q Steps to Boilding u ProIituble

PortIolio
In today's financial marketplace, a well-maintained portfolio is vital to any investor's success. As an individual
investor, you need to know how to determine an asset allocation that best conforms to your personal investment
goals and strategies. In other words, your portfolio should meet your future needs for capital and give you peace of
mind. Investors can construct portfolios aligned to their goals and investment strategies by following a systematic
approach. Here we go over some essential steps for taking such an approach.

Step 1: Determining the Appropriate Asset Allocation for You
Ascertaining your individual financial situation and investment goals is the first task in constructing a portfolio.
Important items to consider are age, how much time you have to grow your investments, as well as amount of capital
to invest and future capital needs. A single college graduate just beginning his or her career and a 55-year-old
married person expecting to help pay for a child's college education and plans to retire soon will have very
different investment strategies.

A second factor to take into account is your personality and risk tolerance. Are you the kind of person who is willing to
risk some money for the possibility of greater returns? Everyone would like to reap high returns year after year, but if
you are unable to sleep at night when your investments take a short-term drop, chances are the high returns from
those kinds of assets are not worth the stress.

As you can see, clarifying your current situation and your future needs for capital, as well as your risk tolerance, will
determine how your investments should be allocated among different asset classes. The possibility of greater returns
comes at the expense of greater risk of losses (a principle known as the risk/return tradeoff) - you don't want to
eliminate risk so much as optimize it for your unique condition and style. For example, the young person who won't
have to depend on his or her investments for income can afford to take greater risks in the quest for high returns. On
the other hand, the person nearing retirement needs to focus on protecting his or her assets and drawing income
from these assets in a tax-efficient manner.

Conservative Vs. Aggressive Investors
Generally, the more risk you can bear, the more aggressive your portfolio will be, devoting a larger portion to equities
and less to bonds and other fixed-income securities. Conversely, the less risk that's appropriate, the more
conservative your portfolio will be. Here are two examples: one suitable for a conservative investor and another for
the moderately aggressive investor.

The main goal of a conservative portfolio is to protect its value. The allocation shown above would yield current
income from the bonds, and would also provide some long-term capital growth potential from the investment in high-
quality equities.


A moderately aggressive portfolio satisfies an average risk tolerance, attracting those willing to accept more risk in
their portfolios in order to achieve a balance of capital growth and income.

Step 2: Achieving the Portfolio Designed in Step 1
Once you've determined the right asset allocation, you simply need to divide your capital between the appropriate
asset classes. On a basic level, this is not difficult: equities are equities, and bonds are bonds.

But you can further break down the different asset classes into subclasses, which also have different risks and
potential returns. For example, an investor might divide the equity portion between different sectors and market caps,
and between domestic and foreign stock. The bond portion might be allocated between those that are short term and
long term, government versus corporate debt and so forth.

There are several ways you can go about choosing the assets and securities to fulfill your asset allocation strategy
(remember to analyze the quality and potential of each investment you buy - not all bonds and stocks are the same):
Stock Picking - Choose stocks that satisfy the level of risk you want to carry in the equity portion of your
portfolio - sector, market cap and stock type are factors to consider. Analyze the companies using stock
screeners to shortlist potential picks, than carry out more in-depth analyses on each potential purchase to
determine its opportunities and risks going forward. This is the most work-intensive means of adding
securities to your portfolio, and requires you to regularly monitor price changes in your holdings and stay
current on company and industry news. (If you are new to stocks, see Stock Basics. For more on developing
a strategy for picking stocks, see Guide to Stock Picking Strategies.)
Bond Picking - When choosing bonds, there are several factors to consider including the coupon, maturity,
the bond type and rating, as well as the general interest rate environment. (For more on these subjects, see
Bond Basics and Advanced Bond Analysis.)
Mutual Funds - Mutual funds are available for a wide range of asset classes and allow you to hold stocks
and bonds that are professionally researched and picked by fund managers. Of course, fund managers
charge a fee for their services, which will detract from your returns. Index funds present another choice; they
tend to have lower fees because they mirror an established index and are thus passively managed. (See
Mutual Fund Basics and Index Investing.)
Exchange-Traded Funds (ETFs) - If you prefer not to invest with mutual funds, ETFs can be a viable
alternative. You can basically think of ETFs as mutual funds that trade like stocks. ETFs are similar to
mutual funds in that they represent a large basket of stocks - usually grouped by sector, capitalization,
country and the like - except that they are not actively managed, but instead track a chosen index or other
basket of stocks. Because they are passively managed, ETFs offer cost savings over mutual funds while
providing diversification. ETFs also cover a wide range of asset classes and can be a useful tool for
rounding out your portfolio. (For more on these, see Advantages of Exchange-Traded Funds.)
Step 3: Reassessing Portfolio Weightings
Once you have an established portfolio, you need to analyze and rebalance it periodically because market
movements may cause your initial weightings to change. To assess your portfolio's actual asset allocation,
quantitatively categorize the investments and determine their values' proportion to the whole. (To learn more, read
Rebalance Your Portfolio To Stay On Track.)

The other factors that are likely to change over time are your current financial situation, future needs and risk
tolerance. If these things change, you may need to adjust your portfolio accordingly. If your risk tolerance has
dropped, you may need to reduce the amount of equities held. Or perhaps you're now ready to take on greater risk
and your asset allocation requires that a small proportion of your assets be held in riskier small-cap stocks.

Essentially, to rebalance, you need to determine which of your positions are overweighted and underweighted. For
example, say you are holding 30% of your current assets in small-cap equities, while your asset allocation suggests
you should only have 15% of your assets in that class. Rebalancing involves determining how much of this position
you need to reduce and allocate to other classes.

Step 4: Rebalancing Strategically
Once you have determined which securities you need to reduce and by how much, decide which underweighted
securities you will buy with the proceeds from selling the overweighted securities. To choose your securities, use the
approaches discussed in Step 2.

When selling assets to rebalance your portfolio, take a moment to consider the tax implications of readjusting your
portfolio. Perhaps your investment in growth stocks has appreciated strongly over the past year, but if you were to
sell all of your equity positions to rebalance your portfolio, you may incur significant capital gains taxes. In this case, it
might be more beneficial to simply not contribute any new funds to that asset class in the future while continuing to
contribute to other asset classes. This will reduce your growth stocks' weighting in your portfolio over time without
incurring capital gains taxes.

