Real Estate Analysis

Overview


Real Estate Analysis is the analysis of a piece of real estate as a financial asset. It is primarily concerned with determining a fair value for the asset. It is often used when evaluating loans or structured securities that are backed by real estate. (see Mortgages for example)

Real Estate Asset Modeling


Real estate as an asset is very similar to a loan or bond, in that it generates a series of cash flows at fairly regular dates. For example, an apartment may charge a fixed rent every month. That means that real estate can be modeled with the same sorts of tools that are used to valuate cash flows in fixed income, in particular, the tools of discounted cash flow analysis can be used.

However, the payments are not entirely fixed. At times, the owner may decide to increase the rent. In addition, the renter may leave at some point, leaving the aparment unoccupied. Additional expenses that are required for the update of the real estate are required to maintain the real estate value and are unpredictable.

In addition, real estate is generally an illiquid asset, which means that it takes time and effort to be able to sell at a reasonable price. This illiquidity adds a complication to valuation, as a fair price for an asset may not be the same price that one could get in the market within a specified time period.

Valuation Methodologies


  • Market Analysis: formulates a price based on an analysis of the market where the property exists. This will include the prices of other properies in the area as well economic factors and trends. Considered to be a form of relative valution
  • Cost Approach: estimates the price as being the cost to construct a similiar property in the same neighborhood on the theory that the market would not pay a higher amount for a property if it can just construct a new property. To be accurate, this method requires that space is available in the neighborhood or must include the premium paid for obtaining the location.
  • Income Approach: utilizes the standard discounted cash flow analysis tools to analyze the value of the income stream that the property could generate.

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