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Role of Economic Value Determinants in Private Real Estate Debt Investments

Role of Economic Value Determinants in Private Real Estate Debt Investments

Economic Drivers

The following economic factors affect the demand for major property types:

  1. GDP: This is, by far, the most important economic factor as it affects all property types. As the GDP grows, the demand for real estate investment also increases.
  2. Population Growth.
  3. Job Creation: Job creation leads to an increase in demand for office spaces. Increased jobs also lead to increased demand for multi-family homes and hotels as business travel and leisure increase.
  4. Household Formation: This is the largest driver for household apartment demand.
  5. Wage Growth: As an individual’s income increases, their capacity to afford better quality housing increases.
  6. Consumer Spending: Affects the demand for retail, industrial and hotel properties.
  7. Retail Sales Growth: Affects the demand for retail and industrial spaces.
  8. Demographic Trends: Affect the demand for retail, family, and hotel properties.
  9. Consumer Confidence: Affects the demand for retail, family, and hotel properties.
  10. Consumer Credit: Affects the demand for retail, family, and hotel properties.
  11. Industrial Production: Affects the demand for industrial property.
  12. Trade and Transportation: Affects the demand for industrial property.
  13. Advances in Logistics: Affects the demand for industrial property.
  14. Changing Supply Routes: Affects the demand for industrial property.
  15. Business Formations: Affects the demand for retail, industrial, family, and hotel properties.
  16. Business Investment: Affects the demand for retail, industrial, and hotel properties.
  17. Business Confidence: Affects the demand for retail, industrial, and hotel properties.
  18. Taxes: Affect the demand for all property types.

Role of Real Estate in an Investment Portfolio

  • Current Income: Real estate provides income for its owners in rent received from leasing the property.
  • Price Appreciation: Investors expect the value of real estate property to increase over time.
  • Inflation hedge: Investors expect rent and real estate prices to rise when inflation is high, creating an inflationary hedge.
  • Diversification: Investors add real estate investments to their portfolios to lower the risk of volatility in returns since real estate returns from rent are more frequent than those of stocks that pay dividends annually.
  • Tax Benefits: Real estate investments receive favorable tax treatment compared to other forms of investments.

Question

George Matthews is looking to invest in real estate property with the highest cash flow volatility. Which property is he most likely to invest in?

  1. A shopping center.
  2. An industrial property.
  3. A hotel.

Solution

The correct answer is C.

The demand for hotel rooms fluctuates depending on economic activity, consumer and business confidence. Moreover, there are no long-term leases to protect hotel revenue streams.

A is incorrect. Shopping centers have long-term leases that protect their returns from market demand fluctuation.

B is incorrect. Industrial estates also benefit from the long-term lease, which protects their returns from market demand fluctuations.

Reading 35: Real Estate Investments  

LOS (b) Explain portfolio roles and economic value determinants of real estate investments.

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