Real Estate Investment: Traditional Methods & Benefits
Audrius Visniauskas November 13, 2020
One of the biggest misconceptions about real estate investing is that you need to invest substantial amounts into real estate in order to be successful. Although having a bigger share helps, this does not mean that investors can’t profit from the real estate market with smaller capital. For example, REITs and real estate crowdfunding require minimum capital—as low as 50 EUR!
So really, even for an average person, it’s never too late to invest in real estate. In fact, it’s one of the best ways of generating passive income, and can be a seriously beneficial asset for anyone looking to build their long-term wealth.
If you learn about the market, read up on best practices in the industry, and make quick, informed decisions about your next real estate investment, you can create your own passive income source. Here are methods to help you see substantial returns on real estate in 2020-2021.
Price: 332,000 €
Purchase property tax: 11.5 %
Total purchase price: 370,180 €
Price per square meter: 6,855 €
Average monthly rental price in the area: 1,212 €
Expected Annual yield (Gross): 3,9 %
Agency fee: -0.4 %
Vacancy: -0.4 %
Total expected annual return (Net): 3.1 %
Purchasing real estate with the intention of earning income through rental or resale, rather than using it as a primary residence, is a method of direct investment in a property. Real estate investors typically purchase homes, apartment buildings, and commercial buildings to rent out to tenants.
Direct investment in real estate can be done in different ways, but the most common method is purchasing a property using a mortgage, which is defined by the term “leverage”. The use of leverage is what attracts many real estate investors because it allows acquiring properties that otherwise would not be affordable.
The housing markets in countries like Spain are very active because the real estate prices still haven’t recovered from the Economic Crisis in 2008-2009. This gives a potential for higher capital gains, which with time would compound and could provide really impressive returns. Additionally, you can always use leverage and use the apartment as a mortgage to acquire more properties and maximize returns.
Risks & Challenges:
The problem with direct investment is that it requires a large lump sum to invest directly, or a smaller, but still substantial amount to obtain financing from a bank, which requires the borrower to be creditworthy and match the banks’ strict lending policies.
A few other risks associated with direct investment include:
- Liquidity. Direct investment in property means that investors can’t sell their stake as fast as with REITs or real estate crowdfunding. Selling an actual property involves multiple parties, such as notaries, land registries, real estate brokers, and even lawyers.
- Financing risk. Although leverage can be used moderately, proceeding with timely interest payments can become challenging in unexpected situations (e.g. during an economic downturn). This fuels the risk of not meeting financial obligations and losing the property.
- Property management. Idle time and unreliable tenants are two of the highest operational risks of this investment type. Any property requires upkeep and renovation spending, which can exceed planned budgets.
An REIT (Real Estate Investment Trust) is an investment fund whose aim is to invest in real estate and pay out most of its rental income to the REIT holder. Investors can put money into a collection of properties a REIT company manages and benefit from the dividends earned. Investors also bear the cost of taxes and any losses incurred.
REITs acquire and develop properties to own and manage them. They are legally required to distribute at least 90% of their taxable income to investors. Income comes from the rent, management fees, and leasing of properties.
REITs are divided into two categories:
▶ Equity REIT. Companies acquire business properties, such as shopping malls, hotels, office buildings, and commercial buildings, and then rent out those spaces. After deducting all operational costs, equity REITs pay annual dividends to their shareholders. The dividends also include any appreciation of the property.
▶ Mortgage REITs. These provide mortgage financing or obtain mortgage-backed securities and earn income from the interest. Mortgage REITs can cover either residential or commercial properties.
Many REITs have issued their stocks and can be publicly traded in New York, London, Madrid, etc. Let’s analyze our favorite example of Empire Realty Trust (ESRT), which owns one of the most iconic buildings of all time: the Empire State Building in New York City. By investing in this REIT, you can consider yourself a proud co-owner of this incredible property.
Stock price: 15.30 $
Annualized dividends: 0.42 $
Annual yield: 2.75%
Data source (May, 2019): streetinsider.com
- Liquid assets. REITs are easy to sell, as most trade on stock exchanges, but one might find it hard to buy due to the lengthy registrations on traditional online brokerages. This marketable feature mitigates some traditional drawbacks of real estate. Traditionally, real estate is illiquid—property can take a long time to sell or purchase — but REITs can be sold in a matter of seconds through your investment account.
