What makes a good real estate investment?

A good investment has a high chance of success, or return on your investment. If your investment involves a high level of risk, that risk should be balanced out by a high possible reward. Even if you choose investments with a high probability of success, though, that isn't a guarantee. You shouldn't put money into real estate—or any other investment—if you cannot afford to lose that money.

Though a traditional mortgage generally requires a 20% to 25% down payment, in some cases, a 5% down payment is all it takes to purchase an entire property. This ability to control the asset the moment papers are signed emboldens both real estate flippers and landlords, who can, in turn, take out second mortgages on their homes in order to make down payments on additional properties. Here are five key ways investors can make money on real estate.

Real estate property

Real estate property is an asset class that plays a significant role in many investment portfolios and is an attractive source of current income. Investor allocations to public and private real estate have increased significantly over the last 20 years. Because of the distinct characteristics of real estate property, real estate investments tend to behave differently from other asset classes—such as stocks, bonds, and commodities—and thus have different risks and diversification benefits. Private real estate investments are further differentiated because the investments are not publicly traded and require analytic techniques different from those of publicly traded assets. Because of the lack of directly comparable transactions, an appraisal process is required to value real estate property. Many of the indexes and benchmarks used for private real estate also rely on appraisals. Because of this characteristic, they behave differently from indexes for publicly traded equities, such as the S&P 500, MSCI Europe, FTSE Asia Pacific, and many other regional and global indexes.

Risk Management

• compare the characteristics, classifications, principal risks, and basic forms of public and private real estate investments
• explain portfolio roles and economic value determinants of real estate investments;
• discuss commercial property types, including their distinctive investment characteristics;
• explain the due diligence process for both private and public equity real estate investments;
• discuss real estate investment indexes, including their construction and potential biases.

General Characteristics of Real Estate

• Real estate investments can occur in four basic forms: private equity (direct ownership), publicly traded equity (indirect ownership claim), private debt (direct mortgage lending), and publicly traded debt (securitized mortgages).
• Many motivations exist for investing in real estate income property. The key factors are current income, price appreciation, inflation hedge, diversification, and tax benefits.
• Adding equity real estate investments to a traditional portfolio will potentially have diversification benefits because of the less-than-perfect correlation of equity real estate returns with returns to stocks and bonds.
• If the income stream can be adjusted for inflation and real estate prices increase with inflation, then equity real estate investments may provide an inflation hedge.
• Debt investors in real estate expect to receive their return from promised cash flows and typically do not participate in any appreciation in value of the underlying real estate. Thus, debt investments in real estate are similar to other fixed-income investments, such as bonds.
• Regardless of the form of real estate investment, the value of the underlying real estate property can affect the performance of the investment with location being a critical factor in determining the value of a real estate property.
• Real estate property has some unique characteristics compared with other investment asset classes. These characteristics include heterogeneity and fixed location, high unit value, management intensiveness, high transaction costs, depreciation, sensitivity to the credit market, illiquidity, and difficulty of value and price determination.
• There are many different types of real estate properties in which to invest. The main commercial (income-producing) real estate property types are office, industrial and warehouse, retail, and multifamily. Other types of commercial properties typically are classified by their specific use.
• Certain risk factors are common to commercial property, but each property type is likely to have a different susceptibility to these factors. The key risk factors that can affect commercial real estate include business condition, lead time for new development, excess supply, cost and availability of capital, unexpected inflation, demographics, lack of liquidity, environmental issues, availability of information, management expertise, and leverage.
• Location, lease structures, and economic factors—such as economic growth, population growth, employment growth, and consumer spending—affect the value of each property type.

Strategies for real estate investment

Navigating through the layered terrains of real estate demands an astute strategy. The following are the fundamental pathways:

Knowledge of location:Identify potential hotspots with promising infrastructure and developmental prospects.

Robust valuation:Ensuring accurate property valuation to ascertain intrinsic worth and safeguard against overpricing.

Purpose and time horizon:Establishing a clear objective and timeframe to align with market cycles and investment goals.

Cash flow and profit analysis:A meticulous evaluation of expected incomes and profit margins to ensure fiscal health.

Prudent leverage:Wisely balancing the use of borrowed funds, mitigating risks while optimising profit potential.

Property-type decision:Considering variables like cost, location, property condition & resale value, decide between new constructions and existing properties.

Indirect investments:Diversifying via REITs and fractional ownership of commercial real estate to access premium properties without direct /complete ownership hurdles.

Credit score management:Maintaining a healthy credit score for advantageous loan terms and better financial flexibility.

Market trend awareness:Keeping an informed eye on market dynamics, policy shifts, and other influential factors.