Real Estate Asset Management: Real Estate Investment Strategy: Part One of Four

The return on every real estate investment is made up of a combination of stock-like and debt-like behaviors. From the point of view of real estate asset management, investment financing is made up of both private and public capital. It is the correlation of the debt and equity components with the source of financing that allows us to define the four main real estate investment structures.

Consider the case of a real estate private equity asset leased to a single credit lessee under a long-term triple net lease. Lease payments resemble the fixed payments associated with a bond, not stock. In fact, the value of a triple red lease fluctuates according to the same factors that influence the value of a bond or mortgage, such as interest rate movements, inflation and the lessee’s creditworthiness.

At the other extreme, an equity position in a vacant, speculative, multi-tenant property with short-term leases is driven almost entirely by capital forces. The value of the building from the perspective of the equity tranche is a function of the supply and demand for space in a given market, at a given time. In fact, the debt-to-equity composition for a real estate investment can change over time.

By way of illustration, let’s take the triple net lease from the first example. As the lease ages and approaches its expiration date, the property acquires a greater equity-like behavior component and less debt-like behavior component; And at the end of the triple red lease, the value of the property is only affected by the forces of equity.

Commercial mortgages are used in real estate asset management to eliminate debt-like behavior from real estate investment. For example, the commercial mortgage-backed securities market divides the cash flows of pools of mortgages to produce bond-like characteristics in the higher-tier tranches and more equity-like cash flow characteristics in the layers. subordinates. Since real estate investment financing is comprised of public and private equity, investors typically define these tranches of debt and equity with four main real estate investment structures:

Equity:

* Private commercial real estate equity: held as individual assets
* Real Estate Public Equity – structured as Real Estate Funds or Real Estate Investment Trusts

Debt:

* Private Commercial Real Estate Debt – held as commercial loans or mortgages held in funds
* Commercial Real Estate Public Debt – structured as Securities Backed by Commercial Mortgages

These investment structures react to a common set of influences, as well as unique influences specific to each individual structure. It is the analysis of the debt and equity components of each structure that enables real estate asset managers and their agents to effectively structure the portfolio to meet specific investment objectives. In the next two articles, we look at the debt and equity components for several different real estate investment objectives.