Summary
In this article, we will be briefly discussing the different forms of real estate investing, primarily focusing on direct ownership and indirect ownership claims.
We will highlight the main motivations of investors for investing in real estate.
We will also mention some of the advantages and disadvantages of different investment forms.
(Source: investopedia.com)
As a substantial portion of our net worth is in real estate, we have decided to write a brief article on real estate investments, giving an overview of its different forms and our motives for investing heavily in this sector.
Forms of real estate investing and motivation for investing in real estate
Let us start by defining in what forms an individual may be able to invest in real estate. There are four primary forms of investing in real estate:
Private equity (direct ownership)
Publicly traded equity (indirect ownership claim, e.g.: REITs)
Private debt (direct mortgage lending)
Publicly traded debt (securitized mortgages)
Regardless of the form, most investors have similar motivation for choosing real estate over other asset classes. These include:
Current income
Price appreciation
Inflation hedge
Diversification
Unique characteristics of real estate investing
When investing in real estate we have to make sure that we understand the unique characteristics of the investment, including heterogeneity and fixed location, high unit value, management intensiveness, high transaction costs, depreciation, sensitivity to credit markets, illiquidity and difficulty to value.
The most important factors impacting the value of a real estate are: location, economic growth, population growth, employment growth and consumer spending.
Let us go a bit more into detail on the specifics of certain investing forms, focusing on publicly traded equity and direct ownership.
Investment in real estate through publicly traded securities
If investors want to invest in real estate through publicly traded securities, there are two popular choices: REITs and REOCs. This writing will be primarily focusing on REITs.
Real estate investment trusts (REITs) are companies that own, finance, and—to a limited extent—develop income-producing real estate across a range of property sectors. REITs must meet a number of requirements in order to qualify as REITs. Most REITs are required to distribute 90%–100% of their taxable income to shareholders. There are two types of REITs:
REITs that own real estate are called equity REITs.
Those that make or invest in loans secured by real estate are categorized as mortgage REITs.
REITs typically offer higher than average yields and greater stability of income and returns, compared to other publicly traded shares. As REITs generally return a significant portion of their income to investors required by law, dividend discount or discounted cash flow models for valuation are applicable.
So why would anyone want to invest in REITs instead of directly investing in real estate? The very first reason would be that it requires significantly less capital. But there are numerous other advantages to it:
Advantages of REITs
Liquidity: Ability to buy and sell shares of almost any amount on major exchanges
Transparency: Readily available share prices and transaction histories
Diversification of property holdings: By property type, geography, and underlying tenant credit
High-quality portfolios: Many companies own high-quality assets in leading markets.
Active professional management: Most companies have strong executive management overseeing dedicated property management teams with economies of scale.
Potentially stable income: Well-occupied properties subject to long-term leases generate predictable property income, sometimes with distributions occurring monthly.
ax efficiency: REIT and passthrough structures avoid corporate income taxation, leaving only the investor to pay taxes on dividends received.
Disadvantages of REITs
Lack of retained earnings: As REITs are required to pay 90%+ of earnings to shareholders, REITs must access capital markets to fund growth. The faster the expansion, the more often the company must raise new capital.
Regulatory costs: REITs have the cost burden of maintaining a corporate structure of a publicly trading company and complying with regulatory filings.
Reduced portfolio diversification benefits: As shares of the REIT are publicly traded, the pricing is partially determined by stock market movements and liquidity rather than only by underlying value. !is reduces the diversification benefits for the overall portfolio as compared to private real estate. 4. Limited in types of assets owned: REITs are also constrained in the types of assets they own. Consequently, many REITs form taxable REIT subsidiaries (TRS), which pay income taxes on earnings from non-REIT-qualifying activities, such as merchant development or third-party property management.
In our portfolio, we own several different REIT names, including. These are all specialty REITs focusing on certain markets, including data centers and medical facilities. We own these names because they give us access to market segments, in which we are not able to tap into with direct investments. It also gives us a chance to invest indirectly “worldwide”, in jurisdictions, where we are not completely familiar with the laws and regulations governing real estate ownership. Of course, the above mentioned benefits are also playing a major role in owning these names.
Direct investment
Investing directly in physical property has also advantages and disadvantages. One advantage being significant control. As the owner of the real estate, we have the freedom to choose the tenants, to plan maintenance and to define lease/rent terms etc. But for these very same reasons, owning a property is also much more management intensive. We only own real estate directly, in our country of residence, where we are aware of the governing regulations concerning real estate investments. Our primary goal, when renting out real estate is to find a tenant, who is willing to rent long term and has the ability to make full payments on time. With this strategy we are aiming to reduce fluctuations of vacancy induced by business/economic cycle fluctuations.
If you enjoyed reading our article, support us by becoming a member or by "buying us a coffee".
Happy investing!
Disclaimer:
Past performance is not an indicator of future performance. This post is illustrative and educational and is not a specific offer of products or services or financial advice. Information in this article is not an offer to buy or sell, or a solicitation of any offer to buy or sell the securities mentioned herein. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. Expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. This article is based primarily on CFA Level II learning material.
