EVALUATION OF RISK ELEMENT IN REAL ESTATE INVESTMENT IN NEW NYANYA

EVALUATION OF RISK ELEMENT IN REAL ESTATE INVESTMENT IN NEW NYANYA

CHAPTER ONE

INTRODUCTION

1.1       Background of the Study

The growing expectation of any investor is to achieve maximum satisfaction in his investment. To attain the investment objective of maximizing wealth, maximizing returns and minimizing risks as a prudent investor will be paramount; therefore, investors choose between ranks of alternative investments.  The term risk is seen as the probability of loss of income, assets or condition of mishap, unfortunate situation or circumstances that result in the decline of revenue or loss of income, property, wealth and other items having economic and financial values. In statistics, risk relates to a situation where a probability or weight can be assigned to a possible outcome arising from a policy decision (Enever and Isaac,1997).

In the financial sense, risk is somewhat more intricate than the calculation of historical or expected returns. It is the possibility that an investor will lose some or all of the initial investment. Such conditions are the outcomes of a fall in product demand, high competitive pressure, unfavourable government policies, poor economic conditions, community uprising, industrial disharmony and management inefficiencies. Environmental factors such as changing weather conditions and environmental degradation are also noted to have adverse effect on investment. The international component of risk is relatively more complex, which arises from divergent economic policies, political and cultural ideologies thus making management of risk across national boundaries a difficult task. From the real estate investment perspective, risk is seen as the level of probability that a required return will be achieved when measured in terms of capital value and income.

As an investment, some properties have a high-risk profile while others have low-risk profile. This depends on the type, nature, location and possibly, the lease term of the property. Over time, the variance of actual return from expected return can be measured and used to help determine probability level. Risk is a deviation from the expected return and not just the chance that the return on an investment will be below expectations (Geddes, 2002). Thus, risk is about the interaction of future returns, which can have a number of possible results, and the chances that any particular outcome will occur. It is all about variances and probabilities. The degree to which actual performance may exceed the expected performance is called the upside potential while the amount by which it falls below expectation is known as the downside risk. Investors are concerned with the upward potentials, particularly when the investment is funded by borrowed capital. Upward potential is the actual bonus over and above the targeted return (Dubben and Sayce, 1991).

Another possible real estate risk investors may face as a real estate investor in Nigeria is government or political risk. Because of the wide ranging power of the executive arm of government and fluidity of functions, the government could acquire private land but the land so acquired must be for public purposes. Unfortunately, there are several instances where government had acquired private land for “public purposes” and “development control” only to turn around and allocate to other individuals to use for their own private projects. Some have experienced their Certificate of Occupancy revoked by a new government due to the fact that the owner does not belong to the same political party. This kind of policy inconsistency is a major discouragement to investors. They should be that as it may, whenever investors are planning to purchase a land in an area, engage professionals (e.g. Estate Surveyors and valuers) to confirm whether or not the land is under acquisition by government or could not be sold (Black, 1986).

There are also financial risks involved in real estate investment. If an investor decides to use a bank loan to buy a property, there is need for the awareness that what we call mortgages in Nigeria, is technically a residential loan. Ideally, a real estate/home loan should be a single-digit interest loan, but what Nigeria currently have are double – digit residential loans. Although, the government established a National Housing Fund (NHF) single-digit-interest loan that could advance a contributor up to N25m, many have not been able to access the loan due to bureaucratic bottlenecks and red tape. Some who have accessed the loan have had to apply for a bridging loan at residential double-digit interest rates in order not to miss their desirable property.

Risk is a common feature of all forms of investment including real estate and fundamental to investment choice. Therefore, any investor who embarks on a project development or acquires a property expects some benefits as future returns. Like any other form of investment, real estate has two principal components: expected return and risk. In an ideal situation, an investor is expected to maximize returns while minimizing risk. Therefore, the investor assumes risk with the hope of making profit or other forms of return. Risk assumption depends on past investment operation, future projection, trend in the economy, government intervention programmes and the expected returns from the investment. Often, the actual returns from the investment may vary from the projected returns. In some cases, the invested capital is lost. According to Ubom (2010), the degree of variability of the actual return from the estimated return of the investment as well as the probability of the loss of capital reflects the risk elements of investment. The higher the degree of such variability, the higher the risk involved and vice versa; and the greater the risk involved in a project, the greater the expected rate of return or cost of capital. The problems associated with investment risk cannot be totally eliminated even in an ideal economic situation. Real estate investors come across various types of risk in the course of embarking on projects and in the life of the projects.

Investment risk may be examined on the basis of the fundamental components or sources of risk and making predictions on how future returns will be affected by each fundamental risk. Risks have been variously classified into business, financial, interest rate, market and business power risks. Other forms of risk are political risk, tenant risk, sector risk, structural risk, taxation risk, planning risk, legal risk, comparative risk, timing risk and holding period risk, risk of unplanned obsolescence as well as management or union risk (Bowlinet al., 1980; Okafor, 1983; Messner, 1984; Dubben and Sayce, 1991;Ajayi, 1998; Geddes, 2002; Chandra, 2010; and Udoudoh, 2016). These risks are collectively described as investment risk. The goal of an ideal investor is to embark on any project or scheme that involves minimum risk with an expectation of maximum profit.

