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REAL ESTATE FINANCE
Real estate capital markets
Original written by professor Roberto Knop Muszynski at IE Business School.
Original version, September 1st 2019. Last revised, June 1st 2023.
Published by IE Business Publishing, María de Molina 13, 28006 – Madrid, Spain.
©2019 IE. Total or partial publication of this document without the express, written consent of IE is prohibited.
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Index
a. The role of real estate in an investment portfolio
b. Real estate investment management
c. The four quadrants
d. Proptech
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The role of real estate in
an investment portfolio
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Capital markets & real estate
• Real estate has long been seen as an attractive hunting ground for
investment returns by institutional and individual investors alike.
When introduced into a multi-asset portfolio, real estate offers key
diversification and inflation hedging benefits, potentially enhancing
the portfolio’s risk-adjusted returns.
• With the right asset mix, a skillfully constructed real estate portfolio
can also offer an income stream that is relatively stable through
market ups and downs.
• While the evidence is strongest for private or unlisted real estate,
there are practical benefits to adding both private and listed real
estate investments to a portfolio.
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Capital markets & real estate
As already mentioned, in relation to the real estate market, we can identify
two investment routes:
• Direct
-Equity Investments: buying RE assets
-Debt Investment: lending RE projects
• Indirect -Funds: buying, RE funds, ETFs
-REITS
-Publicly held companies
-Privately held companies
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Capital markets & real estate: debt investment
Risk-return profiles of different investment strategies:
Private Equity
co-investment
High
Excess return potential
Warrants
Mezzanine
Syndicated
Mezzanine
Subordinated
Senior Direct RE debt
Lending
Higher risk
Senior RE debt
Moderate
Moderate/higher risk
Infrastructure
Lower/moderate risk
debt
Moderate High
Investment Risk
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The three main contributions to an investment portfolio
Stable income Diversification
Inflation Hedge
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The three main contributions to an investment portfolio
1. Diversification
Multiple studies have shown that real estate returns display a low
correlation with returns on listed equities or bonds This means that
adding real estate to a portfolio comprising mainly equities and bonds
can help reduce the total portfolio risk, potentially enhancing its risk-
adjusted returns.
Global equities Global bonds Global real estate
Global equities 100% 5% 23%
Global bonds 100% -20%
Global real estate 100%
Notes: Calculations are based on the annual returns over 2001-2018 of the following indices.
Global equities: MSCI All-Country World Index.
Global bonds: Bloomberg Barclays
Global Aggregate Bond Index.
Global real estate: MSCI IPD Global Annual Property Index.
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The three main contributions to an investment portfolio
1. Diversification
• Real estate assets are typically priced on a local basis and the
performance of individual properties is heavily influenced by local
supply and demand dynamics and regulations.
• Even within a single country, local drivers of real estate returns are
likely to vary across different locations and property types such as
office, retail, industrial and residential.
• This means that adding a large number of properties across
multiple locations and property types to a portfolio of equities and
bonds can offer a double or triple diversification benefit.
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2. Inflation Hedging
• Real estate returns tend to be more closely correlated with inflation
over time compared with equities or bonds, especially when
inflation is accelerating.
• A key reason is that real estate leases typically adjust to reflect
changes in inflation, especially for commercial property such as
office space, while property prices tend to rise with the cost of
construction, which increases with inflation.
• Adding real estate to a mixed-asset portfolio can provide a
valuable inflation hedge for investors seeking to preserve their
purchasing power, especially when inflation is accelerating.
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3. Stable income
• Income from rentals typically contributes a large proportion of
global real estate returns.
MSCI Global Annual property Index Performance
• A skillfully constructed real estate portfolio comprising multiple
high-quality properties with long term leases that expire at different
times can offer a rental income stream that is relatively stable even
through short term volatile markets.
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Management
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• Property management is the:
– Operation
– Control
– Oversight
of real estate. Management indicates the need of real estate to be cared for,
monitored and accountability for its useful life and condition.
• Property management is also the management of personal property,
equipment, tooling, and physical capital assets that are acquired and
used to build, repair, and maintain end item deliverables.
• Property management involves the processes, systems, and manpower
required to manage the life cycle of all acquired property as defined above
including acquisition, control, accountability, responsibility, maintenance,
utilization, and disposition.
