Alternative Investments; Part 2: Categories of Alternative Investments (Part 1)

Sequel to the article published last week which covers the general overview of alternative investments, this article is to explain the categories of alternative investments.

As previously established, alternative investments are less regulated and less transparent than the traditional investments. Also, they have relatively low correlation of returns with the traditional investments. Alternative investments comprise real estate, commodities, private equity, hedge funds, mutual funds, exchange-traded funds (ETFs), infrastructure, e.t.c. This article will focus one of these categories (Real Estate) while other categories will be discussed in subsequent articles.

Real estate investments may be in buildings and/or land, including timberland and farmland, either directly or indirectly. Investing in real estate can be in a variety of forms. It could either be debt or equity based, or in private or public markets. The investment capital to finance the real estate property could either come from debt financing or equity financing. A popular form of financing real estate properties using debt is mortgages.  Equity form of financing is through direct ownership of the real estate property. The ownership could be through sole ownership, joint ventures, or real estate limited partnerships.

Real estate properties, in this context, may be classified as either residential or commercial. Residential properties are owned solely for the purpose of the investor residing in them. This is considered an investment to the owner as they will no longer have to pay rent. Commercial properties are owned with the intention to let, lease or rent them either to other residents or commercial users (who use them as offices, retail stores, industrial warehouses, hotels, e.t.c. Commercial real estate properties generate their returns from income (e.g., rent) and capital appreciation (in situations where you purchase them to sell at a later date).

Real Estate Investment Trusts (REITs) are publicly traded shares of a portfolio of properties. This form is one of the easiest ways to make real estate investments without acquiring a physical property. REITs are regulated by the Securities and Exchange Commission (SEC). This form of real estate investment is a form of collective investment scheme, which pulls funds from multiple investors and uses them to acquire income-generating real estate. The portfolio of the underlying assets is managed by a professional whose job is to maximise your returns. With REITs, an investor holds an indirect interest in real estate. REITs are also traded on the Nigerian Stock Exchange (NSE) hence, to buy one, you have to go through a stockbroker. This is similar to buying or selling shares.

There are several benefits of investing in real estate:

  1. It helps you build an equity for the future.
  2. The value of real estate properties appreciate over time.
  3. Potential to provide an inflation hedge if rents can be adjusted quickly for inflation.
  4. Tax benefits.
  5. It can be used to generate passive income and cash flow.

It is imperative to understand that real estate, like other investments, may fail to perform up to expectations. The value of the real estate property is subject to variability based on national and global economic conditions. Investments in distressed properties are subject to greater risks than investments in properties with stable operations. Hence, due diligence is required when making real estate investment decisions. It is important to conduct proper research before buying a house, taking a mortgage or investing in real estate in general. Several questions should be asked about the risk and expected return. Be certain that you are not investing in properties that are non-existent or have been sold to other investors. Ensure to document every important milestone and get a legal backing.

We hope this article has been able to feed you with helpful insights on real estate investments in a bid to enable you take better and informed investment decisions.

Thank you for reading.

Stay tuned.

References:

Nnabeze, T. (2019, June 30). Nairametrics. Retrieved from nairametrics.com/2019/06/30/what-you-need-to-know-to-start-making-real-estate-investments/

Duhon, T., Spentzos, G., & Stewart, S. (2020). Introduction to Alternative Investments. In CFA Program Curriculum Level I (Vol. 6).

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