Thread by @TihoBrkan

1/ I get a lot of questions about real estate, especially in direct messages. The majority of the questions talk about investing in a unit & renting it out for the next 10 years.

That is a beginner thinking process & not what real estate investing is about.

2/ The other popular thought is RE is all about location, location, location. Yeah ok. We understand the location is important. Very important.

But that's not it. It's far more complicated. I would argue you should think about it from three different angles.

3/ These three sections of real estate are:

• type of real estate (residential, retail, office, hospitality, industrial, mixed-use, etc)

• real estate strategy (core, core+, value add & oppertunistic)

• capital exposure (common & preferred equity, mezzanine & senior debt)

4/ Therefore, your investment objective can be as unconstrained as mine is, or very specific & disciplined so that you can achieve your financial objectives where both the risk & return parameters are met.

Let me give you some basic examples so you can stop thinking about...

5/ ...real estate as in buying a unit & renting it out. That plain-vanilla strategy will surely disappoint you.

Example one: You might focus your capital only on commercial real estate types (such as office and/or retail). Your strategy is lower risk, therefore you only...

6/ ...entertain the core & core plus strategies. These properties are already in good condition, with contractual tenants meaning: already cash flowing.

Your return will mainly come from income, while there is some market appreciation possible. You've also decided for...

7/ ...prime locations only, therefore the entry costs will be higher while yields/CAP rates will be lower. However, these properties are also more stable & have much lower volatility.

One partial reason for this is you've opted for a deal that has a 60% loan to value ratio...

8/ ...or lower. This ensures lower volatility, low DCR (debt cover ratio) needs, lower overall return but also a higher equity investment (down payment) so that you receive more protection & stability.

I could go on & on, but you get the point. Now let's look at another example.

9/ Example two: Someone else might focus their capital on residential real estate (in this case multifamily).

Their strategy is much higher risk as they are interested in earning a meaningful return with their projects.

They opt for an opportunistic strategy.

10/ This basically means they will be developing land into a residential building or completely rehabbing or even demolishing an old building & building a new one.

There are all kinds of additional risks associated with this strategy, on top of the micro & macro conditions.

11/ Because there is some solid construction work going on here, clearly there are no tenants & therefore no income. The overall return potential comes from capital gains at the exit, not from the income.

There is also an additional possibility that the market appreciates, too.

12/ Please consider this 2nd point a little further. Unlike the stock market, real estate can appreciate in two ways.

Either through natural market forces where supply & demand might be out of balance; or secondly through forced appreciation by improving an existing property.

13/ The majority of the time CAP rates will not concern you here. It will be more about the GDV (gross development value), the LTV leveraged used, the cost of construction per m2/sqft and many other elements.

Developers usually hold common equity exposure, which means they...

14/ ...have the highest risk, but also the highest return. It is common for a solid developer, with a constant track record to be able to make around 20% to 30% IRR (meaning annualized internal rate of return) over 2-4 years of the project length.

That basically means a double!

15/ You could partner up with the developer on the equity side, but you also have an option to invest in any of the other capital stack positions. These might be:

• senior debt
• mezzanine debt
• preferred equity

16/ Each of them have their advantages & disadvantages. They all have various risk & return differences, suiting investors with all kinds of risk appetite.

Each of the exposures also outperforms during one part of the investment cycle and underperform during the other.

17/ In summary, think about real estate from three different angles — type, strategy & exposure — as you create your strategy and attack different parts of the business cycle for maximum return with minimal risk.

Assuming we are in the late stages of the investment cycle, the...

18/ ...question I might get asked next is: what am I focusing on right now?

Type: residential, hospitality (we have both right now)

Strategy: core plus, value add & opportunistic (we have all 3 right now)

Exposure: senior debt, mezzanine debt & equity (all 3 in play right now)

19/ Final word of caution:

The equity deal I purchased for an incredible discount in the best location possible (most expensive street in downtown). Even if the property prices fall 20% or so, I'll break even. I have an ability to do a value add, forcing the price higher.

20/ If that wasn't the case (meaningful margin of safety, purchased way below market value) I would not be doing equity deals right now. Especially opportunistic deals.

The main focus should be core & core plus, cash-flowing properties, with low LTV & senior debt exposure only!