At the same time, always consider the outlook of your securities. If you suspect that those same overweighted growth
stocks are ominously ready to fall, you may want to sell in spite of the tax implications. Analyst opinions and research
reports can be useful tools to help gauge the outlook for your holdings. And tax-loss selling is a strategy you can
apply to reduce tax implications. (For more on achieving your proper asset allocation over time, see Maintaining Your
Mutual Fund Equilibrium, which offers insight on general rebalancing principles.)

Remember the Importance of Diversification.
Throughout the entire portfolio construction process, it is vital that you remember to maintain your diversification
above all else. It is not enough simply to own securities from each asset class; you must also diversify within each
class. Ensure that your holdings within a given asset class are spread across an array of subclasses and industry
sectors.

As we mentioned, investors can achieve excellent diversification by using mutual funds and ETFs. These investment
vehicles allow individual investors to obtain the economies of scale that large fund managers enjoy, which the
average person would not be able to produce with a small amount of money.

Summary
Overall, a well-diversified portfolio is your best bet for consistent long-term growth of your investments. It protects
your assets from the risks of large declines and structural changes in the economy over time. Monitor the
diversification of your portfolio, making adjustments when necessary, and you will greatly increase your chances of
long-term financial success.



PortIolio Constroction

6 Asset Allocution Strutegies Thut Work
EsLubIIsIIng un upproprIuLe usseL mIx Is u dynumIc process und IL pIuys u key roIe In
deLermInIng your porLIoIIo's overuII rIsk und reLurn. As sucI, your porLIoIIo's usseL mIx
sIouId reIIecL your gouIs uL uny poInL In LIme. TIere ure u Iew dIIIerenL sLruLegIes oI
esLubIIsIIng usseL uIIocuLIons, und Iere we ouLIIne some oI LIem und exumIne LIeIr busIc
munugemenL upproucIes.

Strutegic Asset Allocution
SLruLegIc usseL uIIocuLIon Is u meLIod LIuL esLubIIsIes und udIeres Lo wIuL Is u "buse poIIcy
mIx." TIIs Is u proporLIonuI combInuLIon oI usseLs bused on expecLed ruLes oI reLurn Ior eucI
usseL cIuss. or exumpIe, II sLocks Iuve IIsLorIcuIIy reLurned 1o% per yeur und bonds Iuve
reLurned % per yeur, u mIx oI o% sLocks und o% bonds wouId be expecLed Lo reLurn ;.%
per yeur.

Constunt-Weighting Asset Allocution
SLruLegIc usseL uIIocuLIon generuIIy ImpIIes u buy-und-IoId sLruLegy, even us LIe sIIIL In
LIe vuIues oI usseLs cuuse u drIIL Irom LIe InILIuIIy esLubIIsIed poIIcy mIx. or LIIs
reuson, you muy cIoose Lo udopL u consLunL-weIgILIng upproucI Lo usseL uIIocuLIon. WILI
LIIs upproucI, you conLInuuIIy rebuIunce your porLIoIIo. or exumpIe, II one usseL were
decIInIng In vuIue, you wouId purcIuse more oI LIuL usseL, und II LIuL usseL vuIue sIouId
Increuse, you wouId seII IL.

TIere ure no Iurd-und-IusL ruIes Ior LIe LImIng oI porLIoIIo rebuIuncIng under sLruLegIc or
consLunL-weIgILIng usseL uIIocuLIon. However, u common ruIe oI LIumb Is LIuL LIe porLIoIIo
sIouId be rebuIunced Lo ILs orIgInuI mIx wIen uny gIven usseL cIuss moves more LIun %
Irom ILs orIgInuI vuIue.

Tucticul Asset Allocution
Over LIe Iong run, u sLruLegIc usseL uIIocuLIon sLruLegy muy seem reIuLIveIy rIgId. TIereIore,
you muy IInd IL necessury Lo occusIonuIIy enguge In sIorL-Lerm, LucLIcuI devIuLIons Irom LIe
mIx In order Lo cupILuIIze on unusuuI or excepLIonuI InvesLmenL opporLunILIes. TIIs
IIexIbIIILy udds u componenL oI murkeL LImIng Lo LIe porLIoIIo, uIIowIng you Lo purLIcIpuLe In
economIc condILIons LIuL ure more IuvorubIe Ior one usseL cIuss LIun Ior oLIers.

TucLIcuI usseL uIIocuLIon cun be descrIbed us u moderuLeIy ucLIve sLruLegy, sInce LIe overuII
sLruLegIc usseL mIx Is reLurned Lo wIen desIred sIorL-Lerm proIILs ure ucIIeved. TIIs sLruLegy
demunds some dIscIpIIne, us you musL IIrsL be ubIe Lo recognIze wIen sIorL-Lerm
opporLunILIes Iuve run LIeIr course, und LIen rebuIunce LIe porLIoIIo Lo LIe Iong-Lerm usseL
posILIon.

ynumic Asset Allocution
AnoLIer ucLIve usseL uIIocuLIon sLruLegy Is dynumIc usseL uIIocuLIon, wILI wIIcI you
consLunLIy udjusL LIe mIx oI usseLs us murkeLs rIse und IuII und LIe economy sLrengLIens und
weukens. WILI LIIs sLruLegy you seII usseLs LIuL ure decIInIng und purcIuse usseLs LIuL ure
IncreusIng, mukIng dynumIc usseL uIIocuLIon LIe poIur opposILe oI u consLunL-weIgILIng
sLruLegy. or exumpIe, II LIe sLock murkeL Is sIowIng weukness, you seII sLocks In
unLIcIpuLIon oI IurLIer decreuses, und II LIe murkeL Is sLrong, you purcIuse sLocks In
unLIcIpuLIon oI conLInued murkeL guIns.

Insored Asset Allocution
WILI un Insured usseL uIIocuLIon sLruLegy, you esLubIIsI u buse porLIoIIo vuIue under wIIcI
LIe porLIoIIo sIouId noL be uIIowed Lo drop. As Iong us LIe porLIoIIo ucIIeves u reLurn ubove
ILs buse, you exercIse ucLIve munugemenL Lo Lry Lo Increuse LIe porLIoIIo vuIue us mucI us
possIbIe. I, Iowever, LIe porLIoIIo sIouId ever drop Lo LIe buse vuIue, you InvesL In rIsk-Iree
usseLs so LIuL LIe buse vuIue becomes IIxed. AL sucI LIme, you wouId consuIL wILI your
udvIsor on re-uIIocuLIng usseLs, perIups even cIungIng your InvesLmenL sLruLegy enLIreIy.

