Magnify Your Equity Return Using Leverage

Real Estate: Quite Possibly The Best Asset Class
13/12/2018
WHAT ASSET CLASS SHOULD I BUY?
13/12/2018

Real Estate also allows for magnified equity buildup on a shorter-term basis by using financing, which is illustrated below. If you were to purchase a $10 million asset all cash and sell the asset in the future at $11 million, you have made $1 million profit, a 10% return.

However, if you were to purchase a $10 million asset utilizing only $1 million of your own money and financing the remaining (allowing the rental income to make the debt payments), then sell the asset, you have also made $1 million profit, however achieved a 100% return.

equity-return-using-leverage

REITs Versus Direct Real Estate Ownership

Investing in a Real Estate Investment Trust (REIT) is a popular way to “diversify” into real estate. However when you invest in a REIT you do not actually own real estate, you own a share of stock in a company. The following are notable attributes of REIT investing:

High Fees

A private REIT can charge up to 17% up front before your investment even touches the real estate. A recent REIT prospectus disclosed the following fees – sales commissions=6.5%, dealer manager fee=3.5%, organization and offering expenses=2.42%, acquisition fees=1.75% and acquisition expenses=0.96%!!! For every $100 you invested, less than $85 actually went towards the real estate! Additionally, a REIT is only required to distribute 90% of the income generated by its properties back to investors, significantly lowering overall returns.

Lower Average Returns

The average publicly traded REIT dividend is 3.4%, significantly lower than average returns from direct commercial real estate ownership. Many individual properties can distribute an cash return ranging from 6% to 12% annually

High Volatility

Given that REIT shares are stocks traded in the stock exchange, they are subject to the high volatility and market shifts of the stock market as a whole.

Lack of Control

The REIT structure is designed to provide an investment similar to what mutual funds provide for stock investing. Although there is a diversity of assets, there is also a lack of control over which assets are being purchased. Just as many investors have control of investing in individual stocks on platforms like E*TRADE and Scottrade, they now have similar control over their commercial real estate portfolio through RealCrowd.

Less Transparency

Although REITs have strict reporting guidelines, most investors know very little about the properties in a REIT portfolio. Direct real estate ownership increases the overall transparency of the investments.

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