SIX RULES IN PROPERTY INVESTMENT - Rule No 1

Property investment is a maze for the uninitiated. The rewards are tremendous but the process can be bewildering and risk-laden. Based on the experiences and exposures in property investment, the author has summarised six important rules that can assist general public who are interested in property investment.

Rule No. 1: Understand the features of Property as an Investment

Property has notable features that distinguish it from other types of investment, such as stocks and bonds. To venture into property investment, understanding the features of property is essential. Under certain circumstances, decision making in property investment always falls back to the fundamental basics of property features. An investor might consider buying a parcel of land even though the price offered is much higher. This is because the investor can foresee that the land offered to him is in a very unique location and the supply of this unique land is limited.

Generally, the features of property are as follows: -

Property as a unique asset
Property is heterogeneous or unique, i.e. no two parcels of real estate anywhere are identical. Even an adjoining pair of semi-detached houses or two neighboring flats will differ in some detail like the sitting of the bathroom and the type of finishes and improvements the respective owners put in.

Property as an immobile asset
Property is immobile, and cannot be moved to another location. Consequently, it is at the mercy of its physical environment. The addition of infrastructure, like an LRT station, in the vicinity of a property will affect its value. Thus, apart from the usual economic and social factors that influence the value of any investment, there is a unique spatial dimension to the analysis of property. The immobility and heterogeneity of real estate also lead to the delineation of sub-markets, often defined by sector – such as residential, retail or office – and location.

Capital Commitment
It requires a high level of capital commitment to invest in real estate, with the result that some kind of financing is invariably used. Hence, changes in credit conditions and regulations governing financial intermediaries like banks and insurance companies could have repercussions on the property market.

High transaction cost
The cost of a transaction in property is high. Because of the complexity of a property transaction, several parties are usually involved: estate agents, valuers, building surveyors, government departments, financiers, lawyers, etc. This implies that the parties involved will have to bear additional costs such as legal fees, valuation charges, stamp duties and mortgage processing fees.

Lengthy transaction time
The transaction time required to complete a property sale is relatively lengthy. In order to balance the interests of both buyers and sellers, the property transaction process involves several stages from the payment of the deposit to the signing of the sales contract and the completion of the sale. At each stage, certain legal requirements must be fulfilled and this takes time to accomplish.

Property as an illiquid asset
Property is illiquid, i.e. it cannot be converted into cash at short notice. This is a consequence of the length of time needed to complete a transaction. Illiquidity exposes property investment to the risk of market shifts over time, a two-edged sword that can, at one moment, enhance the value of the property and at another moment, diminish it.

Management
Property requires management. Because it is a physical asset, neglect and obsolescence can afflict the property. Hence, it is important to manage, maintain and where necessary, renew its physical fabric to retard the onset of obsolescence and enhance its value.

Inelasticity of supply
Property supply is generally inelastic in the short run, i.e. the stocks of real estate cannot be readily increased at short notice, since it takes a considerable time period to build any type of property. A single two-storey detached house could take, for example, up to one year to complete. A large mixed-use commercial property could take, perhaps, four years or more to complete.

Data imperfections
Looking at real estate in aggregate, the property market is characterized by data imperfections. Unlike stock and bond markets, where trading takes place in a fixed geographic location, properties are transacted when and where buyers and sellers (or landlords and tenants) agree on a price (or rent) and enter into legally binding contracts, wherever they might be. This lack of a central trading place implies that data on transactions is not disseminated instantaneously or equally to market participants at low cost, as it would be in the case of stocks and shares.

Effect of market leaders
The property market is also imperfect in terms of supplier power. In economic terms, it is oligopolistic, i.e. there are several large property developers who behave as market leaders, setting benchmarks that others tend to follow. The result is that property prices may not reflect the true supply-demand equation at any one point in time. Prices tend to move quickly upwards but are “sticky” downwards. This, in large part, accounts for the booms and busts of the famous real estate cycle.

Government intervention
Land is one of the primary resources of any country. As such the use, development, management and ownership of land and built-up properties is often affected by government legislations and policies implemented to ensure their optimal use. While government intervention in the use of real estate is inevitable, the degree and extent of intervention depends very much on the type of government and the political climate of the country.