Example

INTRODUCTION The main objective of investment is to achieve higher returns with less fluctuation. In order to achieve this objective, one of the successful strategies that investors have adapted is to diversify their portfolio of investment (Gitman, 2003). By diversifying the portfolio, investors are able to reduce their risk. Diversification does not only include investing in different types of stocks, bonds and risk free securities, but it also includes investment in different industries and different assets (Ross, S., Westerfield, and Jordan, 2009). With the recent fluctuations in the stock market particularly after the financial global crisis, investors have started diversifying even further by investing in different investment opportunities. Investors now believe that real estate is as an important investment opportunity and increasingly investors are investing in real estate (IPF, 2007). There are fluctuations not only in the asset or equity markets but even real estate investment have their own fluctuations as well. So, it is important for investors to analyse the rise and fall in the market of real estate. Therefore considering the changes in the market, the report aims to understand how the commercial property business operate as an investment and analyze the internal and external factor that influence the prices of properties. The main the purpose of the report is to understand how to maximize income on properties through purchasing the right product at the right time and how the capital value is influenced by that. The second part of the statement will identify how to maximize the revenue in term of capital value and income revenue through ‘Pro Active ‘ Management, it will provide further knowledge towards the way management overall affect or improve the value of a property. INVESTMENT IN THE COMMERCIAL PROPERTIES Investment in commercial properties is defined as buying and purchasing of commercial properties with the objective of earning returns or buying commercial properties for the purpose of renting it. Adair et. al (2009) have published a report in which the properties of United Kingdom has been analysed and from the analysis it has been found that the value of the commercial properties in UK accounts to £762 billion. However the value of the residential properties is equal to £3,400 billion. From the £762 billion invested in the commercial properties, it has been found that almost 90% of the investors or owners of the properties are using their properties with the aim of achieving returns by giving their properties for rent to the tenants. The following image portrays the composition of investors of commercial properties in United Kingdom: (Adair et. al, 2009) Adair et. al, (2009) in their research have further revealed that there has been an increasing trend of investment in the commercial properties because of the fluctuations in the stock market. However, as investment in commercial properties is not easy because of the legal complications as well as higher capital required, therefore different small investors and individuals have also started investing in residential properties and giving these properties on rent for returns (Adair et. al, 2009). Before going into more detail, it is important to understand the concept of yield and returns. Initially the term Yield requires an explanation since it defines the overall value of a property and this term is the most basic method of valuation of a property, before going into further details towards the way commercial properties fluctuates in prices the main foundation is needed. Yield can be defined, as the amount years required getting a full investment back on a property. This can be measured by dividing the capital value of the property by the annual income the property is generating. For instance a Property worth 1,000,000$ with annual rent of 70,000$ will require approximately 14 years for the investor to get his money back. Yield is usually also measured as a percentage in order to estimate the annual return compared to the capital value of the property. This is done by dividing the annual rent by the capital value and multiplying by 100 to express it as a percentage. This method is useful for investors when using leverage for a property, for instance if an investor purchases a property worth 100,000$ with annual income of 10,000$ the yield will be 10% percent as it will take 10 years for the investor to receive fully his money back this method is excluding rental growth or decline. In case the property is financed with a loan of 50,000$ the return of investment will be achieved in only 5 years. COMPARING INVESTMENT MADE IN EQUITIES, PROPERTIES AND GILTS As the yield has been defined in detail, the report analyses the income that the investors have achieved by investing in the properties. The research conducted by IPF (2007) has found that average return of investing in the commercial property and the following image shows the performance or the returns that the investors have achieved by investing in properties, equities and gilts. (IPF, 2007) Returns from the real estate are calculated with the annual returns that come from the rent plus the capital gain. The fluctuations found generally are because of the capital gains as the rent is more stable and there are fewer fluctuations in it. The returns from the properties have remained more stable throughout the time period though it has increased during the 1990s but still the investors have been able to yield more stable returns by investing in the properties. However, there have been variations in the returns that investors have achieved by investing in equities. Generally returns from the equities have been found to remain low than the properties and gilts. Although the returns