You cun ImpIemenL un Insured usseL uIIocuLIon sLruLegy wILI u IormuIu upproucI or u
porLIoIIo Insurunce upproucI. TIe IormuIu upproucI Is u gruduuLed sLruLegy: us LIe porLIoIIo
vuIue decreuses, you purcIuse more und more rIsk-Iree usseLs so LIuL wIen LIe porLIoIIo
reucIes ILs buse IeveI, you ure enLIreIy InvesLed In rIsk-Iree usseLs. WILI LIe porLIoIIo
Insurunce upproucI you wouId use puL opLIons undJor IuLures conLrucLs Lo preserve LIe buse
cupILuI. BoLI upproucIes ure consIdered ucLIve munugemenL sLruLegIes, buL wIen LIe buse
umounL Is reucIed, you ure udopLIng u pussIve upproucI.

nsured usseL uIIocuLIon muy be suILubIe Ior rIsk-uverse InvesLors wIo desIre u cerLuIn IeveI
oI ucLIve porLIoIIo munugemenL buL upprecIuLe LIe securILy oI esLubIIsIIng u guurunLeed
IIoor beIow wIIcI LIe porLIoIIo Is noL uIIowed Lo decIIne. or exumpIe, un InvesLor wIo
wIsIes Lo esLubIIsI u mInImum sLundurd oI IIvIng durIng reLIremenL mIgIL IInd un Insured
usseL uIIocuLIon sLruLegy IdeuIIy suILed Lo IIs or Ier munugemenL gouIs.

Integruted Asset Allocution
WILI InLegruLed usseL uIIocuLIon you consIder boLI your economIc expecLuLIons und your
rIsk In esLubIIsIIng un usseL mIx. WIIIe uII oI LIe ubove-menLIoned sLruLegIes Luke InLo
uccounL expecLuLIons Ior IuLure murkeL reLurns, noL uII oI LIe sLruLegIes uccounL Ior
InvesLmenL rIsk LoIerunce. nLegruLed usseL uIIocuLIon, on LIe oLIer Iund, IncIudes uspecLs oI
uII sLruLegIes, uccounLIng noL onIy Ior expecLuLIons buL uIso ucLuuI cIunges In cupILuI murkeLs
und your rIsk LoIerunce. nLegruLed usseL uIIocuLIon Is u brouder usseL uIIocuLIon sLruLegy,
uIbeIL uIIowIng onIy eILIer dynumIc or consLunL-weIgILIng uIIocuLIon. ObvIousIy, un InvesLor
wouId noL wIsI Lo ImpIemenL Lwo sLruLegIes LIuL ure compeLIng wILI one unoLIer.

Conclosion
AsseL uIIocuLIon cun be un ucLIve process Lo vuryIng degrees or sLrIcLIy pussIve In nuLure.
WIeLIer un InvesLor cIooses u precIse usseL uIIocuLIon sLruLegy or u combInuLIon oI dIIIerenL
sLruLegIes depends on LIuL InvesLor's gouIs, uge, murkeL expecLuLIons und rIsk LoIerunce.
. Be uwure LIuL uIIocuLIon upproucIes LIuL InvoIve unLIcIpuLIng und reucLIng Lo murkeL
movemenLs requIre u greuL deuI oI experLIse und LuIenL In usIng purLIcuIur LooIs Ior LImIng
LIese movemenLs. Some wouId suy LIuL uccuruLeIy LImIng LIe murkeL Is nexL Lo ImpossIbIe,
so muke sure your sLruLegy Isn'L Loo vuInerubIe Lo unIoreseeubIe errors.







kLAL-LS1A1L INVLS1MLN1
ReuI esLuLe InvesLmenL InvoIves LIe commILmenL oI Iunds Lo properLy wILI un uIm Lo
generuLe Income LIrougI renLuI or Ieuse und Lo ucIIeve cupILuI upprecIuLIon. ReuI esLuLe
reIers Lo ImmovubIe properLy, sucI us Iund, und everyLIIng eIse LIuL Is permunenLIy
uLLucIed Lo IL, sucI us buIIdIngs. WIen u person ucquIres reuI esLuLe, sIeJIe uIso ucquIres u
seL oI rIgILs, IncIudIng possessIon, conLroI und LrunsIer rIgILs.
UndersLundIng reuI esLuLe InvesLmenL Is crucIuI becuuse IL usuuIIy InvoIves u subsLunLIuI
InvesLmenL und u Iong-Lerm one. Moreover , LIe reuI esLuLe murkeL cun be unpredIcLubIe.
TIIs Is purLIcuIurIy ImporLunL wIen one goes beyond buyIng u Iome Lo ucLuuIIy 'InvesLIng' In
reuI esLuLe. TIere ure u number oI wuys In wIIcI un InvesLor cun purLIcIpuLe In LIe reuI
esLuLe murkeL.
Reul Istute Investment: Rentul
One cun opL Ior reuI esLuLe InvesLmenL wILI un uIm Lo renL LIe properLy ouL Lo u LenunL. TIe
owner (IundIord) eurns u conLInuous sLreum oI renL Irom LIe LenunL, buL Is responsIbIe Ior
puyIng LIe morLguge, Luxes und uny cosLs ussocIuLed wILI muInLuInIng LIe properLy. TIe
owner uIso beneIILs Irom cupILuI upprecIuLIon (u rIse In LIe vuIue oI LIe properLy over LIme).
TIe IundIord runs LIe rIsk oI noL IIndIng u LenunL und couId suIIer neguLIve monLIIy cusI
IIows, wILI morLguge puymenLs und muInLenunce expenses sLIII Lo be borne. As compured Lo
ownIng sLocks und bonds, renLuI reuI esLuLe requIres u sIgnIIIcunL umounL LIme und eIIorL Lo
be devoLed by LIe IundIord.
Reul Istute Investment Groops
ReuI esLuLe InvesLmenL groups ure sImIIur Lo smuII muLuuI Iunds. TIey ure seL up Ior renLuI
properLIes. WIIIe un InvesLor muy own one or more unILs, u proIessIonuIIy munuged
compuny ucquIres, buIIds, muInLuIns und IeLs ouL uII LIe unILs on LIe properLIes In excIunge
Ior u percenLuge oI LIe monLIIy renL.
Reul Istute Truding
ReuI esLuLe Lruders IoId properLIes Ior onIy u sIorL spun oI LIme (Iess LIun Iour monLIs),
uImIng Lo seII LIem uL u proIIL. TIIs process Is cuIIed IIIppIng properLIes. nvesLors uIm uL
purcIusIng sIgnIIIcunLIy undervuIued or very IoL properLIes. SucI owners muy or muy noL
InvesL money InLo ImprovIng LIe properLy beIore puLLIng IL buck on suIe. A beur murkeL
couId resuIL In subsLunLIuI Iosses Ior u reuI esLuLe Lruder, sInce LIe InvesLmenL Is Iurge.
Resoorces
IsLIngs oI uvuIIubIe REO properLIes ure u greuL sLurLIng poInL Lo expIorIng uvuIIubIe reuI
esLuLe InvesLmenL opporLunILIes.
Reul Istute Investment Trosts {RIITs)
A reuI esLuLe InvesLmenL LrusL (RET) Is u corporuLIon LIuL InvesLs In reuI esLuLe. RETs Lrude
on mujor excIunges. A RET uses InvesLors' money Lo ucquIre und operuLe properLIes.
TIe beneIILs oI RETs ure:
RETs provIde IuIrIy reguIur Income.
nvesLors guIn exposure Lo non-resIdenLIuI InvesLmenLs (IIke muIIs und oIIIce buIIdIngs).
RETs ure IIgIIy IIquId.
RETs ure requIred by Iuw Lo dIsLrIbuLe qo% oI LIeIr LuxubIe Income In LIe Iorm oI dIvIdends Lo
sIureIoIders.
BeIore mukIng u cIoIce regurdIng LIe kInd oI reuI esLuLe purLIcIpuLIon, un InvesLor musL
evuIuuLe IIsJIer InvesLmenL cupucILy und rIsk uppeLILe.




