As an asset class, real estate offers distinct economic characteristics, challenges, and opportunities. The primary benefits come from the ability to utilize leverage through the financing of property through mortgages, and the inherent ability of real estate to maintain value in inflation-adjusted terms.
We believe the actions taken by the Federal Reserve to contain the credit crisis that began in October 2007 were both necessary and prudent. The consequences of those programs, however, will come in the form of substantially higher inflation as the government prints money to fund the projected $9 trillion deficit over the coming ten years.
With near-record low mortgage rates, tax incentives for first time home buyers, and the largest widespread decline in real estate prices in our nation’s history, we believe that today’s environment provides a window of opportunity to acquire high quality real estate holdings at a low price, financed at next-to-nothing rates. If the inflation expectations prove true, the properties would only need to maintain their value in real terms to generate enormous returns on equity over the next five to ten years. Investors with the balance sheet, discipline, and skill to construct a intelligently diversified property portfolio have a tremendous advantage.
There are four primary mechanisms for investing in real estate (we do not consider mortgage loans secured by real estate to be a real estate investment. Rather, they are economically comparable to fixed income investments and should be classified as such). These include:
- Property Ownership
- Real Estate Investment Trusts, or REITS
- Real Estate Based Operating Businesses such as property management, development, or rentals
- Tax Lien Certificates
Most of these categories can be further divided based on the type of real estate, such as residential, commercial, industrial, or raw land. Hotel management companies and hotel franchises, for instance, are most certainly tied to the real estate market but they themselves are more properly classified as real estate based operating businesses because the gain for owners comes from the earnings generated by the underlying service or product activity, not from appreciation in land or buildings.