Investment Real Estate

Real Estate

Real estate, as an alternative investment, encompasses a wide spectrum of tangible properties and related financial instruments. It is a popular choice for investors seeking diversification, income generation, and a hedge against inflation.

Definition and Characteristics

Real estate is defined as land and any permanent structures or improvements attached to it, whether natural or artificial. This includes various property types: residential (single-family homes, condos, multi-family residences), commercial (office buildings, retail centers, hotels, hospitals), industrial (manufacturing, distribution, R&D facilities), raw land, and special-use properties.

One of the primary appeals of real estate as an investment is its potential to generate both steady income through rent or leases and capital appreciation from increases in property value over time. However, real estate is significantly influenced by local factors such as employment rates, the local economy, crime rates, transportation infrastructure, school quality, and property taxes.

Real estate investments are typically illiquid, meaning they cannot be easily or quickly sold or converted to cash. They often require a large initial capital outlay and may demand active management and specialized expertise.

Investment Thesis and Return Generation

The investment thesis for real estate is rooted in its ability to generate returns through two main channels:

• Rental Income: Properties can provide a consistent and predictable stream of income from tenants, offering a stable revenue source for investors.

• Capital Appreciation: The value of real estate can increase over time due to factors like demand, limited supply, and surrounding development, leading to capital gains when the property is sold.

Real estate investments can also be acquired with leverage, allowing investors to control a larger asset with a smaller initial capital commitment, potentially amplifying returns. In structured real estate deals, particularly those involving developers and cash investors, the economic ownership is often governed by a "waterfall" mechanism. This typically involves a preferred return for investors, followed by a return of their initial equity, and then a "profit" split between investors and the developer's "promote" or "sponsorship interest". Common measurements of return include "cash-on-cash" (annual cash received divided by cash invested, typically 6-12%) and "internal rate of return" (IRR, typically 15-30%).

Structures and Investor Profiles

Investors can gain exposure to real estate through several structures:

• Direct Ownership: This involves purchasing a property outright, which can generate income through rent or appreciation. This approach requires significant capital and often active management.

• Real Estate Investment Trusts (REITs): REITs are companies that own, operate, or finance income-producing real estate across various sectors. They allow investors to participate in large-scale commercial real estate without direct property ownership. To qualify as a REIT, a company must distribute at least 90% of its taxable income to shareholders annually as dividends. There are different types, including Equity REITs (owning and managing properties) and Mortgage REITs (mREITs, purchasing mortgages and mortgage-backed securities). Publicly traded REITs can be bought through a brokerage account, while non-traded REITs are illiquid and may lack share value transparency.

• Private Real Estate Funds: These are professionally managed pooled private and public investments in the real estate market, seeking returns from property acquisition, financing, and ownership. Real Estate Private Equity Funds specifically invest in real estate projects and companies, providing capital for acquisition, development, and management with the goal of increasing value.

• Real Estate Investing Platforms (Crowdfunding): These platforms allow investors to pool money to access private REITs and private property investments, making real estate more accessible to a broader range of investors.

Risks in Real Estate Investment

Real estate investments are subject to a unique set of risks:

• Illiquidity: The difficulty in quickly selling properties, especially in a down market, is a significant concern. Non-traded REITs, in particular, are highly illiquid.

• Higher Risk: Like most alternative investments, real estate generally carries more risk than traditional stocks or bonds.

• Market Fluctuations and Valuation Uncertainty: Property values are heavily influenced by economic and financial factors such as inflation, interest rates, and local market dynamics. Volatility in appraisal values can affect net asset value and lead to potential write-downs.

• High Initial Capital Outlay and Active Management: Direct property ownership requires substantial upfront capital and often active management, or the cost of hiring property managers.

• Less Regulation: Some real estate investment options, particularly private ones, may be less regulated than traditional assets, potentially increasing risk.

• Geopolitical and Regulatory Changes: Global tensions can affect capital flows, and shifts in tax policies or housing regulations can directly impact REIT returns.

• Climate-Related Vulnerabilities: Properties are increasingly vulnerable to climate-related weather events, leading to higher insurance costs and potential property damage.

• Cybersecurity Risks: Reliance on digital platforms for tenant engagement and financial transactions exposes REITs to cyberattacks and data breaches.

• Conflicts of Interest (for REITs): Externally managed REITs may have conflicts of interest with shareholders, as manager fees might be based on property acquisitions or assets under management, not necessarily aligning with shareholder interests.

• Tax Implications: Profits from real estate sales are subject to capital gains taxes, and REIT dividends are generally treated as ordinary income, not qualifying for reduced tax rates.

Historical Performance and Diversification Benefits

Real estate offers compelling diversification benefits due to its often low or even negative correlation with traditional public equities and bonds. This characteristic makes it a powerful tool to reduce overall portfolio risk and volatility, especially as traditional asset classes show increasing correlation. The inherent nature of private real estate investments, with longer investment horizons and less frequent valuations, also insulates them from short-term public market fluctuations.Real estate can serve as an effective hedge against inflation. As prices rise, property values and rental income can also increase, providing a reliable buffer against inflationary pressures.

Historically, real estate has returned an average of 4.3% annually since 1928, which is lower than stocks (9.9%), gold (5%), and bonds (4.6%) over the same period. However, the FTSE NAREIT All Equity REITs index has shown a higher average annual return of 11.3% over the last 50 years, comparable to or exceeding the S&P 500's average. Private real estate investments have also shown the ability to outperform their public market proxies.