Reul estute uppruisul
Reul estute uppruisul, property vuloution or lund vuloution Is LIe process oI vuIuIng
reuI properLy. TIe vuIue usuuIIy sougIL Is LIe properLy's MurkeL VuIue. AppruIsuIs ure
needed becuuse compured Lo, suy, corporuLe sLock, reuI esLuLe LrunsucLs very InIrequenLIy.
NoL onIy LIuL, buL every properLy Is dIIIerenL Irom LIe nexL, u IucLor LIuL doesn'L uIIecL usseLs
IIke corporuLe sLock. urLIermore, uII properLIes dIIIer Irom eucI oLIer In LIeIr IocuLIon -
wIIcI Is un ImporLunL IucLor In LIeIr vuIue. So u cenLruIIzed WuIrusIun uucLIon seLLIng cun'L
exIsL Ior LIe LrudIng oI properLy usseLs, sucI us exIsLs Lo Lrude corporuLe sLock (I.e. u sLock
murkeLJexcIunge). TIIs producL dIIIerenLIuLIon und Iuck oI IrequenL LrudIng, unIIke sLocks,
meuns LIuL someLImes uppruIsers ure needed Lo IIgure ouL u properLy's vuIue. TIe uppruIser
usuuIIy provIdes u wrILLen reporL on LIIs vuIue Lo IIs or Ier cIIenL. TIese reporLs ure used us
LIe busIs Ior morLguge Iouns, Ior seLLIIng esLuLes und dIvorces, Ior Lux muLLers, und so on.
SomeLImes LIe uppruIsuI reporL Is used by boLI purLIes Lo seL LIe suIe prIce oI LIe properLy
uppruIsed.
n some ureus, un uppruIser doesn'L need u IIcense or uny cerLIIIcuLIon Lo uppruIse properLy.
UsuuIIy, Iowever, mosL counLrIes or regIons requIre LIuL uppruIsuIs ure done by u IIcensed or
cerLIIIed uppruIser (In muny counLrIes known us u Propert Vcluer or Lcnd Vcluer und In
BrILIsI EngIIsI us u "vuIuuLIon surveyor"). I LIe uppruIser's opInIon Is bused on MurkeL
VuIue, LIen IL musL uIso be bused on LIe HIgIesL und BesL Use oI LIe reuI properLy. or
morLguge vuIuuLIons oI Improved resIdenLIuI properLy In LIe US, LIe uppruIsuI Is mosL oILen
reporLed on u sLundurdIzed Iorm, sucI us LIe UnIIorm ResIdenLIuI AppruIsuI ReporL.
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AppruIsuIs oI more compIex properLy (e.g. -- Income producIng, ruw Iund) ure usuuIIy
reporLed In u nurruLIve uppruIsuI reporL.

