Real Estate: Why Analyze?

Stephen Chung

Managing Director

Zeppelin Real Estate Analysis Limited

June 2007

Your humble author did not start out as a real estate analyst. He was first trained as a quantity surveyor (to the uninitiated, and in very simple terms, a quantity surveyor counts how many bricks and how much steel are needed to complete a building and price them, among other tasks) on which he proceeded to become a project manager, real estate broker-researcher, facility-asset manager, and eventually an analyst-strategist, covering most if not all aspects of real estate development, investment, and management. He has also done these in various places of Asia and North America and in the process has also experienced a few major local-regional-global economic events, such as the USA-led high-interest environment in early 1980s, the worldwide stock market crash in 1987, the USA crisis in savings and loans in late 1980s and early 1990s, the Asian Financial Crisis in 1997, the worldwide tech stock bubble in 2000, the Hong Kong SARS epidemic in 2003, and so on. He also realized the effects of such events on asset prices, real estate included. 

These events led him to become more aware of macro economic / social / administrative / cultural influences which at times would dictate real estate prices (much) more than what your competitors next door are charging their purchasers, or for that matter, what added-value a neighborhood infrastructural feature e.g. a pedestrian elevator may bring. And the scope of information and data and related methodologies to deal with them are quite different to those for assessing a certain identified real estate project. This is not a question of whether to perform macro OR micro analyses, but an issue of how best to make use of BOTH macro AND micro analyses. They serve different purposes and look at challenges from different angles. Macro seeks to find out IF a market is suitable for a certain investor to enter, while micro helps an investor to decide whether to go for project A or project B, or both, in a certain market. In short, when macro factors e.g. economy, global cash flow etc and micro factors e.g. neighborhood improvements, local employment etc collide, the macro ones usually prevail.  

In any event, many investors doubt if they would require analysis, or do not know how much of it they will need. With an obvious bias, your humble author thinks analysis is required for all ventures, for all parties, and at all times. The question is what, when, where, and how to apply it. Here are some pointers: 

A)      Reason to have analysis = For risk reduction, not elimination 

Analysis can help with identifying risks and reducing them, though not being able to eliminate them entirely. And analysis does this by encouraging or even in some instances forcing one to take a more systematic approach to assessing investment opportunities rather than by sheer guts, sentiments, and intuitions alone. With reduced risks, the chances for success are comparatively increased and returns on a risk-adjusted basis become better. Such risks could be market ones (systematic) or project specific (unsystematic).  

Can analysis guarantee profitability? NO, else your humble author would not be charging modest fees for services IF analysis means a crystal ball. YET, it can help enhance the chances for success and thus profitability. 

Also, do not underestimate the benefits of having reduced risks. For instance, an investor with slightly better risk control can over time beat another investor just as smart in profit margin per deal yet whose risk control is poor. In short, sometimes the investment duel is won not by being able to produce substantially higher profit margin than competitors, but simply by reducing the chance for loss.   

B)      Analysis can be simple or sophisticated, and needs not be overly quantitative 

The word ‘analysis’ always conjures up images of very sophisticated quantitative methodologies and cool impartial scientific approaches. This could be true yet real estate is NOT rocket science. Subject to circumstances, requirements, and resources available, real estate analysis could be quite simplistic with even no or little quantitative computations. Yet, at other times, it may be worthwhile to adopt complex models and detail data to arrive at finer results. Comparatively, and irrespective of what some investors and gurus may think, the margins for errors are higher in real estate than for shooting a spaceship to Mars. Also, real estate investing is a comparative activity. For instance, your getting an IRR of 15% means little if your competitors are all getting 20% (you are growing weaker compared to them). Yet the same 15% looks very good if your counterparts are only obtaining 8% (you are getting stronger compared to them). Not so with rockets. A 2mm off course may imply bouncing off the atmosphere into wild space and certain death. This error is more absolute.  

C)      Stakes at risk 

An investor doing a big real estate project for the first time, which success or failure would mean the difference between going 1 level up the operational ladder or perish owing to leveraging, should spend more time and effort in analyzing the prospective deal. On the other hand, an investor doing a routine project with plenty of similar prior experience, and which occupies no more than 10% of the resources, may spend less (not nil though) on analysis. Likewise, a real estate investor doing a composite project with 90% residential and 10% retail revenue components may wish to focus more on the residential portion than on the retail aspect. In short, one needs to match resources to risks properly and uses common sense.   

