Five Essential Criteria for Analyzing Your Real Estate Investment
I was recently talking with a business owner who had a stock and bond portfolio. She also owned the building where her company was headquartered and recognized the inherent long-term value of real estate and its stability as investment, but really didn’t know where to start. If she pursued a real estate investment property, she wondered how much capital she would need and whether she had sufficient time to identify and manage it.
As we discussed how she could move forward in her real estate investing journey, I described the three most common ways to invest in real estate and wanted to share that information in an article for the Kenwood Community.
Three Real Estate Investment Models
There are three primary ways to add real estate to an investment portfolio. Each of these three business models provides various advantages, but there are also distinct differences.
- Buying a Property Directly (DIY - The Do It Yourself Model)
- Buying Shares in a Publicly Traded Real Estate Investment Trust (The REIT Model)
- A REIT pools the capital from numerous investors. Investor’s capital is then spread across a portfolio of different properties and various geographic areas.
- Investing with a Private Real Estate Sponsor (The Private Equity Model)
- Private Equity Sponsors generally utilize a combination of their own capital alongside some from outside investors to purchase one specific property and it is not spread across a portfolio.
Initial Five Criteria to Evaluate the Three Investment Models
From an investment perspective, we will compare these three business models based on a total of 10 distinct criteria. This article will evaluate the first five including practical considerations and the inherent differences. We selected these items because they are among the most valuable considerations for an investor to evaluate the best vehicle for their goals and objectives. The first five key areas include:
- Active Versus Passive Real Estate Investing
- Property Management Responsibilities
- Capital Required to Invest
- Deciding What Property to Invest in – Know What You Own
Active Versus Passive Real Estate Investing
Owning and operating real estate is time-consuming. More importantly, it requires some knowledge to avoid pitfalls and achieve the anticipated investment returns. Specifically, it is valuable to have a good understanding of property management, the real estate markets, lease language, negotiating skills, mortgage documents, how to contract for certain services, as well as how to market a property for lease. Being a DIYer means all of these activities become the investor’s responsibilities. Alternatively, by investing through the REIT or Private Equity models, all of those functions are handled by professionals.
Property Management Responsibilities
Property management services involve the day-to-day operational components of real estate ownership. This includes collecting the rents, responding to tenant calls, contracting for any required services, paying all the bills, and ensuring that the property is maintained. Real estate investing as a DIYer means being the property manager, or hiring a third-party company to perform these services (which would reduce the overall profit). Among the advantages of the REIT and Private Equity models are that these services are provided as part of each investment. One additional consideration, some REITs and Private Equity companies utilize internal personnel to handle the property management services while others engage a third party vendor. When the property management services are provided internally, then those employee’s daily responsibilities are entirely focused on the company’s properties. Whereas a third party property manager could also be employed to perform services for someone else’s properties.
Capital Required to Invest
This category highlights some of the biggest differences between the three business models. The DIY model generally requires the largest capital requirement. It includes not only the down payment (generally 20% of the purchase price for an investment property) but also the closing costs (such as transfer taxes and title insurance) and some working capital. The REIT business model only requires modest real estate investing, depending on the share price, and as little as one share could be purchased. Capital requirements for the Private Equity model generally falls somewhere in the middle. In Kenwood’s case, the minimum investment is only $25,000.
Real estate is generally considered an illiquid investment because investors cannot easily and quickly access the equity gains. Providing liquidity to an investor is one of the REIT model’s best advantages. An investor can access their investment simply by selling their shares. The DIY model and the Private Equity models would generally require the investor to either sell or refinance the property in order to access their equity. However, with Kenwood’s model, our Sponsors will generally “buy out” an investor if they need to access their initial equity.
Deciding What Property to Invest in – Know What You Own
Real estate values are highly influenced by their location. If one were to build the exact same building but in two different locations, their market values would not be identical. In fact, they might have significantly different values. As a result, many investors like to know exactly what they are investing in and its location. In this respect, the DIY and Private Equity models are generally similar. Investors decide whether they want to pursue an investment in a specific property. This also means that each investor has complete control. However, investors have no control over the REIT’s individual property decisions. A REIT may focus on specific property types, such as office or multi-family, but they typically choose which target markets to invest in and which properties to purchase, including potentially less desirable ones. On the positive side, having an investment spread across multiple target markets can provide REIT investors with some level of diversification; however, an investor still has no control regarding property-related decision making.
Below is a chart that summarizes the differences that were described above.
Real Estate Investment Model Comparison
Do It Yourself vs. REIT vs. Private Equity (the Kenwood model)
|Do It Yourself Model||REIT Model||Private Equity Model (Kenwood Model)|
|Active Versus Passive Investment||Active – You are responsible for everything.||Passive – The REIT handles all real estate matters.||Passive – The Sponsor (i.e. Kenwood) would handle all real estate matters.|
|Property Management Responsibilities||Active - All responsibilities are yours. You collect the rents, respond to tenant calls, and pay all bills.||Internal or external 3rd party management team. External management may not have the same goals as the internal management team.||Kenwood provides this service exclusively for its investment properties.|
|Capital Required to Invest||Generally large - You need to provide 100% of the equity plus closing costs and working capital.||Relatively small – based on share price.||As little as $25,000.|
|Liquidity||Not liquid. You would need to sell the property to create liquidity.||Very liquid. Easy to sell shares.||Considered illiquid; however, Kenwood’s sponsor will generally buy out an investor’s interest.|
|Deciding What Property to Invest in – Know What You Own||You have complete control.||No control over properties purchased. REIT may specify property type, but not location.||Investors are purchasing a specific property. The investor has complete control if they want to invest.|
Are you ready to start your real estate investment journey? Want to know more? Our analysis continues here as we analyze five additional real estate investment criteria, including:
- Market Knowledge
- Experience and Operating History
- Alignment of Interests
- Tax Advantages Available Through 1031 Tax Deferred Exchanges
- Benefits of Refinance Proceeds