Types oI vuloe
TIere ure severuI Lypes und deIInILIons oI vuIue sougIL by u reuI esLuLe uppruIsuI. Some oI
LIe mosL common ure:
Murket Vuloe - TIe prIce uL wIIcI un usseL wouId Lrude In u compeLILIve WuIrusIun
uucLIon seLLIng. MurkeL VuIue Is usuuIIy InLercIungeubIe wILI Dpen Mcrlet Vclue or
Icir Vclue. nLernuLIonuI VuIuuLIon SLundurds (VS) deIIne MurkeL VuIue us:
Mcrlet Vclue Is LIe esLImuLed umounL Ior wIIcI u properLy sIouId excIunge on LIe
duLe oI vuIuuLIon beLween un educuLed buyer und u reusonubIy moLIvuLed seIIer In un
urms-IengLI LrunsucLIon uILer proper murkeLIng wIereIn LIe purLIes Iud eucI ucLed
knowIedgeubIy, prudenLIy, und wILIouL undue InIIuence.
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Vuloe-in-ose - TIe neL presenL vuIue (NPV) oI u cusI IIow LIuL un usseL generuLes
Ior u specIIIc owner under u specIIIc use. VuIue-In-use Is LIe vuIue Lo one purLIcuIur
user, und muy be ubove or beIow LIe murkeL vuIue oI u properLy.
Investment vuloe - Is LIe vuIue Lo one purLIcuIur InvesLor, und Is usuuIIy IIgIer
LIun LIe murkeL vuIue oI u properLy.
Liqoidution vuloe -- muy be unuIyzed us eILIer u Iorced liqoidution or un
orderly liqoidution und Is u commonIy sougIL sLundurd oI vuIue In bunkrupLcy
proceedIngs. L ussumes u seIIer wIo Is compeIIed Lo seII uILer un exposure perIod
wIIcI Is Iess LIun LIe murkeL-normuI LIme-Irume.
Price versos vuloe
TIere cun be dIIIerences beLween wIuL LIe properLy Is reuIIy worLI (MurkeL VuIue) und wIuL
IL cosL Lo buy IL (PrIce). A prIce puId mIgIL noL represenL LIuL properLy's murkeL vuIue.
SomeLImes, specIuI consIderuLIons muy Iuve been presenL, sucI us u specIuI reIuLIonsIIp
beLween LIe buyer und LIe seIIer wIere one purLy Iud conLroI or sIgnIIIcunL InIIuence over
LIe purLy. n oLIer cuses, LIe LrunsucLIon muy Iuve been jusL one oI severuI properLIes soId
or Lruded beLween Lwo purLIes. n LIose cuses, someLImes LIe prIce puId Ior uny purLIcuIur
pIece Isn'L ILs murkeL vuIue (wILI LIe Ideu usuuIIy beIng, LIougI, LIuL uII LIe pIeces und
prIces udd up Lo murkeL vuIue oI uII LIe purLs).
AL oLIer LImes, u buyer muy wIIIIngIy puy u premIum over und ubove LIe generuIIy-uccepLed
murkeL vuIue, II IIs subjecLIve vuIuuLIon oI LIe properLy (ILs intestment tclue Ior IIm) wus
IIgIer LIun LIe MurkeL VuIue. One specIIIc exumpIe oI LIIs Is un owner oI u neIgIborIng
properLy wIo, by combInIng IIs own properLy wILI LIe subjecL properLy, couId obLuIn
economIes-oI-scuIe. SImIIur sILuuLIons someLImes Iuppen In corporuLe IInunce. or
exumpIe, LIIs cun occur wIen u merger or ucquIsILIon Iuppens uL u prIce wIIcI Is IIgIer
LIun LIe vuIue represenLed by LIe prIce oI LIe underIyIng sLock. TIe usuuI expIunuLIon Ior
LIese Lypes oI mergers und ucquIsILIons Is LIuL 'LIe sum Is greuLer LIun ILs purLs', sInce IuII
ownersIIp oI u compuny provIdes IuII conLroI oI IL. TIIs Is someLIIng LIuL purcIusers wIII
someLImes puy u IIgI prIce Ior. TIIs sILuuLIon cun Iuppen In reuI esLuLe purcIuses Loo.
BuL LIe mosL common reuson wIy LIe vuIue cun be dIIIerenL LIuL LIe prIce puId, Is LIuL one
oI LIe Lwo purLIes (buyer or LIe seIIer) Is Loo unInIormed us Lo wIuL u properLy's murkeL
vuIue Is, buL neverLIeIess ugrees Lo buy or seII IL uL u cerLuIn prIce wIIcI Is Loo expensIve, or
Loo cIeup. TIIs Is unIorLunuLe Ior one oI LIe Lwo purLIes. L Is LIe Lusk oI LIe reuI esLuLe
uppruIserJproperLy vuIuer Lo judge wIeLIer u specIIIc prIce In u specIIIc LrunsucLIon Is ILs
MurkeL VuIue.




Three upprouches to vuloe
TIere ure LIree generuI groups oI meLIodoIogIes Ior deLermInIng vuIue. TIese ure usuuIIy
reIerred Lo us LIe "LIree upproucIes Lo vuIue" wIIcI ure generuIIy IndependenL oI eucI
oLIer:
TIe cosL upproucI
TIe suIes compurIson upproucI und
TIe Income upproucI
However, LIe recenL Lrend oI LIe busIness Lends Lo be Lowurd LIe use oI u scIenLIIIc
meLIodoIogy oI uppruIsuI wIIcI reIIes on LIe IounduLIon oI quunLILuLIve-duLu,
||
rIsk, und
geogrupIIcuI bused upproucIes.
|q|||
PugourLzI et cl. Iuve provIded u revIew on LIe meLIods
used In LIe IndusLry by compurIson beLween convenLIonuI upproucIes und udvunced ones.
|6|

