“When there is blood in the streets, buy property”, is a reverberated adage that has stood the test of time. Although when conceptualized, property referred to any asset class, as this adage is contrarian investing at its core–the belief that the worse things seem in the market, the better the opportunities are for profit. When we consider the last major market events of the Great Financial Crisis of 2008 and the ongoing COVID-19 pandemic, Alternative Investments as an asset class has become a prominent component of investors’ portfolios over the last two decades, in particular Real Estate. With Alternative Investments being highly sought after for
their benefits such as yield enhancement, duration hedging, diversification and overall risk management, it’s clear why investors position themselves within this space; particularly in Real Estate. As such, this week we’ll explore Real Estate investing and how it benefits your portfolio, its uses and how you can participate in it.
Real Estate as an Asset Class
At the end of the 2020 calendar year, Real Estate accounted for approximately the third largest component of Asset Under Management (AUM) at US$1.04 trillion based on data from Preqin. Based on PricewaterhouseCoopers’s (PwC’s) Alternative Asset Management 2020 report, institutional and sovereign wealth funds have begun prioritizing Private Equity, Infrastructure and Real Estate as key portfolio components. What this creates is a clear runway for investor interest in Real Estate, which continues to showcase ample risk-adjusted returns to portfolios. The overall fundamentals driving this over the short to medium term are an accommodative interest rate environment, technological disruptions, changes in governmental regulations, ESG considerations and evolving demographics.
Real Estate Investing
Investors profit from Real Estate in multiple ways, but the primary one is in price appreciation. This is because Real Estate is considered to be a hedge against inflation, such that, property prices are expected to move in line with or ahead of inflation. Of course, this will vary between Greenfield real estate investing (land that has never been used) and Brownfield real estate investing (involves the use of previously constructed facilities that were once in use for another purpose), and also on the location of the Real Estate. Investors will also acquire Real Estate for potential rental yields, which is referred to as the gross annual rental income, expressed as a percentage of the property purchase price. The higher the rental yield, the more attractive the opportunity (of course, relative to the cost of capital to generate that yield). And finally, the greater the proximity of Real Estate to “prime” locations, the greater the potential returns that can be generated.
Investments in real estate can be in the form of equity, debt or a combination which also provides an additional level of yield enhancement for an investor. For example, if an investor borrows US$70,000 at a Loan-to-Value of 70% and at a cost of 6.50% per year and lets assume they can rent a Real Estate property (assuming it is a complete unit and in a prime location) for a rental yield of 9.50% per year. The investor would be earning a risk-adjusted profit of 300 basis points, which equates to US$3,000 for the year. If the investor sold the property five years later at a premium of 5% of the purchase price (US$105,000), considering all the rental earned and coupon payments made (cetrius paribus) , the total return to the investor from this five-year investment would be 13% annualized over the period, with total cashflows of US$50,000. It should be noted here that 13% is greater than the 10% the investor would earn on an annualized basis if they utilized equity only, and this showcases the benefit of using leverage.
Real Estate Exposure
Since establishing the benefits of investing in Real Estate and showcasing the potential returns from investing in Real Estate, it’s paramount we discuss getting exposure to Real Estate. This can be through direct exposure by obtaining a mortgage to acquire a property to then rent at a yield higher than the cost of the mortgage. Another method is potentially acquiring land (which is usually cheaper upfront) with the objective to establish a structure on it to be sold or utilized for rental income. An investor could also acquire shares in a Real Estate Investment Trust (REIT) which are characterized by a high dividend payout ratio but removes majority of the costs associated with managing real estate. Examples of these REITs on our local stock market are Eppley Caribbean Property Fund or as a Collective Investment Scheme (CIS), Barita’s Real Estate Fund would offer similar benefits. There are multiple avenues to get exposure to the asset class of Real Estate and it serves investors well to be positioned in this asset class in any form.
Written by Haughton Richards, FRM, FMVA, Senior Investment Strategist
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