investors have achieved from investing in gilts have remained high but it has the highest fluctuations as well. However, the returns from yield have even gone below the returns from the properties in the 2000 era. The reason for more stable returns of the commercial properties is that it is achieved from constant income streams such as rents from the tenants instead of capital gains while investing in equity. Therefore, it offers more stable returns to the investors (IPF, 2007). The following image portrays that the income that investors have achieved from commercial properties. It is clear that the returns are more stable in the income return which is the rent from the tenants however there are fluctuations in the capital growth as the value of the properties have fluctuated over the years. (IPF, 2007) If the returns from the gilts, equities are compared with the returns of properties then it can be found that the returns of properties have yielded better returns. In addition to this, the attractive feature of investing in the commercial properties is its low fluctuations in comparison to other assets (IPF, 2007). The following image shows the performance of different asset classes in which investors invest: (IPF, 2007) SUPPLY AND DEMAND VERSUS CAPITAL VALUE AND RENT INCREASE One of main factors of the property price value is the relationship between supply and demands for a product. The higher the demand the higher the price is going to rise, the value of a commercial properties is linked with the amount of assets available for investment in the specific market. In case of a shortage of properties the demand is going to raise, this will lead the yield to go down and the capital value to increase. The value of a commercial property in the United Kingdom is determined by the potential of rent increase and therefore capital value. One of the factors determining the potential increase for an asset is the relationship between demand and supply which determine the possibility for the buyers to look for an alternative investment, the higher the demand the higher the chance of rent increase is likely to be. This is because due to the lack of supply the investor is stuck in a position where the current owner of the building is an upper end can fix the terms further towards his own interest. In case the interest for a specific properties goes down the yield will go up and the capital value will go down, this is because the risk of the property increased, as there is less demand for the product. The Supply of properties within a market is linked with the price, if the price is high the demand is high, therefore the properties developer will increase supply to maximize income. However the supply can only be in equilibrium with demand to a certain extent before an oversupply occurs and demand falls which result in a decrease of rent growth and capital value decrease. EXTERNAL FACTORS Above was mentioned how supply and demand affect the price of commercial properties, however supply and demand is also affected by external factors that developers are unable to control. GDP of the country Another factor is the GDP of the country; this can be defined as the Gross Domestic Product. It involves the value of all goods and services produced within the country plus investment produced plus the government expenditure plus export minus import. This figure is used to show the general health of the country quarterly; it shows the foreign investment within the country and the growth capacity. It is mostly useful when compared with the previous results. The GDP is a key financial indicator for investors in term of growth and stability. Rating agencies will rate the Governments according to their GDP and capacity to pay back the debts. Positive figures will influences external investment and increase demand in the properties industry. Financial global crisis has also influenced the real estate market of the world including the real estate market of United Kingdom. One of the factors that have influenced the market is the GDP and with the financial crisis, the GDP of the country has been hurt and therefore it has also influenced the real estate market. Although the financial crisis hit the market in autumn but many ignored the risks that it could have on the market and this led to further losses (Anderson, and Timmons, 2007). Bank of England conducted an analysis in which it was revealed that situation of real estate market had been influenced by the crisis and it was not observed by investors until it started to make an impact (Bourke, 2007). According to Oswald (2009), there are different reasons that caused the inflation and one of the reasons is the reduction in the investment in the housing market. The returns in the commercial properties of UK have yielded high returns over the years. The following graph shows the performance or the returns that the investors have yielded from investing in the commercial properties (Adair et. al, 2009). (Adair et. al, 2009) There has been an increasing trend of investment in the commercial properties to about £81.1 billion (Capital Economics, 2007). However after the financial crisis, the situation started to deteriorate. The following graph shows the lending properties to as a percent of bank loan and it can be seen that increasingly investors have used loans to buy or invest in the commercial properties. After the financial crisis, the returns from the commercial properties were influenced to a great extent. The investors that have been over the years enjoying healthy and positive returns from these properties reported negative returns on their investment in the commercial properties. Adair et. al, (2009) have revealed that the total returns from the properties of UK after the financial