Basics of real estate investing become exceedingly important as the blockchain technology makes it more affordableThaler.One, uses blockchain technology to give individual investors the opportunity to directly invest in real estate projects. We therefore think it’s important to share a few words about how the real estate market actually works, and how real estate impacts our everyday lives. It’s possible that someone who has already worked in the real estate sector might not learn anything new from reading this. But, if you are new to real estate investing, this article provides a great introduction and an overview of the real estate market and opportunities for investment.
Let’s begin by talking about real estate and how it impacts our daily lives. When most people think about investing in real estate, they usually imagine themselves buying a home that they will live in. Others aren’t ready yet to purchase their first homes, and believe that the real estate market — for now at least — doesn’t affect them.
But that’s not really true. If you reflect on it for a second, everything we do, each time we buy a coffee or lunch, go to work in an office, pay our gym membership or the rent on our apartments, we are in one way or another paying for real estate. There is an old saying that wealthy people make money from real estate that the rest of us pay for. We, however, believe that real estate investing should be open to everyone.
There are many different ways of making money by investing in the real estate sector. Property ownership is a great way not only to diversify your investment portfolio but also to protect yourself against the threat of inflation in the future. In addition, property ownership protects your assets from the ups and downs and market volatility that you often encounter when investing in stocks or bonds.
Types of real estateBefore we discuss some of the most common ways of investing in real estate, let’s review the different types of real estate that one can invest in. Each type of real estate has its own characteristics.
“Income generating” real estate means that owners can generate ongoing income from owning these types of properties. Income generating real estate generally falls into three categories: residential, commercial & retail, and industrial.
Residential real estate typically refers to single-family homes, apartment buildings, vacation rentals, and townhouses. This category includes all types of housing which people buy either to live in themselves or to rent out to others to live in, thereby becoming landlords.
Commercial & retail real estate refers to properties that are primarily used for business purposes. Commercial real estate property includes a wide range of property types: office space, hotels, restaurants, retail stores, shopping malls, parking lots, and even gas stations.
Industrial real estate generally refers to things like industrial warehouses, storage facilities, manufacturing plants, distribution centers, as well as other special purpose real estate.
Commercial properties tend to be relatively high profile and usually require significant investments due to their location and purpose. Most high-end commercial properties are located in downtown city centers, as well as in wealthy residential neighborhoods. Expected returns from commercial real estate tend to depend on local economic conditions. When the economy is doing well, commercial real estate usually yields noticeably higher returns.
How to make money by investing in real estate
Investments in real estate are generally considered to be sound choices for most people. This is primarily because real estate assets offer security, stability, long-term passive income, and an inflation hedge.
The most common form of investing in real estate is to acquire a property and then rent it out to tenants. You receive income from your rental property on monthly, quarterly, or yearly basis, and you are supported in your position as landlord by a legally binding contract (e.g. a lease between tenant and landlord).
Renting out property usually offers property owners a relatively low return on their investments (ROI). Mortgages are the key to increasing the ROI on rental property investments. A mortgage is a bank loan used to finance the acquisition of a property. Mortgages require a down payment, the percent of which varies depending on the quality of a property and a few other factors. By using a mortgage, a buyer receives full control over a property having only paid for a portion of the purchase price up front. The buyer retains full control over the property provided that he makes timely payments, including interest payments on the loan, to the bank.
Many investors buy rental properties with the help of mortgages, and use the rental income generated by the acquired properties to slowly pay off the mortgages taken out on these properties. Once the mortgage on a property is fully paid off, investors begin to enjoy a much higher ROI, as the rental income continues to flow.
In order to better understand the impact of mortgages on ROI, let’s take an example. Let’s assume that a loan is taken out to buy a building. A fund spends $10 million to buy an office building in Warsaw, which generates an annual return of 6%, equivalent to $600,000 per year. But instead of paying $10 million outright, the fund takes out a bank loan for 60% of the purchase price, or $6 million at 3% annual interest. The loan must be repaid in 10 years and until then $180,000 in interest must be paid annually. This leaves the fund with $420,000 left over each year, which means that the fund will earn an annual return of 10.5% on the $4 million that it invested. It’s clear that an annual return of 10.5% is far more attractive than the initial proposition of 6%.
Leverage is an essential tool for real estate investing, as it allows investors to minimize up front expenditures while increasing ROI using borrowed capital.
In addition, residential properties generally increase in value over time, as home prices go up, which also adds to the total potential value of this kind of investment in the long run. This compensates for inflation. Whether or not real estate will increase in value depends on a large factor on its class and the situation on the market. For example, a medium-sized commercial space suitable for a grocery store could increase in value if a new apartment building were to be built next door, or it could alternatively decrease in value if a new shopping mall were to be built next door featuring a brand new supermarket. The selection of a target for real estate investment and evaluation of its potential for growth in value should be carried out by industry professionals.
A more complex strategy for property management is “value-added” investing. This means that an investor hopes, after buying a property, to earn more from renting out the existing property than the previous owner received in the past. The investor believes this to be possible because he plans to make improvements to the property or to manage the property better than the previous owner did, thereby justifying the new higher lease price.
Therefore, right after buying the property, the investor begins to actively improve management of the property in the hope of attracting new income. Typical examples of this include looking for new tenants, increasing the square footage of the rental property by moving walls or by making changes to the property’s layout, increasing the monthly rent (often after making cosmetic renovations), or by changing the management company in case of a hotel.
