In general, real estate refers to buildable lands and buildings, including residential homes, raw land and income-producing properties (such as warehouses, office and apartment buildings). Real estate is a type of tangible assets, which are investment assets that can be seen and touched. In contrast, financial assets are only recorded as pieces of paper.
Characteristics of real estate as an investable asset class:
Forms of Real Estate Investment
They may be classified along two dimensions, debt or equity based, and in private or public markets. There are many variations within the basic forms.
Residential properties: an individual or a family purchases a home. In most cases an financial institution makes a direct debt investment in the home by offering a mortgage.
Commercial real estate: a direct equity and/or debt investment is made into a property which is then managed to generate economic benefit to the parties.
REIT investing: mortgage REITs invest in mortgages and equity REITs invest in commercial and residential properties.
Mortgage-backed securities (MBS): securitization of mortgages.
Timberland and farmland.
Performance and Diversification Benefits
There are different types of indices: appraisal indices, repeat sales indices and REIT indices. They are constructed differently and have their own limitations such as sample selection biases and understated volatility. The correlations of global real estate and equity returns are higher than the correlation of global real estate and bond returns.
There are three commonly used approaches to real estate market value:
The comparison sales approach uses as the basic input the sales prices of properties (benchmark value) that are similar to the subject property. The price must be adjusted to reflect its superiority or inferiority to comparable properties. This approach can give a good feel for the market.
The income approach calculates a property's value as the present value of all its future income. It assumes that the annual net operating income (NOI) of a property can be maintained at a constant level forever (that is, NOI is a perpetuity). The most popular income approach is called direct capitalization:
Net operating income (NOI) equals the amount left after subtracting vacancy and collection losses and property operating expenses from an income property's gross potential rental income.
The market capitalization rate is obtained by looking at recent market sales figures to determine the rate of return required by investors.
The discounted cash flow approach is a variation of the income approach.
The cost approach is based on the idea that an investor should not pay more for a property than it would cost to rebuild it at today's prices. It generally works well for new or relatively new buildings. Most experts use it as a check against a price estimate. Limitations:
An income-based or asset-based approach can be used to value a REIT.
|lordcomas: REITs are great for investing indirectly in real estate, as entering the investment world of real estate might be otherwise expensive.|