Do you want to invest in real estate? Knowing how value is created in real estate may help your decision. Real Estate is a hard asset, with a longer time horizon than asset classes such as stocks, futures or options. The length of a Real Estate investment will extend from:
- 12-36 months for renovations or ground-up developments
- To decades for the complete management and maintenance of a rental unit
A property developer needs to have a good flair for the future configuration of a neighborhood. The standard life cycle of a building is measured in decades, with a building rising to its grandeur until it reaches its noble age, and needs redevelopment or recycling.Here’s how value is created.A real estate property can be purchased with the intention to rent it and generate regular inflows or to resale it at a higher price in order to generate a profit. The way in which a property is used (residential, commercial) has a significant impact on its value. Determining this impact and the highest and best use of a property is the property developer’s job.
Rezoning (Buy by the acre, sell by the foot)
- Rezoning of agricultural land: to accommodate a local demand, attract new residents, and create new streams of tax revenue for municipalities. The context is favorable for vast wealth creation for property builders, who can buy land by the acre to sell apartments by the unit. This opportune atmosphere is still a daily reality in major emerging markets where rural land is inexpensive. Urban planning, transparent tenders and environment protection have made it less straightforward in Western countries.
- Rezoning of existing properties: The idea, then, is to buy a property, and request a new zoning designation which makes it more valuable. If you can get the zoning changed, you can then resell the property for a profit.
Renting
In this case, the developer will simply buy a property and rent it to a tenant. We can distinguish many cases:
- Either the landlord is responsible for paying the operating expenses
- Or the tenant is the one responsible for paying all the operating expenses, which is the case for the triple net lease for instance
You can require tenants to sign long-term leases to ensure stable, predictable income, or might prefer to sign short-term leases with the intention to renew the contract and increase the rents for the new tenants. You can also include clauses specifying future increases in leases.In all of the cases it is important to assess the quality of the tenant, especially in terms of credit quality.
Ground-up Development
Properties erection gives life to the dynamic world of construction, the 2nd largest employer on our planet. It involves thousands of trades, management, engineers, skilled and manual labour, and financiers. Judge by yourself, this is a trillion dollar sector and millions of jobs are involved:
- The project owners are involved in organizing the show. The Land developer finds capital/debt with a Lender, in order to create a property infrastructure on vacant land, which is sold by realtors to a Lessor who grants access to Lessees to use the premises. The property is then managed by several representatives to keep the building in mint condition, in legal, financial and liveable terms.
- The project design lies in the hands of the principal who is responsible for the supervision of engineers (surveyor, civil, structural, mechanical, electrical), architects, drafters, CAD operators, consultants, designers to meet the qualification standards prevailing locally and nationally.
- The contractors perform the construction work with project, construction managers and clerks supervising subcontractors or forepersons in charge of workers, technicians, apprentices, suppliers.
- The commercialization phase is monitored by inspectors, regulatory agents, government officers, to allow realtors to publicly solicit potential buyers
- It is estimated that the renovation phase takes place 30 years after delivery of the building. The decline and renewal of buildings, neighborhoods and cities sets the decor in motion again, creating new jobs and wealth opportunities.
Real Estate Trading
Real estate traders buy properties with the intention of holding them for a short period of time, and then sell them for a profit. This technique is also called flipping properties and is based on buying properties that are either significantly undervalued or are in a very hot market. Here again, we can distinguish two cases:
- Pure flipping: the property developer does not want to put any money into the house for improvements and this can be compared to speculation: the investment has to have the intrinsic value to turn a profit without alteration. This is a short-cash term investment
- Fix and flip/ Repositioning: the property is bought, and then remodeled or renovated, and sold at a profit. This can be a long-term investment depending on the extent of the improvements. Older homes in still-attractive neighborhoods remain a key market for residential flippers; these older homes can sometimes be renovated with current finishes and features that make them more attractive to homeowners and appeal to modern tastes.
Conversion/ Redevelopment
This is often the key to great rewards. Converting a deserted hotel in a luxuriant residential resort, or an old office building in students’ apartments building can generate important capital gains. Conversion and redevelopment require more financial needs and more time than simple repositioning. Sometimes it can be close to the process of a ground-up development, but they also generate consequent sources of income.Cities expand, and neighborhoods have their own lives. A 20-year old hotel can make no sense on a busy touristic city where Airbnb and the likes have modified the structure of the demand. Developments must blend in the environment and property developers have to adapt to the demand.
