Journal of Property Investment & Finance

The importance of investment feasibility analysis

Alina Oprea

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Alina Oprea, (2010),"The importance of investment feasibility analysis", Journal of Property Investment &
Finance, Vol. 28 Iss 1 pp. 58 - 61
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(2006),"Uncertainty and feasibility studies: an Italian case study", Journal of Property Investment &
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(2008),"Product development and innovation for developing countries: Potential and challenges", Journal of
Management Development, Vol. 27 Iss 10 pp. 1017-1025 http://dx.doi.org/10.1108/02621710810916277
(1992),"A Framework for Real Estate Feasibility Research", Journal of Property Valuation and Investment,
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JPIF
28,1

PRACTICE BRIEFING

The importance of investment

feasibility analysis

58

Alina Oprea
Bucharest, Romania

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Abstract
Purpose The purpose of this paper is to look at the importance of investment feasibility analysis.
Design/methodology/approach The paper addresses the question of whether a planned course
of action is likely to achieve individual or enterprise objectives, given the available resources and
specific constraints. Key issues are the legal, physical, and financial feasibility of a project proposal.
Feasibility typically addresses the issue of the most appropriate use for a particular site, the most
appropriate site for a predetermined use, or the most appropriate outlet for investment funds.
Findings Even though changes in the economy have increased risk or lowered returns, the
investment market continues to devise innovative and attractive investment strategies and the
determined investor keeps searching for profitable projects.
Originality/value The paper gives investment principles that should be taken into consideration
and will be of interest to those in a similar field.
Keywords Real estate, Investments, Risk analysis, Strategic objectives
Paper type Viewpoint

Introduction
Real estate is defined as land and all natural and man-made improvements attached
thereto, including air and mineral rights. When we acquire real estate, we also acquire
an associated bundle of rights in the property, such as use, possession, control,
enjoyment, exclusion, and disposition.
Real estate market activities fluctuate as a function of supply and effective demand.
When the top of the cycle has been reached, with high prices reflecting high profits, the
entry of new builders act to add to the supply and to reduce the prices and profits
accordingly, resulting in a reversal of the cycle. The micro cycle is local in character,
while the long-term cycle shows an ever-increasing value for real estate over time.
But, despite all obstacles, limitations and restrictions, real estate is a popular
investment. Even though changes in the economy have increased risk or lowered
returns, the investment market continues to device innovative and attractive
investment strategies and these determine investors keep searching for profitable
projects.

Journal of Property Investment &

Finance
Vol. 28 No. 1, 2010
pp. 58-61
q Emerald Group Publishing Limited
1463-578X
DOI 10.1108/14635781011020038

Real estate investment

A real estate investment can be illustrated as the commitment of funds by an
individual with a view to preserving and increasing capital and earning a profit.
Investment also represents the forgoing of some present comforts in anticipation of
future benefits.

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Conventionally, real estate investment has offered an above-average rate of return

while acting as an effective hedge against inflation. It allows an investor to use other
peoples money through leverage. There may also be tax advantages to owning real
estate. However, due to the real estate market characteristics (highly stratified; local
markets; heterogeneous product; private, not public transactions; unsophisticated
investors; unorganized market) this segment does not offer a highly liquid investment
and moreover, it often carries a high degree of risk.
Investment property held for appreciation purposes is generally expected to
increase in value to a point at which its selling price covers holding costs and the
propertys present and future intrinsic value.
An investor who hopes to use maximum leverage in financing an investment should
make a small down payment, pay low interest rates, and spread mortgage payments
over as long a period as possible. By holding and refinancing properties, an investor
may substantially increase investment holdings without contributing additional
capital. The highly leveraged investor has correspondingly high risk.
By exchanging one property for another with an equal or a greater selling value, an
investor can defer paying tax on the gain realized until a sale is made. A total tax
deferment is possible only if the investor receives no cash or other incentive to even out
the exchange. If such cash or property is received, it is called boot, and it is taxed.
Depreciation or, in other words, cost recovery, is a concept that allows an investor to
recover in tax deductions the basis of an asset over its useful life. Only costs of
improvements to land may be recovered, not cost for the land itself.
Feasibility analysis
All investors motivations and advantages, such as: pride in ownership, personal
control, self-use and occupancy, estate building, security of capital, high operating
yield, leverage, tax shelter, capital appreciation, portfolio diversification, should not
just be seen out of the real context, and the investors should consider the major
importance of feasibility analysis.
In general, when we refer to investment analysis in real estate, we are referring to
analysing a particular property to evaluate its investment potential. This analysis
should also help answer other important questions:
(1) Should the property be purchased?
(2) How should it be financed?
(3) How long should it be held?
(4) How risky is the investment, etc.?
We have seen that real estate investors, whether they take a debt or an equity position,
place funds at risk in anticipation of receiving a future stream of cash receipts. They
are in effect buying a set of assumptions about the projects ability to generate the
anticipated revenue.
In its simplest form, the feasibility is a profit and loss style statement whereby the
estimated expenses of the project are subtracted from the estimated revenue of the
project giving a profit or loss. A comprehensive financial feasibility analysis will go
much further than this by analyzing such things as cash-flow, sensitivity to variations
and performance indicators.