• When holding properties, investors will need to decide whether to hire a
property management firm to oversee the investment or become the
landlord and do it themselves.
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In real estate property management, the property manager or management
company has 4 major areas of responsibility:
• Marketing and Financial: Involves an understanding of operating
expenses and budgeting.
• Tenant and Occupancy: Understanding the needs of the tenants is
important for this function. Getting them to move in is only the beginning.
• Facility: The physical management of the structures and outdoor areas.
Landscaping, electrical, plumbing, roof, walls, appliances, and much more
are all part of the physical property.
• Administration & Risk Management: This is the files and records part of
the property management function. Certain reporting requirements must
be met for municipal and local governments. Meticulous records for
accounting and taxes are a must.
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NUMBERS: REAL ESTATE FINANCE
• The real estate portfolio is supported on one simple aspect: the numbers.
• These numbers provide transparency to the deals–revealing whether or not
they’re good or bad.
• The portfolio should be comprised of each of your investment asset broken
down by the various numbers:
• RENTS • SALE PRICE
Incomes
1 Buy 2 Explotation 3 Mainteinance 4 Sell
Expenses
• PURCHASE PRICE • REPAIR COSTS • HOLDING COSTS
• TRANSACTION COSTS
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NUMBERS: REAL ESTATE FINANCE
• The next BIG aspect is financing.
How did you find and structure the financing of your deals? EQUITY vs DEBT
Which are the biggest threats for a RE Project?
1 Rents, Sale Prices
Incomes
1. Buy 2. Explotation 3. Mainteinance 4. Sell
Expenses
2 Costs, specially funding, capex, opex
IRR Decrease!!
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ASSET ALLOCATION
• Another critical part of learning how to start a real estate portfolio is asset
allocation. For investors, this includes determining the appropriate asset
allocation model for your goal. Although a complicated task, real estate
investors will need to select a combination of assets that not only have the
highest probability of meet their goals, but also doing so at the level of risk they
desire.
• As mentioned earlier, the appropriate asset allocation will take into account
your overall strategy, as well as risk tolerance.
• Investors will need to participate in riskier investments to achieve those results,
while others seek safer bets, by passing bigger gains for consistency. That
said, the more risk you’re willing to take on, the more aggressive your real
estate portfolio will be, and vice versa.
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ASSET ALLOCATION
+215%
Average 4th
position
Source: Annual Callan Periodic Table of Investment Returns
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ASSET ALLOCATION
+4,3% last 10 years
Average 4th position
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The Four Quadrants
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The 4 Quadrants
• Capital markets are markets for buying and selling equity and debt
instruments.
• Capital markets channel savings and investment between suppliers of
capital such as retail investors and institutional investors, and users of
capital like businesses, government and individuals.
• Capital markets are key to the functioning of an economy, since capital
is a critical component for generating economic output.
• Capital markets include primary markets, where new stock and bond
issues are sold to investors, and secondary markets, which trade
existing securities.
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The 4 Quadrants
• A classical approach to the real estate capital markets considers a
simple “debt” and “equity” construct “4 quadrants of capital”
• Credit ratings are a very important part of the credit markets and are
used by investors; issuers; commercial banks; investment
banks/broker-dealers; government agencies
● Mortgages ● Real Estate investment
● CMBS Public Private
● Private equity
debt debt
● CDOs ● REITs
Advantages Disadvantages Public Private Advantages Disadvantages
equity equity
• High liquidity • High volatility • High leverage • Low liquidity (private)
• High transparency • Less leverage • Custom strategies • Bigger capital investment
• High diversification • High diversification • Low volatility • Long inv. periods
• High degree of income • Difficult to project • Difficult to customize
• Risk selectable (defaults and prepay)
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What drives capital to real estate?
• What influences capital or “funds flow?
–Return on Alternative Investments
–Inflation Expectations
• How does inflation impact commercial real estate?
Treasuries yields and debt costs
Capitalization rates / valuation Interest rates
Equity yield requirements
Operating costs
Inflation Real Estate
Demand for space; tenant credit
“Real estate stocks not only offer diversification to your
portfolio, but are also a strong inflation hedge”
https://www.entrepreneur.com/article/374985
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Proptech
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What is Proptech?
• Proptech, short for "property technology," refers to the use of technology and
innovation to transform and improve various aspects of the real estate industry.
