Investing in Real Estate: BC/AC

Abstract

Real estate, as the largest asset class globally, and the most visible proxy for the wealth of nations and of its main cities, is in a state of turmoil, with lots of uncertainty in world that will be marked by the most accelerated and profound recession in recent history—for most countries, the only comparable time dates back to the Great Depression of the 1930s and for others to the impact of the two world wars. Such is the water shedding impact of the pandemic that we could venture that for real estate—and for investing in it specifically—there will be a “before COVID” time and an “after COVID” one, with the all known unknowns that for sure will impact cities and their real estate and infrastructure with them. In order to understand what the future of real estate investing could be, in an “after COVID” world, it is useful to reconsider what was driving value and investing in a “before COVID” world, also on the basis of what we have been discussing so far on the future of cities. As a start, real estate investing is, as all other forms of investing, all about comparing a cash-out (a price, or the investment to be done on day one) with the net present value of all future cash-ins coming from the invested asset. Eventually, also a real estate asset can be evaluated on the basis of a discounted cash flow and taking into consideration a proper discount rate (associated with the level of riskiness of the specific investment, on top of other considerations regarding the prevailing risk-free rate of the economy and the risk premium the market would pay for macro asset classes, such as equities versus bonds, or real estate versus bonds). If also real estate can be associated with discounted cash flows, a good proxy for future payments is the attainable rent—hence rent over price (as a perpetuity) is a first index (or “rule of thumb”) that could be used to estimate the value of the investment. If this “rent/price” ratio could be associated with the expected return offered from the supply side of real estate assets, two other common ratios could be effectively describing the willingness to buy on the demand side and their relative price inelasticity given limited supply, as shown (through regression analysis applied to real estate historical series) in Table 7.1.