The macro fundamentals are fairly positive, and the Fed has embarked on monetary policy normalization, having already effected four rate increases thus far in the current normalization cycle. This has taken rates from effectively zero to 1.25 percent currently.
And what more, the Fed has positioned itself for more rate hikes in the future.
Notwithstanding the recent raises, interest rates are still at very accommodative levels. The fed funds futures have baked in a 41.9 percent probability of a quarter basis-point increment in the Fed funds target rate at the December 13 meeting.
The implication of rising interest rates for real estate as an investment option is mixed. When the benchmark interest rates rise, the mortgage rate also moves in tandem, making investment in real estate prohibitively unattractive.
However, the scope of better economic growth that accompanies a rising interest environment perks up demand for real estate and in turn pushes up its prices.
What is A Real Estate?
Real Estate refers to a real or physical or tangible property, also encompassing land and buildings along with its natural resources.
Meanwhile, real estate investing refers to financial activities centered around generating returns from a tangible property or cash flows tied to a tangible property.
It is one of the oldest form of investments that existed long before equity investment kicked in. The attractiveness of real estate as an investment option is premised on its cash flow, liquidity, profitability, tax break and the diversification it offers
Getting Started With Real Estate Investing
1. Buying Basic Rental Properties
Buying an investment property is the basic approach toward real estate investing, with renting being the basic tenet around which the approach is built. On buying a property and renting it out to a tenant, the landlord gets enough money to pay off the costs associated with owning a property, namely mortgage payment, taxes and maintenance costs.
Most often, the rent is fixed to accommodate a premium over the costs to the owner of the property, which tantamounts to his/her returns. However, in some cases, owners prefer to wait patiently to pay off the mortgage before they can seek a return. By that time, most of the rent becomes a profit, while there is also opportunity in the form of capital appreciation.
2. Buy, Renovate and Purchase Properties
This strategy, also called flipping property, capitalizes on beaten down prices of a property due to many different reasons such as foreclosure or quick sales. Buying such a property and spending money on renovating it, the buyer would resell it for a profit.
A REIT, or Real Estate Investment Trust can be a publicly traded company, which is added to the investment portfolio for diversifying risk. It could also be a private company. Compared to the other asset classes forming part of the portfolio, a REIT vests the twin advantages of generating higher returns and minimization of risk.
Investing in REITS can also be made through real estate-focused ETFs and mutual funds.
Returns from a REIT is in form of dividend income as well as capital appreciation.
REITs generated a three-year average return of 9.85 percent between March 2013 and March 2016, in line with the averages in the 20-year period, according to Investopedia.
Types of REITs
– City Office REIT Inc (NYSE:CIO)
– Columbia Property Trust Inc (NYSE:CXP)
– Agree Realty Corporation (NYSE:ADC)
– CBL & Associates Properties, Inc. (NYSE:CBL)
– Duke Realty Corp (NYSE:DRE)
– Prologis Inc (NYSE:PLD)
– Chesapeake Lodging Trust (NYSE:CHSP)
– Hospitality Properties Trust (NASDAQ:HPT)
– Rayonier Inc. (NYSE:RYN)
– Weyerhaeuser Co (NYSE:WY)
– Global Self Storage Inc (NASDAQ:SELF)
– Public Storage (NYSE:PSA)
– Inverarity Inc (NYSE:HIFR)
– American Tower Corp (NYSE:AMT)
Data Center REIT
– Core Site Realty Corp (NYSE:COR)
– Digital Realty Trust, Inc. (NYSE:DLR)
– Vornado Realty Trust (NYSE:VNO)
– JBG SMITH Properties (NYSE:JBGS)
– Vanguard REIT Index Fund (NYSEARCA:VNQ)
– iShares US Real Estate ETF (NYSEARCA:IYR)
– Schwab Strategic Trust (NYSEARCA:SCHH)
– iShares Cohen & Steers Realty Maj. (ETF) (BATS:ICF)
– SPDR Dow Jones REIT ETF (NYSEARCA:RWR)
– Real Estate Select Sector SPDR Fund (The) (NYSEARCA:XLRE)
4. Commercial Crowdfunding Service
Crowdfunding allows rich investors, having a net worth of over $1 million access to the real estate through crowdfunding, which is a form of peer-to-peer lending. This brings down the price of entry for investors. Apartments costing millions of dollars could be part owned by investors by contributing as little as $5,000.
Global real estate crowdfunding industry was estimated at $3.5 billion in 2016, according to National Real Estate Investor, quoting data from Massolution.
Some of the real estate crowdfunding platforms include RealtyShares, RealtyMogul and ifunding.
5. Real Estate Trading
This would include instruments such as options, which allow the buyer an option for purchasing a real estate asset at a predefined sale price over a fixed period. Options contract is usually entered into by property developers, or investors in commercial real estate or high-valued residential property.
The buyer of the option, who purchases the option by paying an option premium, which is a relatively smaller amount compared to the transaction price, can choose to or not to exercise the options or sell it to a second buyer before the expiry of the option.
This real estate trading provides flexibility and low-cost trading opportunity for the buyer.
6. Rent Out A Room
Companies such as Airbnb allow people to generate money to pay off mortgages or the rent through renting out rooms. Additionally, they also make a decent, neat profit.
Pros & Cons of Real estate investing
Certain Cash Flows
Leases from real estate is a steady stream of income for investors. Usually, this lease is higher than the dividend income associated with stocks.
Capital or Asset Value Appreciation
Real estate prices historically follow an increasing trajectory compared to most other asset classes. The rationale is this – The net operating income from a real estate asset gradually increases along with rent increases and the scope of better management of the asset.
Rental income from tenants are sometimes indexed to inflation and so when the rent revision comes up, the impact of inflation on the returns is taken care of.
Real estate is favorably treated by the U.S. Tax code. Some of the provisions that work in the favor of this asset are:-
- Several mortgage interest reduction
- Accelerated depreciation allowed by the Tax code boosts cash flows
- The 1031 provision allowed by the IRS, which investors can use to exchange into a like-kind instrument and defer all taxable gains into the future.
Equity Build-up &-Loan Pay-downs
As one pays down on his mortgage and part of the principal over the months, he/she in turn builds equity in his/her property. Equity in real estate is the difference between what a property is worth and what is owed on it.
- High transaction costs
- Necessity to manage, both day-to-day operations as well as strategic management, taking into account the long-term position of the asset in the market
- Real estate investment is cyclical in nature, putting at risk one’s investment
Real estate investing Vs. Investing In Other Classes of Securities
Although investing in stocks fetches you higher return, provided you are an well informed and prudent investor, it exposes you to high risks as well, given the volatility associated with the stock markets. Very often, you are driven along, rather than you being in control. However, when you invest in real estate, you are almost entirely in control of your actions.
Meanwhile, bonds are relatively safer bets, with the returns from this class of asset said to be less volatile and hence are relatively safer. As a corollary, returns from bonds are not very attractive.
In nutshell, real estate is an investment option that combines the high returns of an equity along with the safety of bonds.
Real estate investment, thus, has become well and truly entrenched today, as investors warm to the idea of generating decent returns without assuming concomitant risks. Today the reality of realty investing is sinking in and is creating a revolution in the world of investing.