Real estate investments comprise a significant part of the portfolio of many individual and institutional players today. Because property markets are not perfectly correlated with the other conventional investments, these assets are usually added to the portfolio for the main benefit of diversification. Real estate investment can take a variety of forms, from private equity investments in properties, to publicly traded debts investments. In this article we will briefly cover general forms of real estate investments and some benefits and costs that are associated with direct property ownership or development.
Real estate has the potential to provide the investors with competitive long-term returns from different sources. The physical property purchased by the investor has the ability to increase in value overtime - capital appreciation is the sole purpose of short term property flipping. The second source of returns is income generation from renting or leasing of the purchased property. Investors like to see tenants locked into long term multi-year leases which can guarantee cash flow for many years in advance to potentially protect the investors during economic downturns. One lesser-known benefit of investing into real estate is inflation hedging, if the rules and regulations of the local markets permit the owners of the ropery to adjust rents with increasing prices of goods, they have the potential to avoid losing real income.
Real estate investing may be classified along 2 dimensions: debt or equity based, and in private or public markets. Equity investments in real estate that occur in the private markets are often referred to as direct investments in real estate. The money to finance real estate property purchases comes from many sources. A well-known form of debt financing for real estate purchases is mortgages. Private investors – institutional and individual, real estate corporations, and real estate investment trusts (REITS) - may provide the equity financing for the purchase.
Indirect investment in real estate can be considered the purchase of REITS shares. These shares are publicly traded investment securities and represent indirect ownership of the physical properties the investment funds hold in their portfolio. When these funds sell their shares in public markets, the proceeds are used to purchase physical property for their portfolio. Another form of indirect investment into real estate is asset backed securities, these are debt instruments generated by packing hundreds of mortgages into one investment product called collagenized debt obligation. The purchaser of these new securities reserves the right to receive future cash flows from the underlying portfolio of physical properties those securities represent
Direct ownership of real estate.(Sole ownership, joint ventures, limited partnerships)
Mortgage-backed securities (residential and commerical)
Shares in real estate corporations
Collateralized mortgage obligations
Shares of real estate investment trusts ( REITs)
Investing in in physical properties can be a lucrative source of income and a way to diversify your investments portfolio, however it has some costs associated with it which can add up to thousands of dollars over the lifetime of the investment. Before proceeding with any investment, it is prudent to perform a comprehensive cost analysis of the deal to evaluate the plausibility of the endeavor. Below we will review some of the initial purchase costs associated with direct ownership of physical property for investment purpose
Legal costs can easily be the most exorbitant expense when it comes to real estate investment, especially if the deal is complicated and involves multiple entities. It is imperative to engage an experienced attorney early on to avoid costly mistakes that can affect the structure of the deal later on. Complicated multi-entity deals require for proper contract drafting to protect investors against any future pitfalls and legal actions. Legal help can also be engaged for due diligence process in the early stages of the project planning. Real estate attorneys are versed in local permitting, restrictions and zoning laws can be consulted on what structural alterations can be performed on the physical property to increase the value of your investment. Hiring an attorney to perform a title search is also an important part of any physical property purchase. You want to make sure that you are the direct owner of the property and in order to do that you have to determine whether the tile is free and clear and is unencumbered by any financial liens, legal issues or other legal hindrance.
Engineering and environmental costs are an integral part of any ground up or renovation development project. Most of the environmental and engineer reports are require by stringent local regulations. Many institutional investors are also keen on investing in environmentally clean projects that benefit the local community or at least do not contribute to pollution or hinder the surrounding lifestyle. This is when environmental due diligence comes into play and hiring experienced professionals in the field can help you navigate the endless maze of rules and regulations to build the most environmentally friendly project.
Real estate investment, like any investment, may fail to perform in accordance with expectation. Property values are subject to price fluctuations based on national and global economic conditions and also local real estate conditions. Interest rate levels always pose a risk for the increase in borrowing costs and local government regulations always have a considerable influence on any investment in physical property. Because real estate is almost always considered a long-term investment all of the above factors have the time to drastically influence the final outcome of the project. Investors should consider all the reasons listed in the article and other macroeconomics factors before investing in any private or public real estate endeavor.