At LEX, our mission is to empower wealth creation by solving real estate’s access and liquidity problems. The LEX platform can be a great tool for investors to broaden their investment portfolio beyond just stocks and bonds via access to real estate assets that were not accessible in the past.
Investing in real estate can help you create wealth and generate income in several ways:
1. Appreciation. Like stocks, real estate can increase in value. (Also like stocks, real estate can decrease in value.)
2. Income. Like bonds, real estate can pay you income, consisting of your share of income derived from the rent received from tenants. (Unlike bonds where all income is contractual, rental revenue is only promised for the duration of each lease, so income may be reduced if any vacancies occur or to cover other expenses. Real estate income based on equity investments is also junior in liquidation preference to bonds.)
3. Leverage. Because most real estate properties use mortgage debt, equity holders’ gains are magnified by the leverage ratio of debt to equity. For example, if a $10M building with a $6M mortgage, and $4m of equity, increases in total value by 10% (from $10M to $11M), the value of the equity holders’ interests increase by 25% (from $4M to $5M). (The same effect can also magnify losses.)
4. Amortization. As the mortgage debt is paid down over time, the value of the equity holders’ interests increase by the amount of principal repaid even if the value of the building as a whole stays the same. For example, if the $6M mortgage debt is paid down to $5.5m on the $10M building, the value of the equity holders’ interests increase by 12.5% (from $4M to $4.5M) even if there is no change to the value of the building at $10m.
5. Fixed-Rate Refinancing. Because mortgages are often fixed-rate, and mortgage payments typically consume a large portion of the building’s revenue before income distributions are made, equity holders can increase the amount of their income distributions by seizing any opportunity to refinance the mortgage to a lower fixed rate.
6. Lower Volatility. The underlying value of a real estate asset tends not to change much in the short term. This can be very attractive to investors who may want to diversify a portion of their investments away from volatile stocks and alternative investments.
7. Inflation Protection. When consumer prices go up, the value of many assets do not, resulting a loss in real value. But rent prices have historically also gone up when consumer prices go up, meaning that real estate values typically keep pace with inflation.
8. Tax benefits. Direct investment into real estate is more tax efficient, compared to non-real estate investments and most publicly traded REITs. The tax code allows real estate investors to both defer when their taxes are due and to classify a portion of what might otherwise be treated as income as capital gains, which are taxed at a lower rate. Registered publicly traded REITs may be more liquid than direct investments. Additional details available here. Publicly traded REITs are typically more liquid than direct investments in real estate.
LEX Markets offers unlisted equity securities issued by commercial real estate owners. Investments in real estate are subject to risks including fluctuations in rental rates, changes in the terms and availability of other financing supporting the property, changes in taxes, environmental and zoning laws, reduced tenant demand, and others. Investors must be prepared to bear the economic risk of such an investment for an indefinite period of time and be able to withstand a total loss of their investment.
August 12, 2022
The goal of this article is to offer practical guidance on how to begin building a real estate portfolio, and how the risk and return profiles of different assets fit together.