TIe uppruIser cun generuIIy cIoose Irom LIree upproucIes Lo deLermIne vuIue. One or Lwo oI
LIese upproucIes wIII usuuIIy be mosL uppIIcubIe, wILI LIe oLIer upproucI or upproucIes
usuuIIy beIng Iess useIuI. TIe uppruIser Ius Lo LIInk ubouL LIe "scope oI work", LIe Lype oI
vuIue, LIe properLy ILseII, und LIe quuIILy und quunLILy oI duLu uvuIIubIe Ior eucI upproucI.
No overurcIIng sLuLemenL cun be mude LIuL one upproucI or unoLIer Is uIwuys beLLer LIun
one oI LIe oLIer upproucIes.
TIe uppruIser Ius Lo LIInk ubouL LIe wuy LIuL mosL buyers usuuIIy buy LIuL Lype oI properLy.
WIuL uppruIsuI meLIod do mosL buyers LIemseIves use Ior LIe Lype oI properLy beIng
vuIued? TIIs generuIIy guIdes LIe uppruIser's LIInkIng on LIe besL vuIuuLIon meLIod, In
conjuncLIon wILI LIe uvuIIubIe duLu. or InsLunce, uppruIsuIs oI properLIes LIuL ure LypIcuIIy
purcIused by InvesLors (e.g., skyscrupers) muy gIve greuLer weIgIL Lo LIe Income upproucI.
On LIe oLIer Iund, smuII reLuII or oIIIce properLIes, oILen purcIused by owner-users, muy
gIve greuLer weIgILIng Lo LIe suIes compurIson upproucI. WIIIe LIIs muy seem sImpIe, IL Is
noL uIwuys obvIous.
or exumpIe, sIngIe upurLmenL buIIdIngs oI u gIven quuIILy Lend Lo seII uL u prIce per
upurLmenL. n muny oI LIose cuses, LIe suIes compurIson upproucI muy be more uppIIcubIe.
On LIe oLIer Iund, u muILIpIe-buIIdIng upurLmenL compIex wouId usuuIIy be vuIued by LIe
Income upproucI, us LIuL wouId IoIIow Iow mosL buyers wouId vuIue IL. As unoLIer exumpIe,
sIngIe IumIIy Iouses ure mosL commonIy vuIued wILI greuLesL weIgILIng Lo LIe suIes
compurIson upproucI. However, II u sIngIe IumIIy dweIIIng Is In u neIgIborIood wIere uII or
mosL oI LIe dweIIIngs ure renLuI unILs, LIen some vurIunL oI LIe Income upproucI muy be
more useIuI. So LIe cIoIce oI vuIuuLIon meLIod cun cIunge dependIng upon LIe
cIrcumsLunces, even II LIe properLy beIng vuIued doesn'L cIunge mucI.
The cost upprouch
The cost approach factors in the price of the land plus construction, material, labor,
and all other costs to replicate the home at current market rates
TIe cost upprouch wus IormerIy cuIIed LIe summuLIon upproucI. TIe LIeory Is LIuL LIe
vuIue oI u properLy cun be esLImuLed by summIng LIe Iund vuIue und LIe deprecIuLed vuIue
oI uny ImprovemenLs. TIe vuIue oI LIe ImprovemenLs Is oILen reIerred Lo by LIe
ubbrevIuLIon RCND (reproducLIon cosL new Iess deprecIuLIon or repIucemenL cosL new Iess
deprecIuLIon). ReproducLIon reIers Lo reproducIng un exucL repIIcu. RepIucemenL cosL reIers
Lo LIe cosL oI buIIdIng u Iouse or oLIer ImprovemenL wIIcI Ius LIe sume uLIIILy, buL usIng
modern desIgn, workmunsIIp und muLerIuIs. n prucLIce, uppruIsers uImosL uIwuys use
repIucemenL cosL und LIen deducL u IucLor Ior uny IuncLIonuI dIs-uLIIILy ussocIuLed wILI LIe
uge oI LIe subjecL properLy. An excepLIon Lo LIe generuI ruIe oI usIng LIe repIucemenL cosL, Is
Ior some Insurunce vuIue uppruIsuIs. n LIose cuses, reproducLIon oI LIe exucL usseL uILer LIe
desLrucLIve evenL (IIre, eLc.) Is LIe gouI.
n mosL InsLunces wIen LIe cosL upproucI Is InvoIved, LIe overuII meLIodoIogy Is u IybrId oI
LIe cosL und suIes compurIson upproucIes. or exumpIe, LIe repIucemenL cosL Lo consLrucL u
buIIdIng cun be deLermIned by uddIng LIe Iubor, muLerIuI, und oLIer cosLs. On LIe oLIer
Iund, Iund vuIues und deprecIuLIon musL be derIved Irom un unuIysIs oI compurubIe suIes
duLu.
TIe cosL upproucI Is consIdered mosL reIIubIe wIen used on newer sLrucLures, buL LIe
meLIod Lends Lo become Iess reIIubIe Ior oIder properLIes. TIe cosL upproucI Is oILen LIe
onIy reIIubIe upproucI wIen deuIIng wILI specIuI use properLIes (e.g., pubIIc ussembIy,
murInus).
The sules compurison upprouch
TIe suIes compurIson upproucI In u recl estcte cpprciscl Is bused prImurIIy on LIe prIncIpIe
oI subsLILuLIon. TIIs upproucI ussumes u prudenL IndIvIduuI wIII puy no more Ior u properLy
LIun IL wouId cosL Lo purcIuse u compurubIe subsLILuLe properLy. TIe upproucI recognIzes
LIuL u LypIcuI buyer wIII compure uskIng prIces und seek Lo purcIuse LIe properLy LIuL meeLs
IIs or Ier wunLs und needs Ior LIe IowesL cosL. n deveIopIng LIe suIes compurIson
upproucI, LIe uppruIser uLLempLs Lo InLerpreL und meusure LIe ucLIons oI purLIes InvoIved In
LIe murkeLpIuce, IncIudIng buyers, seIIers, und InvesLors.
