Real estate management phase in the context of the investment cycle. Also issues of technical and economic usage of real estate, depreciation and amortization methods as well as characteristics of land property and liquidation (demolition) are described in this article.
1.1. PLACE OF THE REAL ESTATE MANAGEMENT IN BOTH CYCLES
Building developed on the plot, which is a part of property or is a separate real estate, usually is being exploit for many years in order to bring increments to the owner.
Lifecycle of each building could be presented in various ways. The basic one is to distinguish investment stage from the exploitation phase. Both stages could be divided into more specific and precise parts. Investment phase is fundamentally different from the exploitation phase, which means that they have not only dissimilar aims but also methods to achieve these aims. The goal of the investment phase is to construct the building, to be more specific to finish the construction as soon as possible and to obtain a legal right of use. Methods used during investment phase have roots in:
• investor’s strategy, position on the market, income. Aspiration of most investors is to be involved in the project which will not only bring income but also a comparative advantage on the market.
• in law, technical, economical and financial terms.
During investment phase investor has to make key decisions, which lead him to next steps of the process. First decision is strategic- to “start or not” the investment. Decision usually ends the preliminary stage of thinking over the matter. Next step leads to choice of designer (mostly the architect) who is responsible for putting together design and technical documents in order to obtain a construction permit. Usually that ends the preparation stage. Investor needs to find contractors- builders and managers of builders who turn ideas into physical form. After construction process is completed next stage is the procurement of permit to use the building.
Building operations – during this stage most important is effectiveness. It means that income obtained from building day to day operations should be higher than exploitation/operating costs (costs include small repairs and amendments, as well as major overhaul in the long term).
Aims and objectives of owner during this stage of building lifecycle may be very ambitious- like possibly high income generation, growth of value, or even costs and loss decrease. Plans are usually executed by the property manager acting on the behalf of the owner.
Aim to generate a profit is most commonly allied with commercial properties, which were developed in order to bring benefits to the investor and the owner. Therefore professional property manager not only tend to supervise day to day operations (administrate) but also to enhance property’s market attractiveness. Stages of building lifecycle described till now are closely connected with each other. Property’s ability to create an income and decrease operating costs results from the basic investment aims. Economic value of each property defined during the exploitation phase has an influence on owner’s strategy and further operations. Both stages together- investment and building operations, create a lifecycle of the building, see character below:
Fig. 1.1. Lifecycle of the building
Source: H. Hajduk, Zarządzanie przedsięwzięciem budowlanym, “Problemy rozwoju budownictwa” 1993, nr 2.
As presented on the diagram lifecycle begins with the concept of investment. Sometimes idea comes naturally, for example when investor already has a land parcel. Then after a process of: ideas inception, refinement, feasibility study, contract negotiations and formal commitment act, construction phase begins. After completion and formal opening, starts exploitation phase, and this ends with building’s demolition. Phases differ significantly with each other, not only with aims, methods but also with duration time. Investment stage should not exceed couple of years, while exploitation stage last for decades or even longer.
Building’s operations Management/ Repairs
Many of currently used properties, especially in Europe, were developed even centuries ago.
Good project characteristics
Investment is a stage when building is developed, constructed; next stage is exploitation and it is closely connected with property management.
Decisions made during investment process determine quality and value of each property, and they have a crucial importance for property management.
Investment process is a stage when shape and physical attributes of the property are created.
Management is an art of work on already shaped material- property; of course changes are always possible (overhaul, reconstruction).
Therefore in many cases exploitation costs (and profitability) do not depend on property managers’ decisions but on technical and technological solutions applied in the building. Today exploitation phase (operations) is more commonly associated with property management in order to stress out change of approach from passive to active.
Exploitation stage simply means “use” of the building and facilities.
Usually owner’s approach to property is passive, except for the attempts to decrease costs. Property management represents an active approach, which includes strategic planning to possibly prolong property’s lifecycle, and also to find additional income source. In other words real estate is not seen as only a source of expenditures but income also.
Awareness in terms of managing income and expenditure balance is a very important issue on the property market.
Following activities are strongly recommended:
- routine actions:
- concerning exploitation: conservation, overhauls, modernization, increase of utilities’ price
- concerning income level: rent collection
- non routine action aimed at: value growth, innovation, new source of income etc.
1.2. TECHNICAL AND ECONOMIC USAGE OF THE REAL ESTATE, DEPRECIATION AND AMORTIZATION, METHODS OF AMORTIZATION
Technical and economic usage takes place during every day operations. Different aspects are connected with this issue. Ageing of building is a natural effect of a time passage, even when is not utilized. But technical and economic usage of property is a result of exploitation process. Property elements do not use up evenly. Elements of building’s construction are most durable, whereas furnishing is less durable. It is almost certain that during a long exploitation parts like sinks, taps, phone cables, lining etc. need to be replaced even couple of times. Simply their lifecycles are much shorter than building’s. It means that exploitation costs (management costs) have to include costs of repairs and replacements of equipment. If building is supposed to bring income it has to be kept in a proper standard, without technical defaults and make a positive impression (aesthetic design).
