Owner's Goals and Objectives

Investors purchase income-producing real estate for two primary reasons:

1. Speculation
2. Investment

Speculation offers investors an opportunity to take a high risk and potentially receive a high reward from a relatively short-term holding period. The return is typically achieved at the time of sale and is realized from the profit made on the sale of the property.

Investment in real estate, on the other hand, typically extends for a longer holding period and offers investors five fundamental opportunities:

• Periodic return (cash flow):

  Example: An owner/investor may purchase real estate to obtain a steady source of income over a specific time period. The cash flow will provide a rate of return that can be compared to other investments and is enhanced by the tax shelter effects of the real estate, such as depreciation. The strength of a rent roll or market will greatly impact the quality of the cash flow that the owner will receive.
  

• Capital preservation (safety):

  Example: An owner may want to protect his principal investment by acquiring high quality real estate that will hold its value over time. The property may not provide a strong return but should retain its initial value. Some properties may even appreciate in value even though the owner may not make any further investments in the property due to a superior location. 
  

• Capital appreciation (hedge against inflation):

  Example: During inflationary times, when wages are going up, residents and tenants leasing real estate expect their rent to go up also. This in turn creates a higher rent value and a higher value to the property.
     

• Leverage (using borrowed funds):

  Example: The assumption with leverage is always that the return on the acquisition exceeds the cost of the borrowed funds. In essence, by using leverage you can control, and increase the value of, properties with minimal capital.
  

• Income tax advantage (tax shelter):

  Example: An owner may want the ability to defer recognition of income through a deduction of cost recovery (originally called “depreciation,” now most commonly called cost recovery), which provides an owner with the ability to pay less income taxes each year than he or she might otherwise have to pay on alternative investments.

In addition to the five fundamental financial reasons for investment, investors also enjoy pride of ownership from owning income-producing property.

Though not every property will fall clearly in the speculative investment category, one source of the distinction is based on the cash flow. If the property has a negative cash flow, it could be a property being used for speculation. This can be seen in an example where owners purchase rental buildings with negative cash flow, with anticipation of rehabbing or re-tenanting a building to provide higher returns.

While all investors have these financial goals, the goal of an effective real estate manager is to understand the mix of the various elements as it relates to the individual investor’s risk tolerance.