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Real Estate: Investment and Financial Strategy.

Real Estate: Investment and Financial Strategy

REAL ESTATE MARKETS and transactions are complex. Sound investment strategies require careful consideration of the institutional framework (including tax laws, real estate law, etc.), the evaluation of future cash flows and capital gains appropriately discounted, the assessment of risk, sources of financing, and many other factors. Peter Chinloy's book attempts to address these considerations from the perspective of the individual investor (including homeowners), financial intermediaries, real estate brokers, and developers. His target audience is "the researcher in real estate, as well as the real estate investor, appraiser, broker, developer, financier, securities and financial analyst, planner, and the professional who seeks to develop an underlying strategy for investment in physical and financial assets and liabilities of real estate markets." Some of the limitations of the book arise from attempting to address such a heterogenous audience on so many divergent topics.

He begins with an enticing proposition: "Real estate markets are imperfect, and it is possible to beat the market with the appropriate strategy." He then goes on to promise: "This book develops a strategy for the acquisition and management of physical and financial real estate assets." To an extent, he delivers on this promise, but the strategy is not developed as effectively as it could be.

The first section consists of two chapters and provides interesting surveys of appraisal techniques and several aspects of real estate law. The discussion of a hedonic approach to appraisal highlights the potential usefulness of this technique, but does not provide enough information to permit its application nor does it provide citations of other sources on the subject. This type of omission occurs throughout the book and reflects a missed opportunity to make the book much more helpful to practitioners.

The second section consists chapters and mainly focuses on methods to calculate present and future values, annuities, and effective interest rates. The effective interest rate, which takes into account the effects of points, fees, prepayment penalties, and the frequency of compounding, is the appropriate measure to start with in determining the cost of funds to an investor and is the unknown in many of Chinloy's analytical frameworks. However, readers unfamiliar with iterative solution techniques may find the determination of effective rates inaccessible. Many of the analytical approaches in the remainder of the book rely on calculating effective rates using these techniques. Unfortunately, the author provides only a few sentences on iterative solutions and no numerical examples.

The third section consists of two chapters and examines decision rules for buying, holding, and selling real estate. Tax considerations are a central focus. The framework of the analysis involves the construction of income statements, balance sheets, and spreadsheets with sources and uses of cash related to the real-estate investment. The author highlights the important distinction between economic accounting and tax accounting in areas such as depreciation, capital gains, and the like. For instance, depreciation for tax purposes may be accelerated and significantly larger than economic depreciation on the same real-estate investment in the early years. Accrued, but unrealized, capital gains appear in the economic income statement, but are not taxable and, therefore, are omitted from the income statement for tax purposes. The ultimate decision rules essentially involve comparing after-tax expected returns with after-tax expenses and comparing rates of return on holding versus selling.

The final section consists of four chapters and focuses on financial aspects of real estate investment. Included are chapters on passive investment (i.e., syndication, limited partnerships, and real estate investment trusts), mortgage-backed securities, hedging strategies to reduce risks from interest rate fluctuations and refinancing, and on direct lending in the mortgage market by savings and loan associations, and mortgage banking companies.

Taken as a whole, Chinloy's book contains a great deal of valuable information. However, the attempt to address so many issues for such a diverse audience creates many abrupt transitions and organizational problems. Further, the attempt to merge theoretical expositions with "how to" discussions is not very successful. It is as though a large number of independent seminar topics geared to audiences of differing levels of expertise have been pasted together to create the book.

The book has many inaccuracies. For example, the author states that borrowers with adjustable-rate mortgages have lower default rates than those with fixed-rate mortgages, when the data indicate the opposite is true by a wide margin. He also states that the Government National Mortgage Association purchases loans. It does not. It guarantees the timely payment of interest and principal on securities backed by mortgages. Further, the book has literally hundreds of typesetting errors. In some cases, sentences cannot be interpreted even in the context of the surrounding material. In one instance, the real interest rate is defined as the nominal interest rate plus expected inflation. Many readers in Chinloy's target audience may not immediately recognize that the sign is wrong.

In short, the book needs to be significantly reworked to make it a useful contribution to the literature. Many of the underlying themes and ideals have merit, but they are obscured by the assorted problems and limitations noted.
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Author:Holloway, Thomas M.; Peach, Richard W.
Publication:Business Economics
Article Type:Book Review
Date:Oct 1, 1989
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