Technical usage may also cause a devastation of the building, if it will be overexploited, or fixtures and replacement will not take place for a long time. Then only (major) overhauls may bring back the building to the proper standard.
Technical usage strongly influences economic side of property management. High exploit costs cause difficulties in generating a profit.
Economic usage is the effect of building’s ageing.
Most commonly it is associated with machines and devices, rather than with buildings. Technological progress brings new products and solutions to the market and use of old ones is no longer efficient- in case of properties changes are made thru modernization or adaptation.
During exploitation process basic importance has an issue of amortization (it shows how property is creating a new value for the owner).
Amortization is a price creating element, not a cost, while cost was already counted as investment expenditure. In other words- each unit price of service and product includes part to cover amortization cost.
Amortization is a source of constant, but not significant source of money for the company, which does not increase income, therefore does not increase a tax rate.
Amortization costs are calculated each month, amount depends on:
- period of amortization
- initial property value
Amortization period is regulated by the state. Machines and appliances are sorted in groups with similar period of physical and economic usage. In case of buildings and structures amortization period is defined between 40 and 50 years. Amortization rate compared with initial value shows yearly amount of amortization. 1/12 of this amount may be calculated each month to company’s operating costs, which decreases generated profit.
Amortization process leads to economic depreciation of buildings and other structures. Along with amortization, current value of building decreases. After amortization period ends (40-50 years) book- keeping value of property will significantly decrease. But due to:
- major overhauls, modernization, and so on initial value may change
- book- keeping value depreciation does not influence significantly an actual market value of property.
Described in this article method of amortization (constant rate applied thru the process) is best known and used one. Other methods are used much seldom:
- decreasing amortization (decreasing rate)
- progressive amortization (increasing rate)
Independently from used method, amortization needs to take place during the anticipated period and can not exceed initial value of the building (unless it was modernized and there was a value increase).
1.3. CHARACTERISTICS OF LAND PROPERTY
Most significant feature of each real estate is immobility. As a part of land it can not be physically destroyed, although buildings and edifices may be demolished. Therefore most basic element of real estate concept is that a building can be a separate property or with can be a part of property together with the land parcel. According to Civil Code: “ Real estate is a part of land, which is a distinct property, also buildings or parts of buildings permanently connected with land, if from a legal point of view are properties separated from a land property (are not a part of land property)”.
- Real estate is a part of the land and as a part of it is immobile.
- It may be divided into small parcels or joined into a bigger property.
- Parcels’ value may be increased by development process- e.g. buildings. Buildings located on a parcel increase its attractiveness.
- Price and value increase when real estate gains additional functions and can be sold/ rent to a wider range of potential users.
- Non homogeneity, there are no exactly alike parcels of real estate. Types of buildings located on parcels are different, also sizes and shapes of properties, and so on. Even if two parcels seem to be exactly alike, actually they are different due to their unique location.
- Certainly property developers tend to standardize projects to lower costs, but even then properties differ.
Most commonly properties are divided into:
- Land properties
- Built-up properties (including buildings and other structures)
Land property, which includes not only a parcel as a part of surface of the earth, but also area below it and above it (air rights, surface rights and subsurface rights). Land property is:
- Agricultural land
- Land under lakes, rivers etc.
Most significant feature of land properties is that they are not used for buildings development, no matter is they are located in rural or urban area. Development process can not take place on land property unless necessary permit is granted:
- There is a possibility to locate a small habitat on the agricultural land, but maxim size of it is regulated by law.
- Changes in spatial management plan may include options to build properties on the Greenfield land.
- Real estate law and local spatial plans may include such an option.
Decision changing land’s qualification has a significant economic meaning for its owner. Greenfield land located near city area may be divided into small parcels and sold to investors/ developers for the price couple of times higher then the Greenfield was worth before development permit was obtained.
1.4. LIQUIDATION (DEMOLITION)
Liquidation of building property is a result of owner’s decision or administrative decision. Second option is possible in Poland when:
If property is bought by the state in order to develop public use property. It may include existing buildings demolition, regardless of their technical condition.
- Demolition forced by law regulations due to poor technical condition of property.
- Demolition forced by law regulations if required development permit was not obtained, and investment was completed against the law.
In case when owner decides on his own to demolish existing building, usually follows economic rules. Sometimes land property, without old buildings located on the parcel is worth much more. Real estate owner while making decision about demolition needs to make sure that “cleared” from the buildings property will have a higher market price.
As presented on character 1.1 liquidation is a last stage in property’s life cycle. Building “used itself”, but a land parcel probably gained a value, while cities are spreading and need additional space. Parcel may be used for a new development, it is reasonable to demolish old building.
Corrections to the presented rule:
- Building can not be demolished if it is on the list of historical monuments. Conservator needs to make a decision and issue a permit to do so. Usually role of conservator is to preserve existing buildings and to find other solution than demolition. Major overhaul, modernization etc. are advised. In majority of countries state and local authorities participate in costs of such an investment. In Poland even half of investment’s costs are returned to the owner if only process of modernization was conducted in cooperation with conservator.
- According to law building demolition needs to be conducted professionally, without threat to the third parties.