crisis have declined considerably. The returns reached a figure of -1.0% in September 2007 which further declined to -7.3% at the starting of 2008. The returns although improved in the next few months but by the end of the year 2008, the returns from all properties of UK reached a massive loss of -13.0% Employment First of all the level employment in the country will determinate the general financial health of the economy, the property commercial property is directly linked with employment. This is simply because higher employment leads to higher office space needed and higher demand. As mentioned above the higher the demand the higher rental growth will be Taxation Another indicator is tax policies; favorable tax policies will influence foreign investments in the country and be favorable for potential growth. Inflation In addition inflation is also a key indicator, as it needs to be controlled through playing with the interest rate; too high inflation will decrease consumer purchase power and create an oversupply goods and prices to decrease. Finally the interest rate fixed by the bank of England affect directly the cost of borrowing for businesses, favorable interest rate is positive for development as it increase purchase power, however it also needs to be regulated with inflation. STRATEGIES FOR PROACTIVE MANAGEMENT Investors that are proactive can yield higher returns from the market than investors that are reactive. The main reason for this is that proactive investors are able to predict the changes in the market before they actually occur and thus they are able to earn better returns than reactive investors (McLaney, 2009). Proactive investment is riskier than reactive investment but still it yields higher return. There are some areas that the proactive investors need to consider while making investment: a. One of the strategies that proactive investors need to consider is to analyse the feasibility of the investment option. It is important for investors to make sure that the investment option is feasible as the capital invested can be lost. b. Every investment opportunity or investment option has its rise and fall. Therefore it is important for the investors to analyse the rise and fall in the prices of the real estate and then make the investment decision accordingly. For instance, there is a time when the prices of real estate fall a little and investors need to keep an eye on the cycle of prices and purchase the asset when the prices is low and similarly sell the property when the prices are high. c. Moreover, when investors are giving properties for the purpose of rent, it is critical for the investors to analyse the credit worthiness of the tenant, expected returns on the investment, etc. d. It is also important for the investors to analyse the laws and acts that are prevailing in the market. For instance, Financial Services and Markets 2000 (FSMA) has mentioned in-detail the regulatory aspects that the investors need to consider while making investment. e. As the world has now become a global village and investors can now even invest in opportunities that are prevailing in other markets as well. Therefore investors need to analyse the return from the investment in which they are about to make investment and in other investment opportunities of the world, so that they are able to achieve higher returns. Moreover, investors need to understand the laws of each country or state, for instance an investor may earn higher return but because of higher tax rate the net profit might not look much profitable therefore it is also important to analyse these risks or regulations. CONCLUSION Real estate has become an important investment opportunities for investments particularly after the crisis that hit the global economy. The global crisis has influenced most of the industries of the world, and similarly the real estate industry has also been influenced and the returns from the real estate have also shown decline. However, as the economy has started to recover and it can be estimated that the real estate industry would also recover and some proactive investors might be analyzing the market and waiting for their turn to invest in the market again. References Adair, A., Berry, J., Haran, M., Lloyd, G., and McGreal, S. (2009). ‘The Global Financial Crisis: Impact on Property Markets in the UK and Ireland’. University of Ulster Real Estate Initiative, Available from http://news.ulster.ac.uk/podcasts/ReiGlobalCrisis.pdf [Accessed 3 January 2013] Anderson, J. and Timmons, H. (2007). Why a US Sub-prime Crisis is Felt Around the World. The New York Times. Bourke, C. (2007). Feeling the Pinch. Estates Gazette. Capital Economics (2007). UK Commercial Property Market Monthly. Deloitte. (2012). Real Estate Predictions 2012: New Realities, new perspectives. Available from http://www.deloitte.com/assets/Dcom-Austria/Local%20Assets/Documents/Studien/uk-re-real-estate-predictions-2012.pdf [Accessed 3 January 2013] Devereux, M., Griffith, R., and Klemm, A. (2004). ‘Why has the UK corporation tax raised so much revenue?’. The Institute For Fiscal Studies, Available from http://discovery.ucl.ac.uk/14904/1/14904.pdf [Accessed 3 January 2013] Gitman, L. (2003). Principles of Managerial Finance. Boston: Addison-Wesley Publishing. IPF. (2007). Understanding commercial property investment. Available from http://www.bpf.org.uk/en/files/reita/reita_org_documents/reita_guides_ifa_guide_May07.pdf [Accessed 3 January 2013] McLaney, E. (2009). Business Finance: Theory and Practice. New Jersey, Pearson Education Oswald, A. (2009). We’re going back to work - but will we be sitting comfortably?. The Times. Ross, S., Westerfield, R., and Jordan, B. (2009). Fundamentals Of Corporate Finance Standard Edition. New York, McGraw-Hill. Read More