D)      Scales 

A person wishing to buy his own home and has a purchasing budget of say US$1,000,000 cannot afford to, or for that matter does not need to, employ too much time and effort in analyzing the prospective transaction. In most cases, a simple list of what one must have in a home (based on lifestyle etc) and a reality check on home finances (sufficient mortgage carrying capacity) should suffice. Contrarily, a US$ 2B real estate fund should spend more time and effort on analyzing investment strategies, markets, and prospective opportunities. Sometimes, it may mean performing investment scenario simulations to identify the best possible market choices and project selections. The related expenses are more than covered first by the sizable revenue and income in such funds, and second, by potential losses had these analyzes not been done or done sufficiently. 

E)      Analysis is for benchmarking and estimation and is not astrology 

Analysis is NOT used to foretell what dollar sum a project can actually be acquired for, or for that matter, be sold for. First, one does not always know the seller or buyer. Even if one does, the seller or buyer can always change his or her mind (in an instance at times too). As a market group, sellers and buyers come with different characters, investment experiences, market perceptions, business acumens, financial strengths, and the like, which in turn explains why sometimes a real estate-land tender or bid could fetch a wide range of offer prices. Analysis should instead be used for benchmarking and estimation, thus enabling an investor to make the best possible buy-sell decisions based on his or her own resources and capabilities and / or to budget for the purchase or sale.  

Based on market observations and news media reports, say a land auction has fetched prices way above the pre-auction estimates by appraisers, brokers, and the like. Very often, the general view is that these professionals have under-estimated the prices and very few, if any, would query if it were the buyers (successful auction bidders) who have overpaid for the land sites. Likewise vice versa. Notwithstanding the possibility of having improperly done valuations or estimations, deeming the market participants to be in the right and knowledgeable all the time and market prices to have reflected all aspects pertinent to the market is WRONG. And even seasoned and experienced market participants, ranging from speculators and investors to developers, have made wrong market assessments in the past, overpaying for purchased properties and underselling disposed properties in the process. Such may also happen in future.   

F)      No fool-proof eternal winning formula or quantitative model yet

Perhaps some fellow counterparts may wish to take issue with this, but at least your humble author has yet to find the ‘Holy Grail’ of real estate analysis, i.e. a sure-win formula which lasts for centuries and for all investment occasions. Speculatively, there are reasons for their non-existence. First, such a model is likely to be built from or at least be partly relied on past performance data and market trends, yet these latter items could change. A formula may work for a (short) while, and sometimes they do and could bring substantial rewards, yet becomes useless (even harmful) if employed on a prolonged period of time unqestionably. Second, the influence of the winning formula itself may alter the course of events thus in turn render the formula less applicable as time passes.

In summary, analysis is useful but it is not magic. Hard work and a cool head are required. Furthermore, analysis can-should also be used together with (good) intuition and (good) common sense. Good intuition refers to intuition based on proper industry and professional experience while good common sense is not common at all, despite the term. Intuition still uses one’s experience in real estate while common sense requires forgetting one’s experience for a while and assessing the opportunity from a layperson view. IF all 3 angles confer, it is all the better. IF not, at least there is a chance for further investigation or reconciliation.  

Related webpages:

Our Analytical Track Record

Common Q & A on Analysis

Notes: The article and/or content contained herein are for general reference only and are not meant to substitute for proper professional advice and/or due diligence. The author(s) and Zeppelin, including its staff, associates, consultants, executives and the like do not accept any responsibility or liability for losses, damages, claims and the like arising out of the use or reference to the content contained herein.  

About Zeppelin: Zeppelin Real Estate Analysis Limited focuses independent real estate analysis, investment strategy, and portfolio allocation. Together with Zeppelin Property Development Consultants Limited, the Zeppelin Group (ZPG) is involved in real estate development, investment, and management in China including Hong Kong, and offers services related to asset, project, facility, and marketing management.

Stephen Chung (Real Estate Analyst, Writer, and Speaker, BS BBldg(HKU) MS in Real Estate(MIT) MRICS MHKIS MAACE PQS RPS(QS) F.PFM NAREIT) has years of experience and track record as a prominent real estate writer contributing independent-angle, critical, professional, yet interesting and easy to read articles to various media sources, reflecting his 20 years+ real estate development, investment, and management experience in China, USA, and Canada, professional attribute, academic excellence, and wit. He has also delivered lectures and talks to universities and business associations and had been interviewed by the Asian Wall Street Journal and Radio Hong Kong. Stephen would be happy to contribute his writings, analyses, articles, and other works for publication subject to mutual agreement.

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