Investment in Real Estate

• Investment in Real Estate

  • Why do investors want to invest in property?
  • A store of wealth
  • A source of long term income
  • A workable asset
• Investment possible because occupiers are prepared to rent rather than own space
• Property as an Investment

  • Expenditure on the purchase of an asset
  • Two types of investment: Existing or new assets
• Existing

  • Investment in Australian-Real Estate Investment Trusts (A-REIT)
  • An interest in an existing (perhaps tenanted) office block or a buy-to-let residence
• New fixed assets


  • Development of a new office block or land sub-division – property investment
• Direct Property Investment


  Purchase of a property directly from the owner
• Who invests directly in property?

  • Mum and dad landlords
  • Institutional Investors purchasing or funding in office development
• Large-scale institutions don't invest in the residential market
• Total Returns

  • Income – rents
  • Capital – price growth
  • Total Returns = Income + Capital
• Property Investors: Who are They?

  • Individual investors
  • Institutional investors
• Individual investors

  • Mum and dad investors
  • Individuals investing in Superannuation funds
  • Wealthy individuals
• Motivations of individual investors

  • Total Returns = Income + Capital
  • Poor income returns
  • Reliance on capital growth
• Institutional investors

  • Superannuation funds
  • Diversified managed funds
  • Investment companies
  • Property development & investment companies
  • Property funds
  • Property unit trusts
• Motivation of institutional investors

  • Total Returns = Income + Capital
  • Good initial capital growth, reliance on steady income returns
• Investment Decision-Making Process

  1. Personal & financial circumstances

  2. Intermediary e.g. property funds

  3. Personal & financial motives

  4. Return & Risk

  5. Suitable property

  6. Right price

  7. Right financing

  8. Amount $$

  9. Equity

  10. Debt

  11. Direct Investment

  12. Indirect Investment
• Why Invest in Property - Residential?

  • Rental income
  • Capital gain
  • Negative gearing
  • Potential future home
  • Investing for retirement
  • Diversification to investors who already own other investments such as shares
• Why Invest in Property - Commercial?

  • Capitalise on economic growth through demand for property
  • Total Returns – income return and capital
  • Prospects of rental and capital growth over time
  • Long term, stable income flow – superannuation funds
  • Diversification benefits of property
  • Inflation hedge
  • Purpose built building – capital growth + potential income
• Property Asset Market

  • Real Estate Assets = Future Cash Flows
  • The real estate asset market is part of the broader capital market
• Types of Investment Products

  • Debt Instrument: Investing in debt
  • Equity Instrument: represents an ownership interest
• Debt Assets

  • The rights to future cash flows to be paid by borrowers
  • More secure than equity assets
  • Secured creditor: give owners a "senior" claim for obtaining cash from underlying asset
  • Debt cash flows are contractually specified
  • Finite maturity dates
• Equity Assets

  • "Residual" or "subordinated" claim on the cash flows generated by the underlying asset
  • More control over managing the underlying asset
  • More ability to benefit from growth potential, value of asset can increase
  • Infinite Life - Must sell to realise value of asset
  • Present value of asset is derived from expected future cash flows
  • More uncertainty of cash flows (vacancies) → more volatile
• Major Types of Capital Asset Markets and Investment Products

  • Public Markets: Equity Assets, Debt Assets
  • Private Markets: Equity Assets, Debt Assets
• Australian Property Investment: Market Segments

  • Equity or Debt Investments
  • Public or Private Markets
• Pricing Property Investments

  • The value of Real Estate Assets are determined by the perceived potential to generate income
  • The worth of a property asset is its value in terms of per dollar of current net rent or income
  • Determined by calculating the asset's capitalisation rate
• Capitalisation Rates (1)

  • Indicates how much an investor is willing to pay to acquire a property
  • Reflects the potential total returns available from that investment
  • The lower the Cap rate the more an investor is willing to pay for a property
• If demand for property increases

  Cap rates fall
• If demand for property decreases

  Cap rates rise
• Capitalisation Rates (2)

  • An inverse relationship
  • A general rule: Better property = Lower Cap Rate
• Capitalisation Rates (3)


  • Shows how many multiples of income the investor is willing to pay to acquire property
  • Price often referred to as the Capital Value and the Capitalisation rate capitalises income into Capital Value
• Better property


  Lower Cap Rate
• Capitalisation Rate


  Shows how many multiples of income the investor is willing to pay to acquire property
• Three determinants of Cap Rates

  • Opportunity Cost of Capital
  • Growth Expectations
  • Risk
• Properties with Low Cap Rates (e.g. 5-8%)


  • Premium offices, Prime retail and industrial etc
  • Usually new build so long-term return potential + less vacancy risk
  • High quality tenants so low vacancy risk (secure returns)
  • Prestige for investors so in high demand
  • Favourable locations – CBD, prime retail location
  • Low initial return but high total returns
• Properties with High Cap Rates (e.g. 9%+)

  • Grade C, D office spaces, non prime retail areas, non core industrial
  • Older buildings with short life span
  • Need return up front so returns mostly in the from of initial income
  • Little or no potential for rental or capital growth due to building obsolescence
  • High risk of vacancy due to age and location but also quality of tenants. Low rent + poor location = low quality tenants (high risk)
• Required/Target ROR

  Rate required by the investor given the risk of investment
• Expected ROR


  Rate that the investor will earn if the property is purchased for its asking price
• Asking price is acceptable by the investor if: Expected ROR greater than Required ROR
• Types of risks

  • Market risks
  • Financial risks
  • Property risks
• If demand for property increases Cap rate

  fall
• demand for property increase cap rate?

  rise