Real Estate Investments | CFA Level I Alternative Investments
Welcome back! In this lesson, we’ll explore real estate investments as an alternative investment option. We’ll discuss various forms of real estate investments, evaluate their performance, benefits, and touch on some due diligence considerations. Let’s dive right in!
Forms of Real Estate Investments
Real estate investments can provide income in the form of rents, as well as potential capital gains at exit. They offer diversification benefits to an investor’s portfolio and can serve as an inflation hedge. Real estate investments can be differentiated according to their underlying assets:
- Residential properties: Includes your own home, which also makes you a residential property investor!
- Commercial properties: Properties bought for rental income, like offices, hotels, malls, hospitals, and industrial buildings. Note that even residential properties bought for rental income are considered commercial real estate.
Real estate investments can also be categorized as equity investments (ownership of properties, rental income, capital gains) or debt investments (mortgages and construction loans, interest receipts). They can be either private investments (direct ownership) or indirect ownership through publicly-traded securities like Mortgage-Backed Securities (MBS) and Real Estate Investment Trusts (REITs).
Measuring Real Estate Performance
There are various indices to measure returns to real estate, such as appraisal index, repeat sales index, and REIT index:
- Appraisal index: Based on periodic estimates of property values by experts but can be subjective.
- Repeat sales index: Based on change in prices of properties with repeat sales but may suffer from sample selection bias.
- REIT index: Based on the actual trading prices of REIT shares but may not be representative of the properties of interest to the investor.
Historically, REIT index returns have shown strong correlation with global equity returns but very low correlation with global bond returns. Appraisal and repeat sales indices have low correlations with traditional asset returns, indicating potential diversification benefits.
Factors to Consider When Investing in Real Estate
Property values are influenced by global and national economic factors, local real estate market conditions, and interest rate levels. Other factors to consider include:
- Manager skill: Important for indirect investments through publicly traded securities like REITs, as their decisions directly affect performance.
- Leverage: Amplifies gains and losses, increasing the risk to both debt and equity investors.
- Property development risks: Regulatory issues, changes in economic conditions, and potential inability to secure long-term financing at the appropriate time.
And that’s all for real estate! Up next, we’ll move on to infrastructure investments. See you soon!
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