 In New Nyanya where this study is based, there has been phenomenal growth in real estate investment due to the influx of people and investors from other parts of the country as well as the ongoing renaissance in infrastructural development. There is therefore the need to empirically evaluate the risk element in real estate investment in New Nyanya in order to generate a roadmap that would guide prospective investors in the real sector.

1.2       Statement of Problem

It is very important for investors in residential real estate to first ascertain the risk factors of an investment asset before committing investment funds to such investment. Investors’ informed decisions with respect to the risk and develop strategies of real estate investments in order to ensure profitability. Residential real estate investment is usually rental properties intended to generate a return from rental income or capital appreciation. Investments in these real estate assets are associated with multiple risk complexities which includes: investment illiquidity, asset value volatility, asset valuation inaccuracies, leverage-amplifying negative performance during falling markets, limited/ imperfect benchmarks to gauge closed-end fund performance, combination of a large lot size (capital intensive investments) and high transaction costs. However, the researcher will provide an overview of real estate investment risks in New Nyanya and Nigeria at large.

1.3       Aim And Objectives Of Study

The primary aim of this study is to evaluate risk element in real estate investment in New Nyanya. The objectives of the study included:

1. To examine the various forms of investment available to the real estate investor in New Nyanya
2. To identify the qualities expected from an investment that is attractive to the investor.
3. To highlight the various stages of real estate development.
4. To examine the different elements of risk in relation to the various stages of real estate development.

1.3       Research questions

1. What are the various forms of investment available to the real estate investor in New Nyanya?
2. What are the qualities expected from an investment that is attractive to the investor?
3. What are the various stages of real estate development?
4. What are the different elements of risk in relation to the various stages of real estate development?

1.5       Significance Of The Study

The finding of this study will be of benefit to the following groups; firstly, investors who bear the cost of property development, secondly, the tenants and thirdly, real estate firms who are involved in the management of properties. This will again enable the investors to understand the trends of property investment as it relates to its cost in the face of risk. The research will also be of great importance to students and researchers who are interested in studying the real estate investment risk on residential properties.

The government and the financial sectors regulators (CBN) will find this research useful as it highlights the risk of residential real estate investment /development and provision of sustainable housing for her teaming citizens.

1.6       Scope and Limitations of the Study

The study helps to evaluate risk element in real estate investment in New Nyanya. Some factors militated against the success of this work, though the researcher endeavoured to accommodate them. Thus, some of the constraints inherent in the course of carrying out the research include, among others, the peculiar nature of real property market. It is not like commercial markets where one can easily come face to face with both the buyers and sellers to get information he wants. In real property market, information is not easily circulated among Estate Surveyors. Vital information required by the researcher from some respondent Estate Surveyors were not collected due to pressure of work and other commitments facing them during the time the researcher required those information.

1.7       Definition Of Operational Terms

Market analysis: The market analysis is activity of gathering information about conditions that affect a market. A market analysis studies the attractiveness and the dynamics of a specific market within a special industry.

Development risk: Development risk is defined as the risk that the leasing or sale of the project will generate insufficient returns to cover cost and create the desired return due to a lack of sales or inadequately meeting the needs of the market in terms of type and location. The more unusual a particular type of project is for the developer, the higher the chance that the developer will misread the market and the higher the development risk. (DICKINSON, 2001)

Building site risk: This is the risk that the selected site is unsuitable, or needs to be modified at cost to become suitable, for the intended use due to environmental issues (such as contamination) or its natural characteristics (stability, water levels, subsidence etc.) (DICKINSON, 2001)

Risk Management: Risk management as a systematic and integrated approach to the management of the total risk that a company faces. Risk management is the process of identifying, assessing and controlling threats to an organisation’s risk. (DICKINSON, 2001)

Market Value: This is the worth of an interest in property in which measurable buyers and sellers would agree to, when referred to market with existence of condition for comparative market application. Market value can also be defined as the higher price in terms of money which a property should bring in comparative or open market under all condition requisite to a fair sale, the buyer and seller each acting prudently, knowledge and assuming the price is not affected by undue stimulus. (Wendth and Paul, 1979)

Value: This is the monetary worth of a thing that is expressed as the value of the goods or services measured by the amount of other goods and services for which it will be exchange. (Wendth and Paul, 1979)

Residential Properties: Residential properties are those properties that are occupied for the purposee of providing shelter to the occupants and serves as a habitation for them. Residential properties are properties providing housing accommodation, (Leramo,1992)  Residential properties are generally constructed to mean property primarily acquired for residence and its attributed to giving shelter, security, comfort, privacy, investment, and personal identify, (Malady and O’ Donneland, 1994).

Property: Legally there are two types of property. They are real property which is land and buildings and personal property that is all kinds of personal possession. In economic the term property means anything that yield interest or income to the owner, The terms property  is defined as the bundle of right invested in a persons or a co operate bodies over a specific parcel of land, buildings object, e.t.c in the relation to other persons which gives right  to use and enjoy and control on  the land.