Mark Twain, the American author and humorist, quipped: “Buy land – they’re not making it any more”. This is indeed one of the many reasons why real estate should be part of any diversified portfolio.
Diversification is a means of reducing risk by investing in a blend of asset classes that have little correlation with one another.
Real estate is the largest asset class, and is an excellent, practical means of investing, chiefly because most of us wish to own our homes. Typically, it is the largest investment a person will make.
As well as owning a home as a residence, real-estate investing is the purchase, ownership and management of property with the intention of making a return, whether through renting or selling, or both.
Real-estate investment can be income-producing or non-income-producing. Offices, retail and rented residences are the most common income-producing real-estate investments.
A property in which the owner resides, vacation homes and a vacant property are typically non-income-producing. Unlike public capital markets, the real- estate market is imperfect, with “information asymmetry” being commonplace.
This essentially means that all relevant information is not known to all parties, and one party may have more, or better, information than the other – unlike the public capital markets, where information is supposedly disseminated to all market participants as it becomes available.
Real-estate properties are typically unique and do not trade very often. In the public markets, assets are continuously priced, whereas determining a market value for real estate can be highly subjective and imprecise.
Typical sources for pricing data are market listings, real estate agents, results of auctions and foreclosures, and sales of comparable properties in the surrounding area.
Appraisers, professionals who may be certified or licensed to value property, are commonly used to objectively assess a market value by estimating a likely price between a buyer and seller.
Real estate is considered a driver of the economy, a significant source of individual wealth and a fairly low-risk investment. Income-producing properties are a source of cash flow, much like a dividend from a stock or coupon from a bond.
The yield is usually determined on a net operating basis, or the sum of the positive cash flows from the rent and other income less expenses such as taxes and fees. To maintain consistency and viability of cash flow, it’s important to have quality tenants.
Real estate also offers the potential for capital gain should the investor sell at a higher price, and the risk of capital depreciation should the investor sell at a loss. Investors have an opportunity to increase the value and yield of a property by improving it. The capacity to leverage is also an attraction.
Investors may have to make an equity payment of as little as five per cent while borrowing the remainder.
An investment of US$5,000 on a $100,000 property that is sold for $120,000 yields a 300 per cent return. If the investor paid $100,000 upfront, the return would be 20 per cent.
Perhaps the greatest appeal of real estate is that it’s bricks and mortar. It’s something you can touch, feel, see and have pride of ownership in.
Anthony Galliano is chief executive of Cambodian Investment Management. [email protected]