[Ebook PDF] Commercial Real Estate Analysis and Investments, 3rd Edition

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Commercial Real Estate Analysis and Investments, 3rd Edition

ISBN-13: 978-1133108825
ISBN-10: 1133108822

Author: Geltner, Miller, Clayton, Eichholtz (Author)

Commercial Real Estate Analysis and Investments 3rd edition

What This Book Is About
What is real estate? You could say that it is land. In that sense, real estate is the quarter of the earth’s surface on which all 7 billion human beings live. Or you could say it is built space, the structures in which we live, work, and play, that shape and define our cities, and shelter our dreams. Or you could say that real estate is one-third of the value of all capital assets in the world, over $30 trillion worth of assets in the United States alone. No matter how you define real estate, you can’t ignore it. Real estate is important, regardless of what line of work you are in.
But think a bit more about what real estate is. Perhaps most obviously, it is not called “real” for nothing. Real estate is real. It is dirt and bricks and concrete and steel. Like any major aspect of the real world, real estate can be studied academically from several different perspectives, bringing to bear several different academic and professional disciplines. So if you ask someone, What is real estate? the answer you get will likely depend on the profession of the person you are asking. While an architect will describe real estate from an aesthetic and functional perspective, an engineer will describe it from a physical structural perspective.
An environmental scientist will describe it from an ecological perspective, and a lawyer will describe it as a bundle of rights and duties associated with “real property,” that is, land and the permanent structures on it. All of these answers would be correct, and a complete study of real estate requires a very comprehensive multidisciplinary approach.
Yet this book, while not ignoring these various perspectives, is not intended to be a complete multidisciplinary text. In order to provide sufficient depth and rigor to our study, this book will have to concentrate on one of the major disciplines for studying real estate. The discipline we will be using is that of economics. Indeed, we need to be more precise even than that. Within the economic study of real estate, there are two major branches: urban economics and financial economics. The former is the branch of economics that studies cities, including the spatial and social phenomena relevant to understanding real estate. The latter is the branch that studies capital markets and the financial services industry. These are the two major branches of economics we will be using in this text because they are the most relevant for understanding commercial property from an investment perspective. Our major emphasis, however, will be on the second of these two branches, the financial economic aspects of real estate.
Why is the financial economic study of real estate so important? To answer this question, let’s go back to our original question, What is real estate? Just as the architect’s or engineer’s answer to this question emphasizes the physical (bricks and mortar), and the lawyer’s answer emphasizes the legal (bundle of rights), the successful real estate business professional’s answer is likely to emphasize the financial economic aspects. The investor’s fundamental answer to the question is, Real estate is potential future cash flows. The nature of these cash flows, their magnitude, timing, and risk, will fundamentally be determined in the rental market, which is where urban economics comes in. But whatever is the specific nature of the potential stream of future cash flows generated by real estate, any such stream is, more
generally, nothing more and nothing less than what is called a capital asset. And capital assets trade in capital markets. So that is where financial economics takes over.
Capital markets determine the opportunity costs and values of investments and capital assets, and allocate the flow of financial capital (aka “money”) to and among the underlying physical assets, which in turn produce the future real benefit flows that are the defining characteristic of capital assets. But perhaps more to the point for those with a more public policy or urban planning perspective, financial capital ultimately determines what real estate assets will be built, where, and when, in an entrepreneurial capitalist society such as that of the United States and many other countries. The physical structures and  aesthetic characteristics studied by the engineer or architect would not and cannot exist in reality without the financial capital to command the resources to produce them. Therefore, the academic discipline
that studies financial capital is of vital importance to any real estate professional. As noted, this discipline is financial economics.
Once again, we should be more precise. Within the discipline of financial economics, two major fields are typically covered in the core curriculum in graduate-level business schools: corporate finance and investments. Corporate finance concentrates on applications relevant to the financial and strategic management of large corporations whose equity is usually traded on the stock exchange. The investments field studies applications relevant to individuals and institutions making investment decisions about the wealth they own or manage.
Both of these fields are relevant to analyzing commercial property from an investment perspective. Indeed, more so than in the classical (or “mainstream”) presentations of these two fields, in real estate, the topics and applications addressed in corporate finance and investments are more closely interwoven. In real estate, we need to integrate these two fields that have grown apart in the mainstream literature and pedagogy.
