BE 4418 : Development Economics I

B.Sc. (Hons) in Facilities Management/ B.Sc. (Hons) in

Quantity Surveying
Department of Building Economics
University of Moratuwa

Terans Gunawardhana – Senior Lecturer

University of Sri Jayewardenepura
Session 03: Principles and Sources of
Investment
3
Content
What is investment, real investment and financial
investment
Distinguish between savings, investment, speculation
and gambling
Types of Investment
Factors affecting the choice of investment
Factors influencing the personal preferences of the
investor when taking investment decisions
What is ideal investment
Rate of return and yield
4 What is investment, real investment and
financial investment ?
 Investment
 Investment is to allocate money in the expectation of some benefit in
the future

 Real investment
 The MV of a property as an investment will depend upon supply and
demand; the price being dependent on the property’s net income or
rent and on the yield that typical investors would expect to achieve
given the general and specific risks associated with owning that
property.

 Financial investment
 Stocks, Bonds, FDs...
 Appreciation, Dividends/ Interest
5 Savings,investment, speculation and
gambling
 Savings is disposable income- consumption; storing
money safely such as in a bank or money market
account for short-term needs
 Investment is making a long-term commitment taking risk
and let it grow
 Speculation is the purchase of an asset with the hope
that it will become more valuable at a future date
 Gambling is the wagering of money or something of
value on an event with an uncertain outcome with the
primary intent of winning money or material goods.
Gambling thus requires three elements be present:
consideration, chance and prize
Comparing Investment Returns

 The investor must decide whether or not the investment

will provide an adequate or competitive return. The
answer to this question will depend on;

(1) the nature of alternative real estate investments,

(2) other investments that are available to the investor,
(3) the respective returns that those alternatives are expected to yield,
and
(4) differences in risk between the investment being considered
relative to those alternative investments available to the investor.
7 Types of Investment
 Bank Products
 Stocks
 Investment Funds
 Insurance
 Gold
 Real Estate
4.5%
9 Cont…
 Every purchase of property can be regarded as an investment,
whether it is to secure an income in the form of rent to the
owner or for occupation.
 A business may make a sensible choice between investing
capital in buying a property for business occupation or renting
similar property owned by someone else so that the capital
can be invested elsewhere.
 A further typical case is where a business has invested capital
to buy business premises for occupation but now wishes to
realize the capital tied up in the property in order to invest it
elsewhere in the business. In this case it might enter into a
lease-back or a mortgage transaction. In a lease-back it will
sell its interest in the property and take the property back on
lease, paying an annual rent.
10 Types of Real Estate Markets

 Property Market : Exchanged at Value

 Space Market : Occupy at a rent

11 Factors affecting the choice of investment

the security and regularity of the income;

the security of the capital;
the liquidity of the capital; and
the costs of transfer, i.e. the costs of buying and
selling.
12 Cont…

 An investment that offers the investor the opportunity of

maintaining the real value of capital and income is
described as a “hedge against inflation” and is said to
be “inflation proof”.
13 Factors influencing the personal
preferences of the investor when taking
investment decisions
 This is all about understanding Risk and Reward

 The greater the financial risk you are willing to take, the
better the rewards you are likely to reap; however,
greater financial risks can also be associated with
greater losses due to market fluctuations.
14 What is an ideal investment?

 It is highly a subjective judgment

 Risk takers
 Risk-averse investors
the security and regularity of the income;
the security of the capital;
the liquidity of the capital; and
the costs of transfer, i.e. the costs of buying and selling.
15 Cont…
 Buyers are those who propose to tie up capital in land or in
land and building; there are three main angles from which
they may view the transaction:

1. For occupation having regard to the personal, social or

commercial benefits to be derived from that occupation.
2. For long-term investment having regard to the income
(annual rent) expressed as a yield (percentage return) on the
capital invested.
3. For short-term gain or profit, buying and reselling after
improvement or repackaging
16 Rate of return and yield
 The valuer is often asked to value an interest in property
where the value is clearly dependent on the amount of rent
that an occupier would pay for the right to occupy and on
the level of return an investor would require on their capital.

 The basic principle is that investors invest capital to

obtain an annual return, in the form of a net income,
which represents an acceptable rate of return to
compensate for the investment risks involved.
17 Cont…
 For example, what net income will be required if X wishes to invest
Rs.1,000,000 in shop premises and requires a return of 6% on the
capital to be invested?

6% of Rs.1,000,000 = Rs.1,000,000× 6/100

= Rs. 60,000 net income

 To use the income approach the valuer must determine the

yield. This represents the rate of return that buyers, at the
valuation date, are seeking in relation to the particular
interest in that type of property, of that investment quality, in
that location. The yield is normally based on the analysis of
comparable transactions.
18 Cont…

 Yield in the normal context of the income approach is called

the ‘all risks yield’ (ARY) as it is the single yield most used to
analyze comparable sales evidence of investment property
sales.
 Nominal and actual or effective rates of interest
 Timing of payments
19 Cont..
Property Type Yield YP
Residential 3.30% - 5.00% 20 - 33
Commercial 5.50% - 6.25% 16 – 18
Industrial Warehouse 7.00% - 8.30% 12 – 14

Agricultural
Tea/Coconut/General 10.00% 10
Tea bought leaf 12.00% - 14.00% 7-8
Rubber 12.00% - 14.00% 7-8
 Factors affecting the choice of investment
20
Activity:
An investor plans to sell his existing business, which is not performing
well, at Rs. 60 million. After selling his business, he is willing to identify
new investment opportunities as listed below. You are asked to
produce an analytical report on such alternatives for the investor.

 To save in a fixed deposit in a state bank

 To buy gold coins
 To buy a coconut estate
 To invest in share market
 To start a hotel (business)
21

Thank you!