Experienced real estate investors know that it’s all about location, location, location. That’s particularly true when directly investing in commercial or residential properties.
Many investors embrace direct property ownership and being a landlord. When they identify the right location, this can be a fruitful endeavor – assuming tenants are diligent about paying rent and tenant replacement is easy. Still, there are challenges.
“As with other real assets, valuation is a challenge in real estate investing. Real estate valuation methods include income capitalization, discounted cash flow, and sales comparable, with each having both benefits and shortcomings. To become a successful real estate investor, it’s crucial to develop strong valuation skills and understand when and how to use various methods,” noted Harvard Business School.
On other hand, direct real estate ownership is capital intensive, underscoring the utility of real estate investment trusts (REITs) for many investors. Real estate, which is one of the 11 global industry classification standard sectors, is accessible via active funds and hundreds of index-based strategies, including exchange traded funds.
There are benefits to accessing property assets via the fund structure. For example, the location burden isn’t put directly on investors. Likewise, REITs develop and manage their own properties, sporting teams of experts to do that. Additionally, the allure of not having to hit it big on location is potentially compelling for many investors.
“For example, consider direct real estate investors who owned a rental property (leveraged at 20% equity) for at least 10 years, starting anytime between 1991 and 2012 in any of the 100 biggest metropolitan statistical areas, or MSAs. They would have experienced inconsistent and sporadic compound annual growth rates based on the investment time window and property location,” wrote Morningstar analyst Jeremy Pagan.
Regarding location, broader REIT strategies hold allure for investors on other fronts. For example, some states and cities are experiencing declining populations while others are rapidly growing. That says investors need to be up to date on demographic and population trends, not just property prices.
Likewise, regulations governing property development aren’t linear across U.S. cities. Put simply, it’s easier to develop real estate (and less costly) in some major metro areas than it is in others. These factors add to the risk profile in direct property ownership.
“Unless you have a time machine, factors like these may be beyond your ability to forecast. That said, for those who get the timing right, the rewards can be great when investing directly in real estate,” concluded Pagan.
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