Article 3 of 5: Real Estate As An Investment Option
This is the third in a series of five pieces to help investors understand the benefits of owning commercial real estate, then differentiate the dynamics and variety of ownership channels.
Many investors get started in real estate by owning one or more individual properties.
They may elect to rent a former home, acquire a property that already has a tenant, or inherit a property that they decide to rent. In this case, the owner must choose to engage a property manager or become the landlord. In addition to dealing with tenants, repairs, and maintenance, there are periodic costs for roofs, painting and prepping between tenants.
Rather than become a landlord, an investor may choose to get exposure through real estate securities, in the form of mutual funds, exchange-traded index funds or a host of public REIT stocks. These allow investors to own a slice of a professionally managed real estate portfolio, made up of hundreds or thousands of properties.
Public real estate securities trade on major stock exchanges, so they can be easily bought and sold.
Because they are publicly traded, they are priced based on market supply and demand, and are more correlated to corporate stock than private, or non-traded, real estate investments.
Non-traded REITs give investors the advantage of owning private real estate while avoiding the fluctuations of public markets. Click below to learn more about private real estate investments.
Article 2 of 5: Real Estate As An Investment Option
This is the second in a series of five pieces to help investors understand the benefits of owning commercial real estate, then differentiate the dynamics and variety of ownership channels.
Two investors that each own Amazon stock own the same investment; however, two investors that each own warehouses leased to Amazon do not. All commercial real estate (CRE) is different and can be categorized and analyzed in many different ways.
CRE Sectors
The heart of every major city is the Central Business District, which is home to the “core” sectors of Office, Industrial, Multi-Family, and Retail which make up the bulk of CRE, and are typically the most expensive buildings. They are often owned by large institutions i.e., insurance companies or pension funds as portfolio diversifiers. Satellite sectors include hotels, regional malls, self-storage, data centers & even cell towers. Each sector has unique demand drivers and sensitivity to economic factors. Many investors diversify their real estate holdings across multiple sectors.
Geography and Demographics
The most valuable domestic markets are the “Gateway Cities” of Boston, New York, Miami, Seattle, San Francisco & Los Angeles. Industrial warehouses are more valuable closer to the ports of Houston, Savannah, and Long Beach, CA because of their import traffic. CRE gets more affordable in smaller markets. Every geographic center can then divided by “sub-markets”, which might be identified by average household income or education level, proximity to transportation, or other magnets like schools and shopping. The size and characteristics of a market’s population have a major influence on real estate. Demand for apartments, for example, is higher near universities, military bases, hospitals, or other major employers.
There is an expression that All Real Estate is Local, which speaks to the need for knowledgeable community members when evaluating the merits of owning a particular property.
Risk / Return Characteristics
Real estate investments can also be categorized by their risk/return characteristics. The spectrum can be categorized as Core, Core Plus, Value-Add, and Distressed. Core properties generally have high occupancy and stable tenants. The steady income stream and predictable cash flows put core properties on the more conservative end of the real estate spectrum.
As you move down the spectrum from core-plus to distressed, properties have greater cash flow uncertainty and capital improvement needs. Investors may choose properties with greater risk for the possibility of greater capital appreciation.
Additional metrics in determining a building’s category can include age, design characteristics, and remaining lease terms.
As you learn more, it becomes readily apparent that investors need to rely on experts to determine the best buildings for any portfolio.
Article 1 of 5: Real Estate As An Investment Option
This is the first in a series of five pieces to help investors understand the benefits of owning commercial real estate, then differentiate the dynamics and variety of ownership channels.
For centuries, the two asset classes creating the most wealth have been stocks and real estate. Today, most people’s first investments are in stocks or stock funds. Established investors should consider adding real estate investments to enhance their portfolio.
Real estate has a different return composition.
Over the long term, U.S. stocks (i.e., the S&P 500 Index) have averaged annual returns in the 11% range. This comes mostly from appreciation and a modest (around 2%) dividend. Established real estate investments have comparable total returns, but a different return composition, with about 70% of the return coming from income. There are also tax advantages that can improve after-tax return. Both stocks and real estate investments can benefit from long-term capital gain tax rates, but real estate can offer additional tax benefits from pass-through depreciation.
Real estate has a lower risk profile than stocks.
Stock prices can fluctuate dramatically with quarterly earnings surprises, broad stock market gyrations and investor emotions. Real estate prices are driven by demand, net operating income (NOI), and interest rates, which all move more slowly. Demand can be driven by sector (apartments or warehouses, e.g.) or by the growth or decline of a specific market. Rising borrowing costs can restrict net income, however this is often offset by price appreciation in an inflationary environment.
Real estate behaves differently than stocks during economic cycles.
Stock prices are driven by earnings expectations and rise or fall in anticipation of changes in corporate earnings and broader economic forces. Building values tend to be much more stable through cycles, as values are determined by consistent rental income rather than less predictable corporate profit expectations.
Geography and sector diversity are important considerations.
The types of buildings you invest in and their location are important. Population shifts, regional economies, state-specific tax and business climates all impact real estate.
To learn more about how real estate can be classified by sector, location, and risk/return characteristics, read the next blog in our real estate series, “All Real Estate Investments are Different”.