Investment
feasibility
analysis
59

JPIF
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60

Feasibility analysis addresses the question of whether a planned course of action is

likely to achieve individual or enterprise objectives, given the available resources and
specific constraints. Key issues are the legal, physical, and financial feasibility of a
project proposal. Feasibility typically addresses the issue of the most appropriate use
for a particular site, the most appropriate site for a predetermined use, or the most
appropriate outlet for investment funds.
Feasibility analysis is iterative and continuous. It involves the following eight steps:
(1) Assessing the physical and legal aspects of the site.
(2) Estimating demand for the space.
(3) Analyzing competitive space.
(4) Estimating costs of acquisition, construction, or rehabilitation.
(5) Estimating the cost and availability of borrowed funds.
(6) Estimating absorption rates.
(7) Developing cash-flow schedules.
(8) Evaluating the estimated cash flows in terms of acceptability of the expected
outcome.
Feasibility analysis seeks to answer the question Will it work? rather than a single
specific course of action, several alternatives may be identified, therefore, feasibility
analysis seeks to determine whether all, none or some of the alternatives offer an
acceptable probability of achieving minimum investor objectives. In an investment
analysis context, a real estate project is feasible when the real estate analyst determines
that there is a reasonable likelihood of satisfying explicit objectives when a selected
course of action is tested for fit to a context of specific constraints and limited
resources.
Financial feasibility presumes that both equity investors and lenders financial
objectives will be met if the project goes forward. Before undertaking a full-scale
financial feasibility analysis, it is prudent to use a screening technique to identify with
minimum cost projects that obviously are not feasible. The preliminary analysis
should proceed from both the equity investors and the lenders points-of-view.
Lender objectives are that the project generates sufficient cash flow to permit
repayment of interest and principal on the mortgage loan, and that the projects most
probable selling price will be sufficient, in the event of default and foreclosure, to
generate through a forced sale the cash necessary to retire the mortgage loan. Two
common measure of this ability are the debt coverage ratio (the relationship between
the projects expected net operating income and the annual debt service obligation) and
the loan to value ratio (the relationship between the projects estimated market value
and the amount of mortgage loan).
Equity investors objectives are often stated in terms minimum acceptable rates of
return on equity fund. They often also specify a minimum acceptable current yield
Although a full-scale feasibility study is time-consuming and expensive, and may
lead to reluctance, investors should at least use a simplified process for identifying
projects that can be eliminated early in the analysis, in order to avoid the following
investment disadvantages and reduce risks: illiquidity, management, depreciation of
value, government controls, real estate cycles, legal complexity.

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Conclusion
As a conclusion, a financial feasibility analysis determines the financial viability and
profitability of a project. After all, no one wants to go to the time and effort of
undertaking a project to find out at the end of the day they have broken even or lost
money. As a consequence, here are some investment principles to be taken into
consideration:
.
The investor should buy the assumptions that create the yield rather than the
yield itself.
.
The investor should be as concerned about what to offer the next buyer as with
what he is buying.
.
The investor should price the property apart from the tax advantages.
.
The investor must compare alternatives.
.
The investor should understand the potential profit and risk in terms of money.
Further reading
Fillmore, W.G., Allaway, W.J. and Kyle, R.C. (2002), Modern Real Estate Practice, 16th ed.,
Real Estate Education, Dearborn, MI.
Reilly, J.W. (2000), The Language of Real Estate, 5th ed., Real Estate Education, Dearborn, MI.
Sirota, D. (2004), Essentials of Real Estate Investment, 7th ed., Real Estate Education, Dearborn,
MI.

Corresponding author
Alina Oprea can be contacted at: alinaups@gmail.com

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Investment
feasibility
analysis
61

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