Lecture 1

Introduction to some general real estate principles and the concept of Real Estate as an Asset Class

Aims for FINM3406

• This course aims to provide students a detailed understanding of real estate finance and investment and the role of property as an asset class.
• Students will learn how to critically evaluate the role that property plays as an investment vehicle and to analyse investment and financing opportunities.
• The course will examine the differing roles that direct and indirect property investment has and the mechanisms for financing property transactions.

Real Estate as an Asset Class

• What is real estate – bundle of rights theory
  • The way in which we treat property is the way in which we govern
• Conceptual frameworks for property ownership (socialist/communist/capitalist – liberal democratic ideology)
• Purpose of built form – historic, current and future and how this impacts investment decisions
• Real estate market characteristics
• Comparison with other asset classes

Scale of Australian Real Estate Sector

• Residential Real estate $7.6 Trillon
• Australian Superannuation $2.6 Trillon
• Australian Listed Stocks $1.8 Trillon
• Commercial Real Estate $0.972 Trillon

What is Real Estate?

• Tangible Asset (physical)
• When viewed as a tangible real estate includes:
  • Land (Cuius est solum, eius est uesque ad coelum et ad inferos)
    • Has to be real estate? Where does it start and stop?
    • Rivers? Beaches?
    • Historically a legal maximum and minimum
  • Improvements on the land (appurtenances)
    • merged with the land as a single asset
    • Title to the land includes all the assets on the land
  • Does not include removable items (plant & equipment)
    • If it's fixed, then considered part of the building
• Can it be Intangible (nonphysical)?
  • Contractual rights (ie leases, mortgages, options etc) - NO
    • Lease forms creates property rights and contractual rights
  • Easements & Profit-a-prendre - YES
    • Property right - access easement (e.g.).
    • Profit-a-prendre - right to take from the property (harvest, e.g.)
• Property Rights vs Contractual Rights
  • Privity of Contract vs Rights against the world
    • I can only enforce my rights against the person I have a contract with
    • Rights against the world - trespassing on your occupied property
• Bundle of Rights Theory
  • Ownership (private right enforceable against strangers)
  • Possession (possession is 9/10 of the law)
  • Control (what is built and what takes place)
  • Enjoyment (can use as see fit)
  • Exclusion (no trespassing)
  • Disposal (sale, lease or by will) & Destruction
• These rights are not unconstrained
  • Government controls (ie Planning, Environment, Heritage and Property Laws, Compulsory acquisition)
    • If the government decides it wants to build infrastructure on your land they can do it
  • Common law (ie nuisance)
    • Can't light a fire on your land and create smoke the goes into neighbours
    • Cannot dam shared river/water over properties
  • Self imposed (Contracts – restrictive covenants, leases, mortgages, liens, caveats)

Conceptual Frameworks for Ownership

• Capitalist perspective
  • Private ownership of property is an individual right
    • Every individual has a right to privately own property
  • Liberal democratic society grundnorm (freedom and liberty)
    • grundnorm - foundational principle of liberal democracy
    • Property rights - communitarial obligation (heritage buildings, environmental protection etc.)
• Socialist perspective
  • State controls ownership and use of real estate
  • State allocates land based upon society needs
  • Private ownership limited – no right to buy or sell
• Communist perspective
  • State owns all real estate. Private property is abolished
    • Determination of how it is used an allocated
  • State determines how real estate is used and allocated, with the goal of equal distribution of resources and wealth
  • Hybrid models exist

Purpose of built form – Why do we need property?

• Enclosure/delimitation of space
• Climate barrier/modifier
  • barrier or modifier of climate
  • Manufactuiring medicine, need modified climate
• Protection and privacy

Buildings create environmental conditions indoors which are more stable and predictable than those outdoors. In so doing they enable activities to take place that otherwise would not.

A building like a company, should help us to do more things and to make things more abundantly better

Purpose of built form – What do we need/use property for?

• Shelter
• Security
• Business base
• Corporate Statement
• Architectural and/or historical/cultural
• Investment
• Infrastructure
• Relationship with people and technology

Characteristics of Real Estate Markets

• Heterogeneous Products
  • Real Property is unique
    • Might be nearly identical in nearly every aspect, never the same
• Immobile Products
  • Real estate exists in a defined spatial context
  • Buildings can be relocated but land is immovable
• Localised Market
  • Markets differ from region to region
• Segmented Market
  • Segmentation can be based on use, size/scale and location
  • further drill down - layers that perform differently.
• Private negotiations with high transaction costs
  • Time consuming, costly and complex
  • Private negotiations between purchaser and seller
  • In real estate in Australia, we are charged stamp duty - charge by the government to 'stamp' your enforce your contract
    • Based upon the value of your contract

Ownership Objective

Corporate Property

• Business Base
• Corporate Statement
• Enabler of Business
• Infrastructure Facility

Investment Property

• Return On Investment
• Diversification by
  • Location
  • Size
  • Sector
• Direct and Indirect
  • AREITS
  • Syndicates

Property sectors

• Residential
• Houses, apartments, affordable housing, retirement
• Industrial
  • Warehouses, factories, specialist plant (ie abattoirs, refineries, mills etc)
• Commercial
  • CBD vs fringe vs various grade of accommodation
• Retail
  • Regional, sub-regional, neighbourhood shopping centres, bulky goods
• Leisure
  • Hotel, resorts, theme parks
• Agricultural
  • Farming, mining
• Infrastructure
  • Roads, tunnels, airports, seaports, bridges

Scope of Real Property

• Public/Private
• Owner occupied/investment
• Multi purpose/single use
• Large scale/small scale

Public

• Infrastructure
  • Roads, rail, ports, dams
• Services
  • Health, defense, law, education, recreation Private
• Corporate Real Estate
• Investment Property

Why are decisions about property generally more complex and time consuming compared to decisions about other asset classes?

(Question has always been formed in the final exam) - would need to compare and contrast other asset classes

• Size – large capital requirements
  • If you are buying or selling a piece of real estate, they tend to cost more than buying an ounce of gold e.g.
  • Larger capital requirements than most asset classes
• Regulatory environment – high degree of regulatory control and compliance
  • massive degree of regulatory control
  • Health and Safety
  • Toxic materials
• Uniqueness
• Time line – long time from inception to use/monetisation
  • contracts, signing etc. Potentially no return for a very long time
• Property is a wasting asset – depreciation and obsolescence
  • Built form depreciates and becomes obsolete
• Limited liquidity
• Quality of management impacts value
  • Improve the value by being smart, with renovations

Equity in real estate - the equity component is the amount you own in the property, excluding the debt component