Quality of Real Estate

What is Quality of Real Estate?

For potential buyers or investors, determining the quality of real estate is a very important undertaking. Real estate is widely considered as one of the most profitable investments for those looking to build wealth over time and invest in opportunities that provide stable incomes and returns. It is one of the low volatility investments that investors can tap into, compared to trading in equities and bonds.

Also, real estate offers investors an opportunity to diversify their portfolio since it demonstrates a low correlation with other asset classes. For example, real estate is not affected by the movement of stock prices, and its prices remain high even when stock prices are down.

Important Considerations When Investing in Real Estate

When investing in real estate, there are various factors that an investor can consider to determine the quality of real estate, and if the investment is right for them. The factors include:

1. Property valuation

Knowing the actual valuation of a real estate property can help an investor know the ideal purchase price of the property. The valuation is also important in other uses, such as sales listing, investment analysis, property taxes, and bank financing. When evaluating a real estate property, the investor should use a method that considers the economic and social trends, government regulations, and environmental conditions in a specific location.

When valuing a property, an appraisal is conducted to determine the market valuation of the property as of a specific date, which is the price that the property will fetch in an open and competitive market. The three main appraisal methods include the income approach, cost approach, and sales comparison approach.

2. Location

The location of a property is one of the most important factors for profitability in real estate investing. Investors consider the property’s proximity to key amenities, such as markets, transport hubs, warehouses, green space, shopping malls, hospitals, and schools.

For residential properties, investors consider the neighborhood status since it will determine how fast the value of the property increases depending on how the neighborhood is expected to evolve in the future.

If a residential property is located in an area where manufacturing plants are being established, it will directly affect the value of nearby residential properties, as potential property buyers move to stay away and opt to buy properties in other locations with better living environments.

3. Expected cash flows

The expected cash flows from a real estate property will determine the net income that an investor will be left with after paying all expenses. A property with a positive cash flow assures investors a good rate of return on their investments, making it an attractive choice of investment compared to other asset classes.

Also, when a property’s value is expected to appreciate due to the planned developments in the area, investors stand to gain from higher rental incomes, as well as capital gains if they decide to sell the property.

4. Indirect Investment

Indirect investments allow investors to own a stake in the real estate industry without actually managing a physical property. An investor can acquire a stake in a company that invests in real estate, such as real estate investment trusts, real estate company stocks, and mortgage-backed securities. Such investments allow investors to earn returns from the real estate sector without owning physical properties.

Different Ways to Invest in Real Estate

The following are the various ways investors can own a stake in the real estate industry:

1. Rental properties

Rental properties are one of the most popular real estate investments for investors looking for a consistent return on their investment. An investor earns income by charging a monthly or periodic rent to the tenants, and the amount of the rent charged depends on the location, size, amenities included, and other factors.

Properties located in affluent neighborhoods charge higher rents than properties located in middle-class areas. The property owners, also known as landlords, benefit from property appreciation over time, and they can sell off the property for a profit.

However, rental properties are hands-on investments, and investors are responsible for paying property taxes, mortgages, insurance, onboarding new tenants, and any other issues relating to the property.

2. Flipping properties

Real estate flippers earn revenues by buying properties to sell at a higher price after a short holding period. There are two approaches to real estate flipping.

The first approach is to buy run-down or old buildings that can increase in value after renovations. In such a case, the investor purchases the property and incurs costs in repairing and renovating it, and later sells it at a cost exceeding the total investment in the property. The second approach is to buy a property in a rapidly growing area, hold it for a short period, and then sell it at a profit.

3. REITs

A real estate investment trust (REIT) is a type of corporation that uses investors’ funds to purchase, manage, and sell real estate properties. REITs pool funds from multiple investors, who, in return, earn dividends from real estate investments without buying or managing any property on their own.

A REIT invests in different types of real estate properties, such as shopping malls, warehouses, data centers, apartments, medical facilities, and office buildings. Investors not only benefit from a steady income, but they also gain from capital appreciation.

More Resources

CFI is the official provider of the Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.

In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:

• Market Value
• Office REITs
• Real Estate Financial Analysis
• Sales Comparison Approach
• See all commercial real estate resources