Public market or private deals
It’s a tough question, because it is not a simple Yes or No question and there aren't any right or wrong answers, plus it depends a lot on the investor's 1) risk appetite, 2) expectation on the returns, and 3) investment horizons. I just want to share some of my thought process on real estate investment through the public or private market.
Typically any real estate investment has two return components: income and capital appreciation.
Total Return = Income + Capital Appreciation
In the public market, the income component is the dividend and the capital appreciation component is the stock price increase. In private deals, the income is the net operating income (NOI), and the capital appreciation is the asset value increase.
Public Market
Private Deals
In the private market, there are mainly 3 types of investment deals: core/core+, value-add, opportunistic.
Core/core+ deals are usually for high quality assets in Class A location which require minimum work after the acquisition. This type of deals usually generates around 7%-8% return. Among the 7-8% return, 4-5% can be attributed to NOI and 3% to asset value increase (based on NCREIF Property Index data on historical commercial real estate asset price in the US).
Value-add deals are typically for older assets in Class B location where the developers could 1) raise rents significantly by extensive renovation, and /or 2) boost income by enlarging the property to increase the rentable space. This type of deals can deliver 10-15% annual return, where 5-8% can be attributed to NOI and 5-7% to asset value increase. The rental and condo conversion deals discussed in Part 5 Case Studies of my Small Lot Development series would fit in this category.
Opportunistic deals are typically for non-performing assets in Class C location or ground-up construction in Class A/B/C locations. It’s difficult to generalize the return on this type of deals. You can typically expect an annual return of 12% or more. One main character of opportunistic deals is that there is usually no income during development and the return is almost entirely from the asset value increase and/or sale on the backend. The ground-up (rental or condo) deals discussed in Part 5 Case Studies of my Small Lot Development series would fit in this category.
Public market vs private deals
Table above is a summary of returns for private deals. From the annual return standpoint, REIT stocks in the public market are similar to core/core+ investment deals in the private market, which are perceived as low risk investments. The value-add and opportunistic deals in the private market provide much higher returns but also come with higher risks.
Fundamentally, the capital market is a market that trades risk. As discussed in Chapter 9.2.6 Relationship between Risk and Return of Commercial Real Estate Analysis and Investment by David Geltner, real estate investment return essentially consists of two components: risk-free return plus risk premium, see figure above.
The US treasury bonds are traditionally perceived as a risk-free investment although its rate of return is minimum. As investors seek opportunities with higher returns, the associated risk increases as well. Investors in control of the capital need to recognize the risks associated with each investment type and determine his/her risk appetite and make investment decisions accordingly.
Public Market
There are roughly 225 public REITs in the US. They encompass a variety of sectors in the real estate industries. The aggregated return on these public REITs can be measured by FTSE Russell indexes. One of these popular indexes is the FTSE Nareit All Equity Reits Index (FNER), which has 159 constituents including most investable US public REITs but excluding mortgage REITs. Another popular index is the FTSE Nareit Real Estate 50 Index (FNR5), which includes 50 largest REITs by market cap.
Here is a summary of returns on the two indexes. Please note that the compounded annual return of 7.4% to 8.0% represents roughly 3.5% (typical dividend yield) + 4.5% (stock appreciation).
Here is a summary of returns on the two indexes. Please note that the compounded annual return of 7.4% to 8.0% represents roughly 3.5% (typical dividend yield) + 4.5% (stock appreciation).
Private Deals
In the private market, there are mainly 3 types of investment deals: core/core+, value-add, opportunistic.
Core/core+ deals are usually for high quality assets in Class A location which require minimum work after the acquisition. This type of deals usually generates around 7%-8% return. Among the 7-8% return, 4-5% can be attributed to NOI and 3% to asset value increase (based on NCREIF Property Index data on historical commercial real estate asset price in the US).
Value-add deals are typically for older assets in Class B location where the developers could 1) raise rents significantly by extensive renovation, and /or 2) boost income by enlarging the property to increase the rentable space. This type of deals can deliver 10-15% annual return, where 5-8% can be attributed to NOI and 5-7% to asset value increase. The rental and condo conversion deals discussed in Part 5 Case Studies of my Small Lot Development series would fit in this category.
Opportunistic deals are typically for non-performing assets in Class C location or ground-up construction in Class A/B/C locations. It’s difficult to generalize the return on this type of deals. You can typically expect an annual return of 12% or more. One main character of opportunistic deals is that there is usually no income during development and the return is almost entirely from the asset value increase and/or sale on the backend. The ground-up (rental or condo) deals discussed in Part 5 Case Studies of my Small Lot Development series would fit in this category.
Public market vs private deals
Table above is a summary of returns for private deals. From the annual return standpoint, REIT stocks in the public market are similar to core/core+ investment deals in the private market, which are perceived as low risk investments. The value-add and opportunistic deals in the private market provide much higher returns but also come with higher risks.
The US treasury bonds are traditionally perceived as a risk-free investment although its rate of return is minimum. As investors seek opportunities with higher returns, the associated risk increases as well. Investors in control of the capital need to recognize the risks associated with each investment type and determine his/her risk appetite and make investment decisions accordingly.
Comments
Post a Comment