Alternative Methods of Real Estate Investment

I. Introduction

     The traditional real estate investment strategy of “flipping” properties, while potentially quite lucrative, has several shortcomings, especially for small-scale investors.[1] Alternative models that allow for investment in portions of a property may offer more flexibility to investors.[2] A particually interesting alternative could be the option to invest in an occupant’s debt through an equity re-sale agreement would offer further flexibility to investors preferring steady returns to potential sporadic payoffs.[3]

II. Background

     The real estate market has long been recognized as a source of investment opportunities.[4] Although there is some debate on the issue of which is better,[5] it seems that historically real estate investments bear returns at approximately the same rate as stock investments.[6] Additionally, the real estate market offers these advantages without the degree of risk inherent in investments in stock.[7]
     The traditional model for investing, however, is fairly limited, generally involving the acquisition of properties in the hope that they will appreciate and be resalable at a profit. This model, while viable in certain situations, is, for several reasons, fairly restrictive in scope. First, although there are always attempts to avoid the necessity of starting capital,[8] this model greatly favors those individuals with substantial funds available for initial investment. Second, this model requires the concentration of risks in certain properties.[9] Third, this model is only viable in a bull market.[10]

III. Discussion

     An alternative model of real estate investing could allow individuals to purchase portions, much like shares, of a property rather than the entire parcel. This method could take at least two forms, each of which would alleviate much of the restrictions inherent in traditional real estate investing discussed above.
     In one form, investors could simply purchase a certain percentage of a property, as they would purchase a certain percentage of ownership in a company through stock purchase. This percentage could be retained or resold at an adjusted rate dictated by market forces of supply and demand. This model would reduce the first two restrictions imposed by the traditional model of investment by reducing the amount of initial capital necessary to invest and allowing for the diversification of risk over a greater number of properties. As in the traditional model, however, absolute profits could only be realized in a bull market.[11]
     A second, more deviant, form of investing in portions of a property interest could allow investors to purchase portions of an owner’s debt. That is, investors could extend a loan, much like a mortgage, to a prospective purchaser in exchange for an agreed upon interest rate. As in the former model, investors would own a share of the property. Instead of waiting for it to appreciate before selling, however, they would gradually sell it back to the occupant at a specified rate of interest. Instead of potential windfall profits, this option would offer a steady stream of income at a given rate. Additionally, as investors would have an equity interest in the property until the loan was paid off, a default would not result in heavy losses.
     If an investor wished to withdraw their money, they could resell their share of the debt to another investor at the same or a different interest rate.[12] Interest rates could be set through an auction system facilitated by a third party (such as a web site) who would keep a small share of the proceeds from each transaction. Such formats already exist.[13] Adapting such a format to real estate loans would be relatively simple. Transacting deals over the internet would allow investors a wide geographic range of properties.[14]
     In addition to offering investment opportunities for lenders, diversifying the home finance market into the hands of a large group of individuals rather than a few large companies could help avert the financial havoc caused by mishaps such as the recent subprime collapse.[15]

IV. Conclusion

     Greater flexibility in real estate investment options would allow investors to choose those opportunities best suited to their individual situations and objectives. Exploration in to the provision of such options, like those discussed above, seems worthwhile. Whether such investments would be preferable to traditionally available options in the long-term would be determined by market forces. Perhaps the surest winners would be those who facilitated such investments. Through the use the internet, this could be done with little overhead and assured commission profits on each transaction.

Sources:

[1] See infra Part II para. II.

[2] See infra Part III.

[3] Id.

[4] See e.g., C. F. SIRMANS, THE COMPLETE REAL ESTATE INVESTING HANDBOOK (3rd ed., 1985).

[5] James Raynor, Returns on Real Estate vs. Stock Market, http://ezinearticles.com/?Returns-on-Real-Estate-vs.-Stock-Market&id=639801 (“There is always going to be debate amount investors over the returns on Real Estate vs. the Stock Market”).

[6] Id. (“When you take a look at the average return on investment (ROI) figures for the modern era from 1926 to 1996, you find that it is pretty close to being a tie”).

[7] GARY W. ELDRED, VALUE INVESTING IN REAL ESTATE 101 (2002) (“[D]ownward price swings in real estate occur far less frequently and with far less severity than in stocks”)

[8] See e.g., ROBERT IRWIN, REAL ESTATE INVESTOR'S CHECKLIST: EVERYTHING YOU NEED TO KNOW TO FIND AND FINANCE THE MOST PROFITABLE INVESTMENT PROPERTIES 137 (discussing real estate options).

[9] Of course, large scale investors could diversify their investments by acquiring a variety of properties. Even still, each property requires a substantial investment and, correspondingly, entails a substantial risk.

[10] Bear markets might offer an opportunity to buy a property which would be retained until the market turned. Actual profits, however, can only be realized during periods of appreciation.

[11] Again, this is an oversimplification. Certainly profits can be made in all atmospheres. Generally speaking, however, this strategy would result in payoffs during periods of appreciation.

[12] This reference is to the interest rate between the original shareholder and the new shareholder. The occupant would continue to pay the originally negotiated interest rate.

[13] See e.g., Prosper Home Page, www.prosper.com (“Where people come together to borrow and loan money”).

[14] Of course, investors can currently buy properties online without physically going to the location. However, one would naturally be less inclined to invest in an unseen property that they were hoping to re-sell at a profit than one they were merely financing. Additionally, the fact that the occupant is seeking alone would itself be a strong assurance of the desirability of the property.

[15] Because losses would fall upon individuals with (one would hope) diversified portfolios who could weather the storm more deftly than companies specializing in a certain type of loan. See generally Gertrude Chavez-Dreyfuss, Dollar Sags on Subprime Troubles, REUTERS, http://www.reuters.com/article/hotStocksNews/idUST1346220070316?pageNumber=1 (discussing the effect the subprime crisis on the economy as a whole).

Comments

[cashflowCindy]

The general public does not understand the fees attached to Mutual Funds. If they do they believe its only 2-3% a year. Little do they understand this 2-3% is making the brokerage companies rich. Its time to get educated before handing someone over your protfolio and understand where the money is being invested. Would you hand the keys over to your $40K automobile?

[Cashflow Cindy]

This is a great time to buy Real Estate with all of the foreclosures. Never before have we had the wonderful opportunites to purchase Real Estate at such remarkable prices. Real Estate is a tangible asset vs. a stock. The issue with stock market investing is the layman does not read the financial statements of the companies they are investing their hard earned money in. Its usually on a Hot Stock tip or 401K. The 401K is a passive investment. They have no idea what kind of return they are getting or should be getting and are paying high fees from the mutal funds.

[Bobby Korey]

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[Bobby Korey]

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[Growth Stocks]

An stock investment service which offers advice should be thoroughly evaluated for its level of support provided and investigated for the integrity of its communications.