Why Commercial Real Estate?
Our role at RealOp is to educate our investors as well as make them money. The following provides a brief overview of the elements of commercial real estate, how it works and why it makes for a good investment.
To begin with, commercial real estate is one of the most dynamic investment classes in the world. It is the only major asset class that produces high yields, significant equity buildup, can be efficiently leveraged for massive gains, and has the security of a hard asset that you can see and touch. In the simplest of terms, you can break it down into three main parts, each affecting the other: the rental market, the asset market, and the development industry.
The Rental Market – This consists of property owners (the supply side) and tenants (the demand side. Based on the dynamics of supply and demand: rents increase or decrease based on available space weighed against demand for that space. When available space remains constant and demand strengthens, rental prices increase. Similarly, if space remains constant and demand weakens, then rental prices decrease in response.
The Asset Market – As with the rental market, the asset market also has a supply side and a demand side. On one hand you have invested owners looking to sell real estate assets and on the other hand, you have investors looking to buy those assets. The behavior of real estate investors in the real estate asset market is determined by perceptions of comparative investment opportunities in other capital markets, say, the stock market, as compared to present risks and returns in real estate.
The Development Industry – Increasing property values drive the incentive to develop, which, in turn, affects rental rates. The activities of the development industry determines the availability of space in the rental market. And the wheel keeps turning ‘round.
Value-added Real Estate Assets Just like how there are different types of stocks such as growth stocks where shares are expected to grow at an above average rate, there are different types of opportunities in the commercial real estate investment world. And while we engage in new development for select clients and are open to any deal with promise, RealOp Investments typically focuses our attention on value-added assets.
These are known as the “growth stocks” of the commercial real estate world. Generally, they are below 75% leased and may require physical improvements to be able to compete for new tenants. Located in primary, secondary and tertiary markets, value-add assets produce lower initial returns between 0% and 4% initially, but can grow to 8% to 12% after the work has been completed.
Commercial Real Estate Performance as an Investment Strategy One of the biggest advantages of commercial real estate is the high annual cash return that it produces. In fact, commercial real estate income stream can produce three times the average stock dividend yield and four times the average bond yield. And unlike other asset classes, commercial real estate is typically leveraged with financing, with only commercial real estate providing rental income that covers debt payments. As tenants pay down the financing, equity is built up in the asset, making commercial real estate a solid investment in both the short term and long term views.