To do this, we must address a number of features that make real estate unique—different from both the typical corporate finance and the securities investment contexts. For example, most commercial property is not held by publicly traded, taxed corporations. It may be held directly by taxed individuals or tax-exempt institutions, or it may be held by real estate investment trusts (REITs), which are publicly traded corporations that are not taxed at the corporate level. But only relatively rarely is commercial property actually owned (as opposed to rented or used) by the taxed corporations that dominate the stock market. Commercial property assets themselves also differ from the underlying assets held by the typical publicly traded, taxed corporation in that there is almost always a well-functioning market for commercial property. The productive physical assets of most corporations (machines, laboratories, factories) are not usually traded in so well-established and liquid a market as the commercial property market. In this respect, real estate assets are more like the assets studied in the mainstream investments field, primarily stocks and bonds. But the commercial property market is not as liquid or efficient in its operation as the securities markets dealt with in mainstream investments. (When was the last time you went online and ordered the sale of half of your ownership of 1000 North Main Street “at market” before close of business that day?) Another fascinating difference between real estate and the mainstream corporate and securities environment is the simultaneous existence of two parallel asset markets in which real estate trades. Commercial properties are traded directly in the private property market, and they are traded indirectly in the stock market through the equity shares of REITs and other real estate firms. (The analogy would be if you could buy pharmaceutical laboratories both directly and indirectly through the purchase of drug company stocks.)
These and other differences require a specific, real-estate-oriented treatment and synthesis of the topics covered in mainstream corporate finance and investments. This treatment can be, and needs to be, consistent with, integrated with, and built on the mainstream financial economic fields. A seamless intellectual continuum should exist from the typical finance course taught in the MBA core to the typical graduate course in Real Estate Finance or Real Estate Investments, an intellectual continuum from “Wall Street” to “Main Street.” After all, since capital and information flow freely between these loci in the real world, real estate investment knowledge and practice should be built on the same principles that underlie the corporate and securities world.
The real estate treatment we need must also present an intellectually coherent framework, rigorous from an academic perspective, built on a few solid underlying concepts and principles, not a hodgepodge of vaguely connected, ad hoc methodologies and rules of thumb. Modern real estate is crying out for a framework of fundamental principles, rigorously grounded analytical tools. The student needs a solid foundation in order to develop fundamental understanding. Yet such an elegant framework should include practical procedures and methodologies that can be applied directly to help answer typical real estate investment decision-making questions in the real world. Built on fundamental economic principles, such methods will allow the student to apply creatively the real estate investment analysis framework she learns in academia to the infinite variety of situations she will no doubt encounter in the real world.
The purpose of this book is to present such a framework, a corpus of principles, methods, and knowledge, at a level that the typical graduate student can readily understand (with a little time, effort, and study, of course). Our intention and hope is that, whether you are pursuing an MBA, MRE, or MCP, whether or not you already have some background in mainstream finance or in real estate or in urban economics, you will find this book useful.
One final point: We know that some people claim that real estate is too complex, or lacking in hard data, to study “scientifically”—that it is an art, not a science. The implication is that we can do no better than to support real estate decision making with purely ad hoc analytical techniques. In effect, the implication of this claim is that real estate decision making should be “shot from the hip,” or based on vaguely articulated intuition, even though this decision making governs one-third of the world’s assets.
But by now, in the twenty-first century, such an attitude truly is ignorance. We can do much better than “seat-of-the-pants” decision making. Yes, real estate is complex, data are less than perfect, and decision making will always be somewhat of an art and require good judgment. Real estate is neither rocket science nor heart surgery, and we will never outgrow our need to always apply common sense. But both financial and urban economics are highly developed, sophisticated fields of study. They contain a very impressive corpus of knowledge and toolkit of methodology, as rigorous as any branch of the social sciences. They encompass a long history and a vast body of scientific literature, both at the theoretical and empirical levels, and have several Nobel laureates to their credit. Quantitative data in real estate data are getting better and more widespread all the time. Financial and urban economics are out there waiting to be applied to real estate investment decision making. Read this book and do it!