By: Nathan Metheny, Managing Principal/Co-Founder
1. Efficient vs. Inefficient Markets
The first major benefit of real estate investing, and commercial real estate investing in particular, is the difference between efficient and inefficient markets.
Efficient Market – a market in which all financial information is available to investors. All information is already incorporated into prices. This means there is no way to purchase assets at a discount because there are no under or overvalued securities available.
The stock market is a strong example of an efficient market. Investors know the value of each stock, and there is no legal way to purchase the stock below the established market price. Given this assumption, it is near impossible for an investor to produce a return above the average.
Inefficient market – A market in which the asset’s price does not always reflect the true intrinsic value. In this market, it is possible to “beat” the market and purchase securities at deep discounts. This, in turn, allows investors to experience large profit margins.
Real Estate is a prime example of an inefficient market. The purchase price of an asset is largely determined by what the Seller and Buyer agree on, having little correlation with the market at large. As such, it is possible, and legal, to buy real estate at a bargain price.
2. Considerable Influence on Asset Value
The second reason includes the considerable influence an owner has over his real estate asset. This is unlike owning stock, in which you are purely a passive investor with no control over the value. There are two major ways to exert this influence in real estate:
1.) Make capital improvements.
2.) Increase Net Operating Income (NOI).
When performing a valuation to determine the market value, the NOI is multiplied by a capitalization rate. This cap rate is determined by current market factors. If you were to increase the annual NOI by $60,000 with a capitalization rate of 6%, the value of your real estate asset would increase by a total of $1,000,000.
The third, not so obvious, reason is the ability to leverage your real estate asset.
Leverage – the use of borrowed money to increase an investors potential return.
Leverage is arguably the most powerful financial advantages of real estate. Leverage allows an investor to increase his cash-on-cash return and exponentialize his investment horizon. Within the stock market, an investor uses 100% of his money to purchase an asset. Whereas, compared to real estate, with the use of leverage, an investor generally uses 20% of his money to purchase an asset.
For example, an investor in the stock market purchases a portfolio of stocks for $100,000. With leverage, an investor has the opportunity to purchase a $500,000 asset with his initial investment of $100,000.
With the help of Wealthrise, you can make use of these benefits through investing in commercial real estate. Sign up for our monthly newsletter to learn more about the benefits of real estate investing and the many ways that you can get involved.
About the Author: Nathan Metheny is Co-Founder and Managing Principal at Wealthrise. In this capacity, his primary roles include acquisition supervision as well as setting the long-term strategy and trajectory for the company.