Nesbit News Article |
Why Real Estate Remains a Strong Investment |
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| Posted: 11/16/2005 |
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| Toll Brothers' November 8th announcement that its projection of 2006 earnings has been reduced, along with its planned housing starts, resulted in not only a decrease in its stock value but also a drop in the Dow Jones US Home Construction Index. Despite this disappointing news from the overheated residential housing sector, which suggests that now is not the best time to invest speculatively in the housing market, other types of real estate remain as viable investment options for institutions and savvy private investors. This article is an overview as to why and how that is true.
For the past several years, institutional investment capital has been attracted to primary and secondary markets for the purchase of Class A office buildings, large distribution buildings, shopping centers, and apartment communities. Institutional capital invests in real estate as an alternative to the stock market and other investment options. Capitalization rates, which are roughly defined as the percentage obtained when dividing a property's net operating income by that property's selling price, have been below 7% for all types of institutional real estate investments, and below 6% for apartments. The low capitalization rates reflect the increased interest from institutional investors in real estate, and have occurred despite an increase in vacancy rates across most real estate categories. The good news for the real estate community is that the flow of institutional capital to investment grade real estate is expected to increase. Rental rates are expected to rise because the demand for new space resulting from job growth is expected to outstrip current and planned growth of product supply, especially for industrial, office and retail space. The "risk premium" (which is defined as the difference between the total return of the investment and the 10 year Treasury bond rate) remains at about 3-4% for real estate, which compares favorably at about 2% less than the risk premium for the stock market. The low risk premium for real estate reflects the relative poor performance of other investments, the institutionalization of real estate, and the general decrease in risk premiums for all investments. Therefore despite rising interest rates, and because of stable or increasing net operating incomes and low risk premiums, capitalization rates are expected to remain stable for investment grade real estate. Especially because many institutional investors intend to allocate a higher percentage of their available investment capital to real estate investments, real estate values should increase in response to an increased investment demand for a marginally increasing supply. While private investors should continue to enjoy respectable returns from investment in the stock of many Real Estate Investment Trusts, non-institutional opportunities also exist for observant private investors. Specifically, opportunities exist for investors in office, industrial and retail properties which are not attractive to institutional investors because of their size, physical condition, or location in a tertiary investment market, such as central Pennsylvania is considered to be for most real estate investment categories. Professionals or small business owners should recognize significant investment opportunity and tax advantages from the ownership of their primary business locations. Condominium opportunities have become popular nationally as a means of creating an economy of scale to enhance private ownership of business property. Office and industrial condominium opportunities are just now being brought to the central Pennsylvania market. The research for this article results substantially from presentations made recently by national experts to the National Association of Industrial and Office Properties (NAIOP) annual conference, as well as other real estate industry journals and professional publications. For more information, contact Dave Nesbit of Nesbit Development, LLC who authored the article.
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