- Diversification. One overlooked benefit of REITs is how resistant they are to bankruptcy, even during periods of severe economic trouble. From 2007-2010, the US went through the worst recession since the Great Depression. How many publicly-traded REITs filed for bankruptcy? One.
Risks & Challenges:
The risks associated with REITs include:
- Price volatility. REITs are a financial instrument traded on the stock market. It is directly tied to the market index such as the S&P 500. Even if the real estate market remains stable, volatility in the equities market will impact REITs as well.
- Structural risks. REITs are equities, not bonds. Like all equities, they carry a certain risk, which is significantly greater than that of bonds.
- Excessive reliance on capital markets. REITs must pay 90% of their taxable income in dividends to shareholders. This is a good thing from the investor’s perspective, but it can also be a risk when REITs are overpriced.
- High transactional fees. Buying REITs, the transactional fee is usually structured in a percentage commission, with the minimum fee which is usually set at 10$. If investor would purchase 50$ worth of REITs, it would be hard to earn more than 20$ to compensated for the entry and the exit fees.
Real Estate Crowdfunding (P2B)
P2P lending, or “crowdfunding”, is a method of financing that allows real estate companies to borrow money without using a bank or credit union as an intermediary. Instead of getting a loan through a bank, crowdfunding platforms take their role as financial aggregators, and then individuals invest their money towards specific projects through the internet.
To better understand how this works, see the example listing below:
Total investment sought: 60,000 €
Loan Duration: 12 months
Minimum investment amount: 100 €
LTV (Loan-to-Value index): 47%
Total expected annual return (Net): 13%
This project was financed on the EvoEstate platform, where you can find investment opportunities from many different European countries.
This is an especially attractive listing due to its high 13% returns and collateral worth 47% of the total loan value. Usually, LTVs which are below 65% are considered to be safe, as it protects the investors from a property’s 35% devaluation during the recession. This particular project has the first-rank mortgage, which means that in case of insolvency, investors will be receiving their capital plus interest first. This particular project has been successfully repaid with an annualised return of 27.34%, because the borrower has repaid prior to the end of the minimum loan term.
- Low capital requirements. Obviously, one of the significant benefits of investing in real estate crowdfunding projects is the minimum investment price. The one listed above is only 100 €, and it can go even lower than that! This allows individuals to diversify extremely easily with a relatively small amount of money compared to other investment options.
- Increased transparency. Unlike REITs and other diversified options, you know exactly what project you’re investing in and know where your money is going. This gives you the option of doing your own research on the prospective property and making informed decisions about your investment choices.
- Less volatility. Since real estate crowdfunding projects are not traded on the stock market, your success is not tied to the overall situation of the market. For this reason, your returns cannot be impacted directly by changes in the market (although it can be impacted indirectly).
Risks & Challenges:
- Indirect investment. Investors have to understand that P2P Real Estate platforms are just an intermediary, and evaluate the project’s feasibility and risks.
- Difficult to sell. Another setback of P2P investments is the lack of liquidity. In most cases, crowdfunding platforms lack a secondary market. The positive thing is that EvoEstate is one of the few that have the secondary market and investors could list their investments at any time.
Private real estate investment funds
Although private real estate investment funds have been a preferred choice for high-net-worth individuals in Europe, their doors remain shut for most of the retail clients. This is typically due to their high minimum investment requirement. In different European states, it can range from 125,000 EUR to 1 million EUR and beyond.
There are two key benefits of this investment model:
- Hands-off investment. Since investors are considered limited partners, asset management is executed entirely by the fund’s managers.
- High returns. Depending on the risk level of the fund, investors can expect annual returns ranging between 10% and 18%.
Risks & Challenges:
- Relatively risky. Although some funds outperformed the stock market in the past, it won’t necessarily be the right indicator for the future, as most of them are highly leveraged. Still, this type of investment is co-financed with debt. During periods of market uncertainty, high unemployment, or other macroeconomic events that come with financing risk, such an investment can result in a partial or full loss of capital.
All four real estate investing approaches are appropriate for somebody. It all depends on your personal preference, understanding of the investments, creativity, and interests. While REITs are a popular option among the people who want to invest small amounts, Real Estate Crowdfunding enables investors to start small without incurring the high transaction fees REITs have.
EVOEstate’s investments start from as little as 50€ and there are no fees for investors. Sign up today and begin securing your future — evoestate.com