REAL ESTATE RISK AND
ITS IMPLICATION FOR PROJECT VIABILITY (A CASE STUDY OF EKEDO RESIDENTIAL
ESTATE, UYO)
CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND TO THE STUDY
Real estate investing involves the purchase,
ownership, management, rental and/or sale of real estate for profit.
Improvement of realty property as part of a real estate investment strategy is
generally considered to be a sub-specialty of real estate investing called real
estate development. Real estate is an asset form with limited liquidity
relative to other investments, it is also capital intensive (although capital
may be gained through mortgage leverage) and is highly cash flow dependent
(Syz, 2008). If these factors are not well understood and managed by the
investor, real estate becomes a risky investment. The primary cause of
investment failure for real estate is that the investor goes into negative cash
flow for a period of time that is not sustainable, often forcing them to resell
the property at a loss or go into insolvency. A similar practice known as
flipping is another reason for failure as the nature of the investment is often
associated with short term profit with less effort (Clayton, 2007).
Management
and evaluation of risk is a major part of any successful real estate investment
strategy. Risks occur in many different ways at every stage of the investment
process. For instance mitigation strategy for fraudulent sale is to verify
ownership and purchase title insurance. Real
estate owners often assume risk on their property exposure in response to
unavailability of coverage. While risk retention by ‑ financially sound
companies may help to reduce their cost of risk, absence of insurance is not
always desirable. In many cases, property owners are required under the terms
of their loan covenants to maintain full insurance to value, with restrictions
placed upon the amount of deductibles they may carry (Fisher, 2005).
Additionally, under high-deductible or self-insurance programs, operating
companies no longer have a budgeted premium, and payment of unexpected retained
losses creates potential cash flow
problems. Finally, property owners or management of companies have no ability
to charge the full cost of retaining property risk to their clients. Although
real estate markets represent a large proportion of total wealth in both
developing and developed countries, the real-estate derivatives markets are
still lagging behind in volume of trading and liquidity with has greatly
influenced project viability (Black, 1986). Over the last few years there has
been increased activity in developing derivative instruments that can be utilized
by asset managers to reduce real estate risk. The possibility of financial loss
occurring as the result of owing a real estate investment and its implication
on project viability will be focused on in this study. Real estate risk might
arise from such things as liability, legal issues, partner problems that can
force a sale, fire or theft, loss of rental income and purchasing property with
an imperfect title.
1.2 STATEMENT OF THE PROBLEM
Real
estate management is a particularly difficult challenge because of its tendency
towards liquidity. Typically, even published indices in real estate are based
on annual appraisals of large properties, not actual transactions. The recent unprecedented
recession has resulted in major long term distress across the real estate
industry, and has had severe implications for owners, developers, managers and
investors alike. Environmental and construction exposures, catastrophic
modeling, stricter lender requirements, and complex requirements involving
distressed banks are just some of the risks facing the real estate industry.
The researcher however will examine the real estate risks and its implication
of project viability.
1.3 OBJECTIVES
OF THE STUDY
The
following are the objectives of this study:
1. To
identify the risks involved in real estate investments.
2. To
examine the effect of real estate risk on project viability
3. To
identify ways to minimize risk in real estate investment.
1.4 RESEARCH QUESTIONS
1. What
are the risks involved in real estate investments?
2. What
is the effect of real estate risk on project viability?
3. What
are ways to minimize risk in real estate investment?
1.5 HYPOTHESIS
HO:
real estate risk does not affect project viability
HA:
real estate risk does affect project viability
1.6 SIGNIFICANCE OF THE STUDY
The
following are the significance of this study:
1. Result
of this study will educate the general public, investors and estate managers on
the real estate risks, how it can be minimized and its implication on project
viability.
2. This
research will also serve as a resource base to other scholars and researchers
interested in carrying out further research in this field subsequently, if
applied will go to an extent to provide new explanation to the topic.
1.7 SCOPE/LIMITATIONS OF THE STUDY
This
study on real estate risk and its implication on project viability will cover
all the risks an investor is exposed to in real estate with a view of
understanding its effect on viability of project.
LIMITATION OF STUDY
Financial constraint– Insufficient fund tends to impede the
efficiency of the researcher in sourcing for the relevant materials, literature
or information and in the process of data collection (internet, questionnaire
and interview).
Time constraint– The researcher will
simultaneously engage in this study with other academic work. This consequently
will cut down on the time devoted for the research work.
REFERENCES
Black,
D., Success and Failure of Futures Contracts: Theory and Empirical Evidence,
Monograph Series in Finance and Economics, Monograph 1986-1. New York
University, 1986.
Clayton,
J. “Commercial Real Estate Derivatives: They‟re
Here… Well, Almost.” PREA Quarterly, Winter 2007), pp. 68-71.
Fisher,
J. D., ‟New Strategies for Commercial Real
Estate Investment and Risk Management‟, Journal
of Portfolio Management, Vol. 32, 2005, pp. 154-161.
Syz.
Juerg M. Property Derivatives. (Wiley: Chichester, 2008).