utu collection methods und vuloution process DuLu ure coIIecLed on recenL suIes oI
properLIes sImIIur Lo LIe subjecL beIng vuIued, cuIIed compurubIes. Sources oI compurubIe
duLu IncIude reuI esLuLe pubIIcuLIons, pubIIc records, buyers, seIIers, reuI esLuLe brokers
undJor ugenLs, uppruIsers, und so on. mporLunL deLuIIs oI eucI compurubIe suIe ure
descrIbed In LIe uppruIsuI reporL. SInce compurubIe suIes uren'L IdenLIcuI Lo LIe subjecL
properLy, udjusLmenLs muy be mude Ior duLe oI suIe, IocuLIon, sLyIe, umenILIes, squure
IooLuge, sILe sIze, eLc. TIe muIn Ideu Is Lo sImuIuLe LIe prIce LIuL wouId Iuve been puId II
eucI compurubIe suIe were IdenLIcuI Lo LIe subjecL properLy. I LIe compurubIe Is superIor Lo
LIe subjecL In u IucLor or uspecL, LIen u downwurd udjusLmenL Is needed Ior LIuL IucLor.
IkewIse, II LIe compurubIe Is InIerIor Lo LIe subjecL In un uspecL, LIen un upwurd
udjusLmenL Ior LIuL uspecL Is needed. rom LIe unuIysIs oI LIe group oI udjusLed suIes prIces
oI LIe compurubIe suIes, LIe uppruIser seIecLs un IndIcuLor oI vuIue LIuL Is represenLuLIve oI
LIe subjecL properLy.
Steps in the sules compurison upprouch 1. ReseurcI LIe murkeL Lo obLuIn InIormuLIon
perLuInIng Lo suIes, IIsLIngs, pendIng suIes LIuL ure sImIIur Lo LIe subjecL properLy. z.
nvesLIguLe LIe murkeL duLu Lo deLermIne wIeLIer LIey ure IucLuuIIy correcL und uccuruLe. .
DeLermIne reIevunL unILs oI compurIson (e.g., suIes prIce per squure IooL), und deveIop u
compuruLIve unuIysIs Ior eucI. q. Compure LIe subjecL und compurubIe suIes uccordIng Lo
LIe eIemenLs oI compurIson und udjusL us upproprIuLe. . ReconcIIe LIe muILIpIe vuIue
IndIcuLIons LIuL resuIL Irom LIe udjusLmenL oI LIe compurubIe suIes InLo u sIngIe vuIue
IndIcuLIon.
The income cupitulizution upprouch
Mcin crticle: Income cpprocch
The income cupitulizution upprouch (oILen reIerred Lo sImpIy us LIe "Income
upproucI") Is used Lo vuIue commercIuI und InvesLmenL properLIes. Becuuse IL Is InLended Lo
dIrecLIy reIIecL or modeI LIe expecLuLIons und beIuvIors oI LypIcuI murkeL purLIcIpunLs, LIIs
upproucI Is generuIIy consIdered LIe mosL uppIIcubIe vuIuuLIon LecInIque Ior Income-
producIng properLIes, wIere suIIIcIenL murkeL duLu exIsLs.
n u commercIuI Income-producIng properLy LIIs upproucI cupILuIIzes un Income sLreum
InLo u vuIue IndIcuLIon. TIIs cun be done usIng revenue muILIpIIers or cupILuIIzuLIon ruLes
uppIIed Lo u NeL OperuLIng ncome (NO). UsuuIIy, un NO Ius been sLubIIIzed so us noL
pIuce Loo mucI weIgIL on u very recenL evenL. An exumpIe oI LIIs Is un unIeused buIIdIng
wIIcI, LecInIcuIIy, Ius no NO. A sLubIIIzed NO wouId ussume LIuL LIe buIIdIng Is Ieused uL
u normuI ruLe, und Lo usuuI occupuncy IeveIs. TIe NeL OperuLIng ncome (NO) Is gross
poLenLIuI Income (GP), Iess vucuncy und coIIecLIon Ioss (= EIIecLIve Gross ncome) Iess
operuLIng expenses (buL excIudIng debL servIce, Income Luxes, undJor deprecIuLIon cIurges
uppIIed by uccounLunLs).
AILernuLIveIy, muILIpIe yeurs oI neL operuLIng Income cun be vuIued by u dIscounLed cusI
IIow unuIysIs (DC) modeI. TIe DC modeI Is wIdeIy used Lo vuIue Iurger und more
expensIve Income-producIng properLIes, sucI us Iurge oIIIce Lowers or mujor sIoppIng
cenLres. TIIs LecInIque uppIIes murkeL-supporLed yIeIds (or dIscounL ruLes) Lo projecLed
IuLure cusI IIows (sucI us unnuuI Income IIgures und LypIcuIIy u Iump reversIon Irom LIe
evenLuuI suIe oI LIe properLy) Lo urrIve uL u presenL vuIue IndIcuLIon.
1he Income Cap|ta||zat|on Approach
As l dlscussed ln a prevlous arLlcle, Los Angeles CounLy ls a ma[orlLy renLlng counLy. ln facL,
homeownershlp ln Callfornla hovers around 37 percenL, a far cry from Lhe 70 percenL of Lhe overall
naLlon. 1hls means LhaL a loL of people are landlords and renLers. MosL people do noL lnvesL money
expecLlng a loss of Lhelr caplLal. lL has become an acL of fuLlllLy Lo Lry Lo flnd an lncome produclng
properLy ln Lhe enLlre sLaLe of Callfornla. 1he lncome approach ls used by real esLaLe lnvesLors
predomlnanLly Lo arrlve aL a markeL prlce for a properLy. 1hls ls useful ln evaluaLlng mulLl-unlL properLles
because you may noL have many sales comparlsons of 36 unlL aparLmenL bulldlngs ln Lhe area. And
zonlng regulaLlons may vold Lhe cosL approach alLogeLher. So you need anoLher meLhod of flgurlng ouL
Lhe value of Lhe place. LeL us use an example of a 4 unlL properLy.

