Characteristics of Real Estate

Real estate is the land along with any permanent improvements attached to the land, whether natural or man-made—including water, trees, minerals, buildings, homes, fences, and bridges. Real estate is a form of real property. It differs from personal property, which are things not permanently attached to the land, such as vehicles, boats, jewelry, furniture, and farm equipment.

People often use the terms land, real estate, and real property interchangeably, but there are some subtle distinctions.

• Land refers      to the earth’s surface down to the center of the earth and upward to the      airspace above, including the trees, minerals, and water.
• Real      estate is      the land, plus any permanent man-made additions, such as houses and other      buildings.
• Real      property—one of      the two main classifications of property—is the interests, benefits and      rights inherent in the ownership of real estate.

Broadly speaking, real estate includes the physical surface of the land, what lies above and below it, what is permanently attached to it, plus all the rights of ownership—including the right to possess, sell, lease, and enjoy the land.

Real property shouldn’t be confused with personal property, which encompasses all property that doesn’t fit the definition of real property. The primary characteristic of personal property is that it’s movable. Examples include vehicles, boats, furniture, clothing, and smartphones.

Land has three physical characteristics that differentiate it from other assets in the economy:

1. Immobility. While some parts of land are removable      and the topography can be altered, the geographic location of any parcel      of land can never be changed.
2. Indestructibility. Land is durable and indestructible      (permanent).
3. Uniqueness. No two parcels of land can be exactly      the same. Even though they may share similarities, every parcel differs geographically.

Land also has some distinct economic characteristics that influence its value as an investment:

• Scarcity: While land isn’t considered rare, the      total supply is fixed.
• Improvements: Any additions or changes to the land or      a building that affects the property’s value is called an improvement.      Improvements of a private nature (such as homes and fences) are referred      to as improvements on the land. Improvements of a public      nature (e.g., sidewalks and sewer systems) are called improvements to the      land.
• Permanence      of investment: Once      land is improved, the total capital and labor used to build the      improvement represent a sizable fixed investment. Even though a building      can be razed, improvements like drainage, electricity, water, and sewer      systems tend to be permanent because they can’t be removed (or replaced)      economically.
• Location      or area preference. Location      refers to people’s choices and tastes regarding a given area, based on      factors like convenience, reputation, and history. Location is one of the      most important economic characteristics of land (thus the saying,      “location, location, location!”).

There are five main types of real estate:

Residential real estate: Any property used for residential purposes. Examples include single-family homes, condos, cooperatives, duplexes, townhouses, and multifamily residences with fewer than five individual units.

Commercial real estate: Any property used exclusively for business purposes, such as apartment complexes, gas stations, grocery stores, hospitals, hotels, offices, parking facilities, restaurants, shopping centers, stores, and theaters.

Industrial real estate: Any property used for manufacturing, production, distribution, storage, and research and development. Examples include factories, power plants, and warehouses.

Land: Includes undeveloped property, vacant land, and agricultural land (farms, orchards, ranches, and timberland).

Special purpose: Property used by the public, such as cemeteries, government buildings, libraries, parks, places of worship, and schools.

Despite the magnitude and complexity of the real estate market, many people tend to think the industry consists merely of brokers and salespeople. However, millions of people in fact earn a living through real estate, not only in sales but also in appraisals, property management, financing, construction, development, counseling, education, and several other fields.

Many professionals and businesses—including accountants, architects, banks, title insurance companies, surveyors, and lawyers—also depend on the real estate industry.

Real estate is a critical driver of economic growth in the U.S. In fact, housing starts—the number of new residential construction projects in any given month—released by the U.S. Census Bureau is a key economic indicator. The report includes building permits, housing starts, and housing completions data, divided into three different categories:1

• Single-family      homes
• Homes with      2-4 units
• Multifamily      buildings with five or more units, such as apartment complexes1

Investors and analysts keep a close eye on housing starts because the numbers can provide a general sense of economic direction. Moreover, the types of new housing starts can give clues about how the economy is developing.

How to Invest in Real Estate

There are a number of ways to invest in real estate. Some of the most common ways to invest directly include:

• Homeownership
• Rental      properties
• House      flipping

If you physical property (e.g., rental properties, house flipping), you can make money two different ways: Revenue from rent or leases, and appreciation of the real estate’s value. Unlike other investments, real estate is dramatically affected by its location. Factors such as employment rates, the local economy, crime rates, transportation facilities, school quality, municipal services, and property taxes can drive real estate prices up or down.

Pros

• Offers steady      income
• Offers      capital appreciation
• Diversifies      portfolio
• Can be      bought with leverage

Cons

• Is usually      illiquid
• Influenced      by highly local factors
• Requires      big initial capital outlay
• May      require active management and expertise

You can invest in real estate indirectly, as well. One of the most popular ways to do so is through a real estate investment trust (REIT)—a company that holds a portfolio of income-producing real estate. There are several broad types of REITs, including equity, mortgage, and hybrid REITs. REITs are further classified based on how their shares are bought and sold:

Publicly traded REITs

Public non-traded REITs

Private REITs

The most popular way to invest in a REIT is to shares that are publicly traded on an exchange. Since the shares trade like any other security traded on an exchange (think stocks), it makes REITs very liquid and transparent.

Like many stocks, you earn income from REITs through dividend payments and appreciation of the shares. In addition to individual REITs, you can also invest in real estate mutual funds and real estate exchange traded funds (ETFs).

What We Like

• Liquidity
• Diversification
• Steady      dividends
• Risk-adjusted      returns

What We Don’t Like

• Low      growth/low capital appreciation
• Not      tax-advantaged
• Subject to      market risk
• High fees

Mortgage-Backed Securities

Another option for investing in real estate is via mortgage-backed securities (MBS). These received a lot of bad press due to the role they played in the mortgage meltdown that triggered a global financial crisis in 2007-08.  However, MBS are still in existence and traded.

The most accessible way for the average investor to into these products is via ETFs. Like all investments, these products carry a degree of risk. However, they may also offer portfolio diversification. Investors must investigate the holdings to ensure the funds specialize in investment-grade mortgage-backed securities, not the subprime variety that figured in the crisis.

Questions

1. Give two Economic Characteristics of Real Estate (land) [1.25 marks]

2. What are the There are five main types of real estate  [1.25 marks]

3. How the Real Estate Industry Works  [1.25 marks]

4. How to Invest in Real Estate  [1.25 marks]

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