Let’s take a look at a simple example of value-added investing. An investor buys a ten story office building in the city center which was built 30–40 years ago (total area of 10,000m2) with retail stores on the ground floor, but they can only be reached from inside the building (another 1000m2). The office space is rented out at $1000 per year per m2 to just two tenants, and the stores are rented out for $3000 per year per m2. This adds up to total annual rental income of $13 million. The investor then gets rid of the existing tenants, renovates floors 3 through 10, and rents out the offices on a floor by floor basis at a rate of $1300 annually per m2. On the ground floor, the investor gives the stores direct entrances from the street, and the stores can now be rented out for $4000 per m2 annually. The second floor is also redesigned as a retail space and these stores are rented out for $3000 per m2. Now the building generates rental income of (9000 x $1300) + (1000 x $4000) + (1000 x $3000) = $18,700. Rental income, and therefore the price of the building, grew by 44%.
Value-added projects are usually only available to individual investors if they have a significant amount of capital to spend and if they have prior experience in this area. In most cases, value-added projects are undertaken by professional investors who use external financing to generate capital for these projects.
Development projects are another more complicated type of real estate investment. Development projects are greenfield projects, newly built from the ground up. A developer acquires a piece of land (sometimes including an old building for demolition) and develops a real estate project on this land which will then be sold to repay the money invested in the project by investors. This type of transaction carries several risks: the developer must apply for a building permit, agree the building type with the local authorities, manage the construction process, and find tenants or buyers for the finished project.
Development projects are almost always financed with bank loans, with the underlying land and new building serving as collateral. This type of bank loan is usually described as “senior debt”. If there isn’t sufficient senior debt available, the developer may seek additional sources of financing which don’t require the land or property as collateral. This kind of financing is called “mezzanine” and carries a higher interest rate than ordinary debt. Senior debt is usually provided by a bank, while mezzanine funding is usually provided by private investors or specialized investment funds.
Development projects can only be undertaken by professional market players. However, most often these projects attract investors who are keen to take a stake in the project but without being involved in managing the project. These investors often pay a project management fee to the developer.
How investors invest their moneyAs we pointed out earlier, opportunities to invest directly into real estate greatly depend on how much money someone has to spend. Those investors who have several million dollars at their disposal can choose from private transactions to real estate funds (REFs), which usually aren’t open to more than a few dozen individual investors at a time. Fund managers and property developers meet directly with these wealthy private individuals. Deal terms are discussed and investors try to personally negotiate more favourable terms.
We, however, are more interested in identifying those opportunities which are available to groups of investors with funds ranging from several thousand to several hundred thousand dollars. One of the most common instruments for investing in real estate are REITs — Real Estate Investment Trusts.
REITs are real estate investment vehicles run by professional managers that use investors’ funds to acquire, use, and sell properties for profits. Through REITs, investors with different investment budgets can buy anything from entire apartment complexes, hotels, to shopping malls, and can act as commercial property operators. REITs are sold on securities exchanges, similar to stocks.
Despite this, REITs have several serious downsides. First, they are heavily regulated and usually cannot invest in development and construction, provide mezzanine financing, or invest in bad debt with real estate assets as collateral. Therefore, REITs generally invest in preexisting real estate which doesn’t offer particularly high returns. Second, REIT investors don’t have a say in the selection of targets for investment; in this regard REIT investors are totally dependent on fund managers. Finally, when you invest in a REIT, you must pay a hefty commission to the fund manager.
Crowdfunding is another way of investing which has become increasingly popular in recent years. Crowdfunding allows individuals to pool their funds over marketplaces (usually internet-based applications) which connect investors with real estate industry participants seeking financing for their projects. Crowdfunding uses technology to give individuals exposure to global investment opportunities. Investors also benefit from increased control and flexibility with regard to their investments.
Crowdfunding for real estate investing only began to develop rapidly over the past two to three years. However, billions of dollars are spent annually on deals made via these crowdfunding platforms. In contrast to REITs, crowdfunding allows investors to personally select those projects which they wish to invest in. However, once an investment is made, it becomes totally illiquid — an investor must wait until completion (or sale) of the project in order to return both his capital and his profit.
We are currently in a fairly interesting situation from the point of view of technological development, primarily with regard to blockchain technology. On the one hand, blockchain technology can be used to create new types of investment funds, which could be less intensively regulated than REITs, as they don’t need to be listed on existing stock exchanges, and they can market across legal jurisdictions, etc. On the other hand, crowdfunding, if done using blockchain technology, could make each individual investment in each specific project totally liquid. Instead of taking money from investors as per a co-investment agreement, project owners would simply issue a token for each specific project for which they would like to raise funds. Then, an investor can, if he wishes, sell his investment just like he was able to sell his shares in a REIT.
This is exactly the area that Thaler.One is focused on. Individual investors can purchase tokens on our in-house platform which are fully secured by tangible real estate. These Thaler tokens offer fully secured and transparent legal ownership of real estate assets. In addition, Thaler holders also benefit from property-related income and commissions for tokenization of the underlying real estate assets though the Thaler.One investment marketplace.
Trust your investment to professional real estate investorsThat was our brief summary of the most common forms of real estate investment and the benefits of investing in real estate for individual investors. Whether you want to simply diversity your portfolio or build a solid foundation to generate future passive income, investing in real estate remains a smart choice. The market for individual investors is currently being disrupted and is changing quickly. Soon, we will see how a large portion of revenues from managing real estate investments will shift from banks and fund management institutions directly to private investors.
It’s important to also remember that one shouldn’t jump into real estate investing without proper guidance, particularly if you haven’t invested in real estate in the past. The best way to begin to invest in the real estate market is with the help of experienced professionals. As an individual investor, you can entrust professional real estate investors to do the groundwork, allowing you to simply invest and enjoy your profits. Thaler is uniquely positioned as a team of experienced real estate market professionals to provide individual investors the opportunity to dive into real estate investing and redefine the possibilities for generating returns at this exciting time in the sector.
Together, we will disrupt this market.
Kristina EroshkinaSource:
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