It encompasses the application of digital tools, software, and data analysis to
streamline and enhance processes related to property buying, selling, renting,
managing, and investing.
• Proptech solutions can be diverse and cover a wide range of areas within the
real estate sector. Some key areas where proptech has made an impact
include:
• Building Information Modeling (BIM):
BIM involves creating digital SMART • Online Property Marketplaces
representations of buildings REAL • Crowdfunding and Peer-to-Peer
• Drones: Unmanned aerial vehicles ESTATE (P2P) Lending
(UAVs), or drones, are used in • Real Estate Investment Platforms
construction for site surveys • Blockchain and Smart Contracts
• Robotics and Automation: Robotic • Automated Valuation Models
systems are employed in construction for
tasks PROPTECH (AVMs)
• Mortgage Technology (Mortech)
• Augmented Reality (AR) and Virtual
Reality (VR): AR and VR technologies CONTECH
provide immersive experiences,
• IoT: IoT devices, such as sensors and
FINTECH
wearables, are used in construction to
collect real-time data
• Artificial Intelligence (AI) and Machine
Learning (ML): AI and ML algorithms can
analyze vast amounts of construction data
to optimize project scheduling, predict
potential risks, and improve decision-
making processes.
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What is Proptech?
Project & Asset Transaction
Financing Construction Management Utilization Solutions
Proptech has facilitated Technology has improved This category includes It includes property
innovations in property Platforms for property management any type of technology marketing solutions,
financing, such as architectural planning processes through the adding value to the website designers,
online mortgage lending and designing. Most development of software properties like smart expense
platforms, crowdfunding of them can create 3D and applications that locks, community WiFi
automate tasks such as management and
for real estate projects, floor maps and other programs, budgeting software.
and digital property tenant screening, rent
visualizations. collection, maintenance marketplaces, listing Every technology
investment platforms Robust HR tools help channels, Global
that allow individuals to requests, and lease used for promoting
invest in real estate with manage projects and management. IoT devices Distribution Systems and managing
smaller amounts of workforces. can also be integrated into (GDS), Online Travel transactions comes
capital. properties to monitor and Agencies (OTAs) in this category.
manage energy
. consumption, security, etc.
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Investing in Proptech: MAIN DRIVERS
• Investing in proptech can be a lucrative opportunity, as the real estate industry
is rapidly evolving through technological advancements. Many opportunities will
be coming from startups and is key to identify real market needs, size, and
scalability
• Here are some tips
1. Effective Partners
Trust is key. And in verifying partners of their effectiveness, you have a
proven measure of the success of their products. The industry is a novel
one, flooded with start-ups and new players, each seeking to outshine their
counterpart. By investigating the backgrounds and merits of start-ups, you
can gain a scope of their expertise and potential. Many of the most notable
enterprises have the backing of major software houses, thereby taking
advantage of years’ experience in the technology scene.
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Investing in Proptech: MAIN DRIVERS
2. Recognize Needs, then Purchase – Not Vice Versa
Key factors are; the number of tenants, geography, types of tenant
companies, and their workday structures.
3. Strategic view rather than tactical
Proptech investments often require a long-term perspective. Many
companies in this space may need time to scale and reach profitability. Be
patient and consider the long-term potential of your investments rather
than expecting immediate returns.
4. Prioritise Big Data
Data is one of the most valuable assets. With Big Data analytics, a
property manager gains understanding to are in facilities usage, frequency,
degrees of use, and apply through endless business scenarios. That level
of sophistication brings insight to decision-makers in ways more intricate
than ever before.
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Investing in Proptech: MAIN DRIVERS
5. Assess scalability and market fit
Consider the scalability of the proptech solution. Evaluate its potential for
widespread adoption and the ability to enter new markets. Look for
companies with a clear product-market fit, strong growth potential, and a
solid plan for scaling their operations.
6. Stay updated on regulations
Understand the regulatory environment surrounding proptech. Keep track
of any legal or compliance requirements that may impact the sector.
Compliance with regulations such as data privacy and security is crucial,
especially with the increasing use of sensitive data in proptech.
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Thank you very much
rknop@faculty.ie.edu
📨 roberto@knop.es
www www.knop.es
www.linkedin.com/in/RobertoKnop
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