Diversification within real estate itself is crucial. Spreading investments across different property types (e.g., data centers, self-storage, senior housing, which have outperformed traditional properties like offices and retail in the last decade) and different geographies can significantly reduce risk and tap into varied growth opportunities. 1 "Vintage year" diversification, spreading investments across different years, can also smooth out the effects of market cycles on portfolio performance. 1

Commercial Real Estate

Commercial real estate (frequently abbreviated to “CRE”) is usaully considered an alternative investment, and benefits from its status as a non-correlated asset type. It’s always long-term investment when investing in a commercial property typically three to seven years, so that also means it’s far less volatile than public markets. If you are interested in shorter term investment period a real estate investment trust is probably a better suited investment vehicle for you.

The way a CRE asset generally operates is tenants sign leases to occupy the space and in turn pay rent, which represents current income for the owners of that property. Another way a real estate asset can generate investment returns may be the one people are most familiar with: if the price at which it can be sold is higher than the price at which it was acquired, owners of that property will have achieved capital appreciation.

Certain strategies within CRE investing also make it an excellent inflation hedge, because leasing agreements can be structured with scheduled rent increases, guaranteeing growth over time in the income from those tenants. If an investor expects that money will be losing value due to inflation, those rent increases will help offset that impact and further their objective of capital preservation.

It’s worth mentioning a fourth investment objective that is relevant and unique to CRE, and that’s tax benefits. One tax benefit, called accelerated appreciation, occurs when a CRE operator performs what’s called a cost segregation study in order to provide investors the opportunity to lower their taxable income by depreciating the asset at a faster rate than the property’s natural useful life. Another common tax strategy is known as a 1031 exchange, wherein an investor who has recently sold a real estate investment can roll those proceeds into the purchase of a second real estate investment, subject to certain conditions, and defer the capital gains from their first investment.

Real estate has long been considered an alternative tangible asset outside of the typical stock and bond market it has many facets beyond the typically thought of homebuyers market. While real estate can be accessed through traditional means, such as direct ownership and real estate investment trusts (REITs), it is also possible to access this asset class through managers who invest opportunistically in private real estate and trade less mainstream real estate-related securities. Together, we select the real estate investments in line with your short- and long-term financial goals.​

Real Estate Investment Trusts R.E.I.T.s

The NAREIT REIT Directory provides a comprehensive list of REIT and publicly traded real estate companies that are members of NAREIT. The directory can be sorted and filtered by sector, listing status, and stock performance. Here is a link to their real estate investment trust members ​​​https://www.reit.com/investing/reit-directory

The ALTERNATIVE INVESTMENTS CENTER is in the process of organizing our own REIT specifically geared towards opportunity zone investments in 2025. If you would like to learn more please schedule a free initial consultation

The Real Estate Investment Fund is a type of fund that by pooling investors money to invest like a condominium in various segments of the real estate market such as logistic complex, offices, shopping centers, hotels, residence. This type of fund can also invest in securities

​

A Real Estate Investment Trust, or "REIT", is a single investment into a diversified basket of real estate properties. REITs are legally required to distribute 90% of all taxable income to investors on a yearly basis. The Alternative Investments Center advisors feel 2024 is a compelling year to be involved in the R.E.I.T. marketplace due to a combination of factors not seen in decades. Why not schedule a consultation with an advisor to learn the many opportunities in the R.E.I.T. space that will occur in 2024? We have some opportunities in commercial and residential that have significant potential.

REITs are often diversified by property type, geography, or multiple categories to achieve strategic objectives

REITs have historically been positively correlated with inflation, which may make them a possible hedge for inflation

A perpetual life REIT has a primary objective to preserve and protect capital and provide attractive current income in the form of regular, stable cash distributions. It is intended to acquire and actively manage a diversified portfolio of multifamily apartment communities which can be located in larger cities or in secondary and tertiary markets. We aim to provide an investment alternative for investors seeking to allocate a portion of their long-term portfolios to commercial real estate with lower volatility than public real estate companies. With ever increasing volatility within the market, hard assets with inflation-protected yield and growth strategies.​

​What Is Industrial Real Estate?

Industrial real estate is a general term used to describe one of the primary categories in the commercial property market. Industrial real estate supports trade, e-commerce, and supply chains globally and ensures the efficient movement of goods and materials across various markets. This category is one of the most versatile and specializes in providing properties for non-public commercial use.

Industrial properties include:

• Warehouses

• Manufacturing

• Production

• Research and development

• Storage

• Hybrid warehouse/office flex spaces

• Distribution facilities

Think of these properties as where the behind-the-scenes work goes on, such as for scientific research, parcel deliveries, mechanical engineering, or transporting goods. These properties can be both small and large and can range from hundreds of square feet to hundreds of thousands of square feet.

Industrial Building Classifications

All industrial buildings will have a specific class grade attached to them. Each of these class grades will describe a different type of industrial property investment, as some of these assets may be more likely to see capital appreciation while others are better suited for capital preservation.

Though your return on investment (ROI) will be influenced by many different property factors, identifying these industrial real estate differences can help you make a better-informed decision as you move forward during your search.

Class A Industrial Properties

Class A industrial buildings are typically the newest and most prestigious structures in their market, which include buildings built with high-quality materials and top-of-the-line mechanical and utility systems. These industrial properties may also feature convenient amenities and have prime locations that prevent low vacancy rates. These properties are sometimes called “investment grade” because they often meet the quality and size standards that make them an attractive option for large institutional portfolios, such as insurance companies or retirement funds.

Class A industrial properties may be more likely to attract high-income earning tenants and credit tenants. Credit tenants tend to provide more cash flow reliability because of their exceptionally good credit and high assurance for making payments on time. This means investors may benefit from fewer outstanding asset issues and risks. An example of a Class A property might be a state-of-the-art logistics facility located near an interstate or airport.

These buildings are typically constructed in the last 15 years, but this can vary by city. Even after the 15-year threshold, extensive renovations that modernize a building can maintain a building’s Class A classification or even elevate a building’s rating.