Characteristics Of Real Estate Investments

One of the beneficial features of real estate is that it produces relatively consistent total returns that are a hybrid of income and capital growth. In that sense, real estate has a coupon-paying bond-like component in that it pays a regular, steady income stream, and it has a stock-like component in that its value has a propensity to fluctuate. And, like all securities that you have a long position in, you would prefer the value to go up more often than it goes down!

The income return from real estate is directly linked to the rent payments received from tenants, minus the costs of operating the property and outgoing mortgage/financing payments. So, you can understand how important it is to keep your property as full as possible. If you lose too many tenants, you won't have sufficient rents being paid by the other tenants to cover the building operating costs. Your ability to keep the building full depends on the strength of the leasing market - that is, the supply and demand for space similar to the space you are trying to lease. In weaker markets with oversupply of vacancies or poor demand, you would have to charge less rent to keep your building full than in a strong leasing market. And unfortunately, if your rents are lower, your income returns are lower.

Capital appreciation of a property is determined by having the property appraised. (We discuss the appraisal process further in, but for now you should just know that an appraiser uses actual sale transactions that have occurred and other pieces of market data to estimate what your property would be worth if it were to be sold.) If the appraiser thinks your property would sell for more than you bought it for, then you've achieved a positive capital return. Because the appraiser uses past transactions in judging values, capital returns are directly linked to the performance of the investment sales market. The investment sales market is affected largely by the supply and demand of investment product.

The majority of the volatility in real estate returns comes from the capital appreciation component of returns. Income returns tend to be fairly stable, and capital returns fluctuate more. The volatility of total returns falls somewhere in between.