Considered as an investment, real estate differs largely from other investments like equity.

E.g. The difficulty in selling (Potential long time span in waiting/hunting for buyer), the much higher ratio of selling cost, etc.

These factors should make it much different than other investments, hence, are there any models in evaluation of real estate that can quantitatively include more factors in a logical manner?

  • What kind of investment are you looking for in real estate? Rental income, growth in value, etc.? – Nicole Sep 30 '11 at 19:40
  • Hi Renesis, an evaluation model for the price of house, that can logically take these factors into consideration. Saying in another way, how do we normally evaluate these factors, and which side normally pay for these factors? (like in-liquidity, selling costs) – Flake Sep 30 '11 at 19:45
  • What I'm asking is what kind of profit are you looking for? A rental income that you don't expect to sell for profit would have very different considerations than one which you will see no (or even negative) rental return but profit on the sale of the asset. It sounds like you want to consider it the second, but knowing that is important to the question. – Nicole Sep 30 '11 at 19:53
  • Hi Renesis, thanks for the elaboration. It could indeed make very much differences. If possible, I would like to know for both situations. Thanks. – Flake Sep 30 '11 at 21:54
  • @Flake it sounds like you're developing the start of a good list of factors there. How about if you make your own wiki-mode answer to the question, and then others can add to it? – poolie Oct 2 '11 at 22:03

Your question is potentially very broad in scope, so I'll try to provide a narrow answer. And I'm assuming that by looking at real estate as an investment you mean that you're expecting to profit from periodic cash flows over the time that you will hold the asset.

If that's the case, then the model for valuing investment real estate isn't all that much different in a macro sense than valuing financial assets. The differences that do exist can be accounted for in estimating your discount rate and your final expected cash flow (i.e., the estimated terminal value of the asset).

As you've noted, the primary differences between an investment in real estate and an investment in financial assets are (1) liquidity and (2) transaction costs. For the former you can attempt to quantify the effect of illiquidity by adding a component to the discount rate. In a sense illiquidity is a form of risk, and the extent to which that risk impacts you depends in part on your goals as an investor. But if you wish to try to measure the impact of illiquidity in the general marketplace, you're going to have to get some data. For transaction costs, I should think that you would account for that in your terminal value.

For more information see http://www.amazon.com/Investment-Valuation-Techniques-Determining-Second/dp/0471414883

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