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Book Review

Pub: New York University Real Estate Review, 2005, Volume 3, Number 3, p. 90

Private Real Estate Investment: Data Analysis and Decision Making, by Roger J. Brown, Elsevier Academic Press (San Diego, 2005), pp. 282, with accompanying CD-ROM.

There are those of us who avoid the Real Estate sections of conventional bookstores like the plague, because of a healthy skepticism of titles that follow the form “How I Made Gazillions in Real Estate With Absolutely No Money Down!” When acquaintances learn that one actually teaches in a university real estate program, and they’ve read “How I Made Gazillions…,” the conversation can quickly turn awkward. Most people who have been around serious investment in the property markets can testify that there is a lot of hard work, serious number-crunching, and real risk in the enterprise. And those who believe that the entry fee is zero (or close to it) or that the risk/reward relationship for the private real estate investor can be tilted inordinately in favor of the “little guy” may be unpleasantly surprised at the experience of pain relative to gain in the actual doing.

Yet there are ample reasons to think that real estate education is sorely in need of a book that takes the subject of private real estate investing seriously, as Roger J. Brown’s work surely does. The widely-circulated Emerging Trends in Real Estate estimates, in its 2005 edition, that “non-institutional” real estate investment totals some $2.8 billion – higher, in fact, that the commercial property holdings of the institutional side (banks, pension funds, insurance companies, REITs, and other such investors). Data published by Real Capital Analytics reveal tens of billions of dollars of fresh acquisitions by “private local investors.” And, in many graduate-level real estate programs (including New York University, where the reviewer teaches), more and more students are seeking rigorous education but have ambitions running more toward entrepreneurial investment and/or development than toward working their way up through the hierarchy of large investment firms.

Often such students are frustrated by texts that concentrate on portfolio construction issues drawn from the literature of mixed-asset investment, and on finance topics dominated by either the lending perspective or corporate-style equity analysis. Brown offers this book as a supplementary text, filling in the gap for a serious study of what he terms “Tier II” real estate – roughly the universe of properties larger than the four-unit residential building, but smaller than the 100-unit apartment complex, and their analogues in the office, retail, and industrial property types.

Brown makes a contribution in examining the “rules of thumb” or threshold performance measures from an analytical perspective.  He devotes a chapter to the subject of when to use – and when not to use – such common tools as rent multipliers, cap rates, cash-on-cash rates, and price-per-unit. The discussion usefully compares the usual reports of such data – as averages or medians of market experience – with the far more interesting and pertinent issue of what is the range of the data, how is it distributed, and how to evaluate increasingly available market information in terms of its reliability for decision-making. While introducing a variety of statistical techniques, he is careful to point out how easy it is to argue for connections between data elements, relationships which upon closer examination turn out to be spurious. Educating students toward gaining such a critical eye for numbers cannot help but be valuable both in their career path and in the practical management of wealth.

Private Real Estate Investment also devotes substantive chapters to subjects such as 1031 exchanges, the issue of active management of the asset versus retaining third-party management, the question of providing or accepting seller financing at non-market terms, installment purchases, and some estate planning nuances. These chapters do a nice job of presenting detailed examples, usually with spreadsheets displayed in the text but also available on the accompanying CD-ROM, with sensitivity tests allowing the student to explore the many variables leading to the ultimate investment consequences. And, with a clear-sighted understanding of the limitations of classroom learning, Brown never fails to underscore the need for the private investor to team with experienced specialists, including but not limited to legal and accounting advisors, and those versed in the art of working with both the public and private agents shaping the local market.

Over the course of a career, most of us probably appreciate the impact of a pithy sentence that carries a world of wisdom, even more than the most elegant equation. So it is nice to find Brown providing a caveat as he examines the gymnastics of deal structures to mitigate or defer tax liabilities, to wit: “It is cheaper to pay taxes than to lose money” (p. 178) as a benchmark rule for examining costs to execute tax-motivated deals. “Pursuing tax objectives for their own sake is counterproductive. (p. 185).” No matter what the finance departments may insist about the priority of quantitative rigor, “Data does not supplant good fieldwork at the site. (p. 72)” And, importantly, “It is impossible to capture all real estate risk with mathematics. (p. 100)”

That said, Private Real Estate Investment does not short the reader looking for a vigorous mathematical workout. In some senses, it may even go a bit overboard with the quantitative exercises. For example, Chapter 5 is entitled, “Chance: Risk in General” and does a superlative job of taking the reader from the simple coin toss to calculation of the “continuous normal distribution,” with a clear commentary on the “bets” being made in terms of their risks and payoffs. But this is pure math, not real estate, as Brown acknowledges in making his segue into Chapter 6, “Uncertainty: Risk in Real Estate.”  Nevertheless, Chapter 6 devotes about 90% of its 36 pages to discussions of “Stable-Paretian Distributions,” “the Expected Utility Hypothesis,” and the “Probability Mass Function.” Brown ties up his analysis of a sample of Los Angeles house sales (the real estate content that is about ten percent of the chapter) with a conclusion about MLE (the Maximum Likelihood Estimation), but most readers will by then have concluded MEGO (My Eyes Glazed Over).

Indeed, for all its strengths, the most fundamental criticism of the book is that it searches for the middle ground between rigor and practicality, but tilts far too often toward mathematical applications that – while undoubtedly skillful – are well beyond what is needed to shape good real estate judgment and inform investment decisions. Somewhere in this bright land there may be private real estate investors who need probability density functions, logarithmic calculations of payoffs, and the “certainty equivalent” exponent for investor expectations. But it may be that such persons are the real estate graduate school equivalents of Mr. Spock from Star Trek, enviably rational but still just a fictional character.

Such quibbling aside, Roger Brown’s Private Real Estate Investment is a valuable addition to real estate’s growing academic library. Instructors will find it a good supplementary tool for exploring important real estate questions that are, by necessity, ignored in approaches to real estate that stress portfolio-level questions or corporate-style decision-making. The examples in the text – and the Excel spreadsheets illustrating them on the CD-ROM – offer some hands-on calculating to flesh out theory. Professors who like to use graphics in class presentations will enjoy the three-dimensional plots liberally provided on the CD – illustrations that are available in the text itself. Students who are looking for discussions of actual dilemmas faced by private investors will find thought-provoking content. And real estate programs can find in the book a model for how to motivate serious discussion of the world of private real property investment – without needing to promise “gazillions” at the end of the rainbow.

Hugh F. Kelly, CRE
Clinical Associate Professor of Real Estate
New York University
June 6, 2005