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Real estate comprises land and buildings. They became an investment alternative, both directly and indirectly. This asset class offers the potential for capital appreciation and stable income. Investors hold it as diversified and as an inflation hedge because of the low correlation with other asset classes (e.g., stocks and bonds).
Direct and indirect investing in real estate
Direct investment
Real estate investment can be direct. We mean, you can buy land and buildings from developers or sellers. You will get potential income from their rising prices and from rental income. Investors typically purchase a residential property and commercial property.
Direct investment has several weaknesses. Purchases require active management. That may be difficult for you if you don’t have property management experience.
Next, the real estate units that you buy are usually of great value. So, when your investment is part of a diversification strategy, it may be challenging to find the right combination of units suitable for the weight of your target’s asset portfolio.
Indirect investment
Indirect investment involves the purchase of financial instruments with underlying real estate, such as real-estate investment trusts (REITs) and mortgage-backed securities (MBS). Both collect funds from different investors and invest in various real estate units.
Unlike direct investment, units purchased are relatively small and have relatively low-risk exposures. Investors only need to buy several units, depending on their asset allocation needs.
Three examples of indirect investment instruments are:
- Real estate investment trusts (REITs)
- Real estate limited partnerships (RELP)
- Mortgage-backed securities (MBS)
Real estate investment trusts (REITs). This investment fund specializes in investing in various types of real estate and is traded on an exchange. Investors can buy it like buying shares. REITs generate a stable income stream for investors but offer little capital appreciation.
Real estate limited partnerships (RELP). In this investment, some investors partner and raise money to buy various types of real estate, both for rent and resale. As general partners are real estate development companies or experienced property managers, who are fully responsible for managing RELP. Meanwhile, outside investors are limited partners, which can contribute to financing real estate projects and get a share of ownership.
Mortgage-backed securities (MBS). MBS is a bundle of various residential or commercial mortgages with certain credit risks. It is similar to debt instruments, such as bonds, because it makes periodic payments. The issue usually comes from government companies or trusted financial companies. In Indonesia, PT Sarana Multigriya Finansial (Persero) is an example. The company collects mortgages from banks and packages them into MBS units.
Types of real estate
There are various types of real estate, each of which has its own characteristics, advantages, and disadvantages as an alternative investment. The six main types of commercial real estate are:
- Land
- Office space
- Residential property such as an apartment or flat
- Retail space
- Industrial estate
- Hotel
Investment in undeveloped raw land can be very speculative. Investors do not get cash inflows from tenants or occupants. Instead, they bear the cost of real estate taxes and other costs of holding land. Investors need to develop by equipping it with roads, utilities, and other services, so its price increase.
Office space is one of the most significant real estate investment segments. Investors buy it for rent to tenants in different periods. Investment in office space offers relatively predictable cash inflows. Office space is also relatively resistant to inflation because rental prices will usually be adjusted by the inflation rate.
Residential properties include apartments, condominiums, co-ops, townhouses, etc. and consists of many units in a single development or building. Individuals or families rent it as residences.
Next is the retail space. Examples are malls and commercial shopping centers. The owner rents out space to retailers for a specified period. In some cases, property owners also receive a percentage of the sales generated by the tenant’s shop in addition to the basic rent.
The industrial segment includes properties such as manufacturing facilities and warehouse space. Again, the rental period varies. Typically, industrial estates have significant costs and involve more complex utility services than other real estate segments.
The hotel includes staying facilities and other business facilities, such as meetings, incentives, conferences, and exhibitions (MICE). Owners usually have extensive hotel chains with various brands such as Marriot, Hilton, Accor, and Best Western Hotels. Owners fund, operate, and oversee the hospitality business. Some owners also hire management companies to manage the daily operations of the property.