Real Estate

Real estate is "Property consisting of land and the buildings on it, along with its natural resources such as crops, minerals, or water; immovable property of this nature; an interest vested in this; (also) an item of real property; (more generally) buildings or housing in general. Also: the business of real estate; the profession of buying, selling, or renting land, buildings or housing.

In recent years, many economists have recognized that the lack of effective real estate laws can be a significant barrier to investment in many developing countries. In most societies, rich and poor, a significant fraction of the total wealth is in the form of land and buildings.

In most advanced economies, the main source of capital used by individuals and small companies to purchase and improve land and buildings is mortgage loans. These are loans for which the real property itself constitutes collateral. Banks are willing to make such loans at favorable rates in large part because, if the borrower does not make payments, the lender can foreclose by filing a court action which allows them to take back the property and sell it to get their money back. For investors, profitability can be enhanced by using an off plan or pre-construction strategy to purchase at a lower price which is often the case in the pre-construction phase of development.

But in many developing countries there is no effective means by which a lender could foreclose, so the mortgage loan industry, as such, either does not exist at all or is only available to members of privileged social classes.

As a real estate investor, you will most likely be purchasing ownership interests and then earning a return on that investment by issuing leasehold interests to tenants, who will in turn pay rent. It is also not uncommon for an investor to acquire a long-term leasehold interest in land, which then has a building constructed upon it. At the end of the land lease, the land and building become the property of the original land-owner.

Private Versus Public Markets

When you are planning your real estate investments, one of your first tasks is to decide what kind of exposure to the real estate market is appropriate for your situation. Different exposures produce varying levels of risk and return. Your choice will also influence the means by which you will acquire the real estate.

The first type of market you could participate in is the private market. In the private market, you would be purchasing a direct interest in one or more real estate properties. You would own and operate the piece of real estate yourself (or through a property manager), and you would receive the rent payments and value changes from that investment. For example, if you were to purchase an industrial building that was leased to one or more tenants who pay you rent, you would be participating in the private real estate market. You could also participate in this market by purchasing properties with any number of partners - this is known as a pool or syndicate.

Equity and Debt Investments

In addition to choosing your market, you need to choose whether to invest in debt or equity.

When you invest in debt, you are lending funds to an owner or purchaser of real estate. You receive periodic interest payments from the owner and a security charge against the property in the form of a mortgage. At the end of the mortgage term, you get back the balance of your mortgage principal. This type of real estate investing is quite like that of bonds. (To read more about mortgages, see Shopping for a Mortgage, Understanding the Mortgage Payment Structure and Paying Off Your Mortgage.)

An equity investment, on the other hand, represents a residual interest in the property. When you are an equity investor, you are essentially the owner of the property. You stand to gain a lot when the property value increases or if you are able to get more rent for your building. However, if things should go wrong (for example, all your tenants vacate and you can't make your mortgage payment) then the mortgagee, who has a priority interest in your property, may foreclose and you must forfeit your equity position to satisfy their security. In that sense, the risks of an equity position in real estate is much like that of owning stock.

The choice of whether you want to invest in equity or debt will depend upon your risk tolerance and your return expectations. The riskier choice is investing in equity, but you can also make a lot more money! As the greater the risk, the greater the reward.