llrsL, you need Lo deLermlne Lhe neL operaLlng lncome. ln Lhls case lL ls:
(ltopetty qtoss locome) - (All expeoses excloJloq tbe looo poymeots) = NOl
Say Lhe 4 unlLs brlng ln $48,000 per year and Lhe expenses amounL Lo $21,600 (a 43 percenL expense
raLlo whlch mosL seasoned lnvesLors rely heavlly upon). So your net operating income ls $26,400
per year. WhaL do you do wlLh Lhls number? Well, mosL lnvesLors research Lhe local markeL and Lry Lo
flnd Lhe prevalllng expecLed raLe of reLurn for Lhe area. 1hls leads us lnLo Lhe caplLallzaLlon raLe of a
home. 1he cap raLe" glves us a beLLer undersLandlng of whaL local lnvesLors are reLurnlng on Lhelr
lnvesLmenLs. LeL us say LhaL Lhe area has a cap raLe of 7 percenL. 1o flnd an underlylng value of Lhls
poLenLlal properLy we use Lhe followlng lnformaLlon:
526,400 JlvlJeJ by .07 = 5J77,14J
So lf we are expecLlng a cap raLe of 7 percenL Lhe maxlmum amounL we should pay for Lhe properLy ls
approxlmaLely $377,143. Many ln Lhe houslng lndusLry wlll say Lhese numbers mean noLhlng ln
Callfornla or any overprlced markeLs because land ls volaLlle here and heck, we have Lhe sunshlne Lax.
Sun only hlLs Lhe wesL coasL, dldn'L you hear? Maybe Lhe numbers from Lhe lncome approach have llLLle
reflecLlon on Lhe prlce, buL uslng 3 meLhods provldes LrlangulaLlon of mulLlple perspecLlves and wlll glve
you a beLLer overall plcLure of Lhe value of Lhe home. lL mlghL even save you should you need Lo sell
lmmedlaLely.
Income Method
The Income Method is the Fundamental or the Intrinsic method of property valuation. The
present value of the property is estimated based on the projected future net income and re sale
value.The method uses the discounted cash flow (DCF) model to determine the present value of
an investment. One underlying assumption of this approach is the principle of opportunity cost of
capital, i.e. that money is of more value to its holder today than in the future. This method is an
essential element to the valuation of any property; it is almost always employed by financial and
investment professionals when valuing assets.
The Income approach capitalizes an income stream into a present value. Using Revenue
multipliers or single-year capitalization rates of Net Operating Income (NOI).
NOI = Gross Potential Income (GOI) Vacancy Operating Expenses.
Procedure:
Central to this valuation method are the various assumptions that are to be made for the DCF
analysis- the future income, re sale value and the opportunity cost of capital.
For the income based valuation of real estate, first the assumptions are made.
Next a DCF analysis is done. The PV of the property consists of two parts:
The annual income generated
The re sale value
The annual income for each year and the re sale value are projected. Using the opportunity cost
of capital, the present value is determined. This PV is the Income based value of the property.
Example of Income Method:
Calculation of Sale PV ( Present Value )
The three-bedroom flat costs Rs 120,00,000. The expected Resale value is for Rs 180,00,000 in
10 years. Let the discount rate be 8%. Then
Sale PV = Rs180,00,000 / (1 + 0.08) = Rs 83,37,500
Calcuation of Income PV ( Present Value )
The three-bedroom flat generating Rs 4,00,000 per year in rent costs Rs1,60,000 in expenses. So
annual income is Rs 2,40,000. Let the discount rate be 8%. The calculation for the net present
value of the first years income is:
Income PV = Rs 2,40,000 / (1 + 0.08)= Rs 2,22,200
The present value of the net income in year 1 is Rs 2,22,200.
Assuming that the flat is not re-sold after one year; instead, it is kept for 10 years. In that case:
Income PV = (Rs 2,40,000 / 1.08) + (Rs 2,40,000 / 1.08) + (Rs 2,40,000 / 1.08) + etc +
(Rs 2,40,000 / 1.08)
Income PV = Rs 16,10,200
The results, based on the assumptions, imply that the present-day value of the three-bedroom flat
is:
PV = Sale PV + Income PV
PV = Rs 83,37,500 + Rs 16,10,200
PV = Rs 99,47,700
Hence the flat should not be bought at the current price of Rs 120,00,000. It is worth noting that
this valuation method generates a result that is highly sensitive to the following variable
assumptions:
Rental Net Income: Rs 2,40,000
Resale Value in 10 years: Rs 180,00,000
Discount Rate: 8%
These assumptions dictate the intrinsic value placed on a property.
Advantages:
It focuses on the value of the property to the individual concerned
Income analysis is very detailed and draw specific conclusions
Disadvantages:
More complex and less intuitive than the sales comparable method
It ignores the actual market prices for property by neglecting the sales comparable method
The ultimate value is highly sensitive to the assumptions made
2) The Cost Approach
The cost approach was formerly called the Summation approach. The value of a property can be
estimated by summing the land value and the depreciated value of any improvements done on it.
It is the land value, plus the cost to reconstruct any improvements less the depreciation of these
improvements.
The overall methodology is a hybrid of cost and the market data approaches. As the cost to
construct a building can be determined by adding the labor and materials cost together but land
values and depreciation have to be gathered from market data. This is most reliable when used
on newer structures.
This method estimates the replacement value of the property by analyzing the cost of its
components- land and building. It is mid way between inferred and intrinsic methods.
Free market value of the land as if vacant + reconstruction cost of building Depreciation
suffered over the years = Value based on cost approach
Procedure:
The value of the land as if it was vacant is estimated. The second step is to estimate the
replacement cost of the building keeping in mind factors like utilities, building improvements,
tenant improvements, soft costs etc. Next, the depreciation amount is assessed and deducted.
Then add the estimated worth of land and the figure so obtained is the value of the real estate
based on the cost approach.
Example:
Market value of land: Rs10,00,000
Replacement cost of the building: Rs 20,00,000
Depreciation: Rs 7,50,000
Value of property = 10,00,000 + 20,00,000 -7,50,000 = 32,50,000
Advantages and Disadvantages:
This method sets the value at the actual cost or price of the property, however it relies upon other
valuation methods to derive the value of the land. Furthermore, it neglects the difference between
cost and value, namely that one property might be cheaper than another but generate a much
higher net income.
3) The Comparable Sales method
Also called the Inferred Analysis method of property valuation, it estimates the value of a house
by comparing it to the prices of similar properties sold in similar locations within a recent period
of time. The basic assumption is therefore that a property is worth what it will sell for, in the
absence of undue stress and if reasonable time is given. It is the most prevalent method in the
residential property market, concerning general trends and projections and employing the
principle of substitution.
This approach looks at the price or price per unit area of similar properties being sold in the
marketplace. The sales of properties similar to the subject are analyzed and the sale prices
adjusted to account for differences in the comparables to the subject to determine the fair market
value of the subject. This approach is generally considered the most reliable, if good comparable
sales exist and can serve as an independent check on the reasonability of a valuation opinion.
Procedure:
The most important task is to systematically assemble data on comparable properties. The
relevant characters to be looked for can be split into transaction and asset characteristics:
Transaction Characteristics Date of transaction, means of payment, transaction speed, etc.
Asset Characteristics Size, location, conditions, utility, building regulations, business climate,
etc.
Ideally, a property should be inspected in person. But considering the paucity of time, property
transaction databases are used. Once, all the data is gathered, the next task is to draw informed
conclusions. This is done by assigning weights to the properties. The ones closer to the property
to be examined are given higher weights.
Important Considerations while comparing:
When selecting properties that you consider comparable to your subject property, important
considerations include:
Statistically, sales far above or far below the bulk of the group are suspect. There likely are
valid reasons for the divergence.
Comparable properties should be from the subject propertys area or as close as possible.
Sold comparables should not be too old and should be in the current time frame as far as
possible.
Similar construction types should be used.
Adjustment of Value for Property Differences:
When comparing similar properties, there will always be differences. Propertys value estimate
should be adjusted for its differences from the comparable properties:
Add or subtract value for difference in lot or acreage size.
Feature differences, such as bedrooms, baths, garage, etc should also be considered.
Financing differences could have also influenced the sale price.
Advantages:
Most easy and straight forward method. It has thus become the practice in residential housing
market.
Leads to an objective valuation being placed on the property.
Disadvantages
Sometimes it becomes difficult to locate enough similar property transactions to draw
meaningful conclusions.
Market value and price might differ due to unreasonable actions by others.
This technique makes no reference to intrinsic value. If a propertys price is reasonable on a
comparable basis, it does not necessarily follow that this is a reasonable buying or selling price
for an individual