Real estate as an Investment tool can take on many forms. Investors have a choice as to whether to invest directly in physical property or indirectly expose their portfolios to real estate publicly traded securities.
The former is a popular investment strategy in Malta that sees a good part of locals investing in physical properties and renting them out to benefit from rental income.
This approach requires active management and investors must commit to ongoing decisions, particularly relating to a property’s maintenance and sale (if any).
The more passive investor doesn’t have to invest the sizeable amount required for a property purchase. With real estate publicly traded securities, investors can invest amounts of different sizes and gain indirect exposures to real estate markets via shares in real estate investment trusts (REITs), through mortgage-backed securities (MBS) or directly in property related debt or equity instruments.
REITs are basically tax-exempt real estate funds at a corporate level. The underlying assets can take the form of equity or debt depending on the fund management’s decisions to invest in physical property or mortgages.
Focusing on the mortgage-backed security (MBS), the underlying assets are a pool of mortgages. Therefore the coupon received on an MBS is derived and dependent on the underlying mortgage cash flows.
The 2008 meltdown in the US housing market, despite regulatory weakness in the US economy, was the result of increased defaults on underlying mortgages following interest rate hikes in mid-2006.
Collaterised debt obligations (CDO), a more complex form of MBSs, sold in tranches (depending on mortgage ratings attributed by regulators), were hardly hit when interest rates reset in 2006. The lowest tranches - the mortgages with the highest default probability and largest coupon, were first to experience a rise in defaults as most of the underlying mortgages were tied to variable interest rates.
A lot has been done to improve regulation in monitoring MBSs and CDOs since 2008 and the US housing market has since marginally improved.
Real estate value is directly correlated to inflation. Hence, should equities and fixed income securities fall in price with further US Federal Reserve rate increases, holding direct or indirect real estate exposure in a portfolio is a good means of diversification.
With a 32.4% chance of a rate hike in the eurozone by end 2017 (Bloomberg data), rates are still low enough to support increases in building permits and housing starts complimented by higher real estate prices through rising inflation. The same may not persist in the US, whose surging economy has already seen strong performance in the housing market. Investors have in fact priced in a 100% probability of a June US Federal Reserve rate hike, on the back of strong recent economic data and three previous rate hikes in 2015, 2016 and March of 2017 respectively.
Investing in REITs, CDO’s or MBSs may yet again be an option to consider in the US, yet in the Eurozone, until an ECB rate hike occurs it would be best to consider these assets only when continued increases in inflation, consumer confidence and positive economic data are recorded.
Disclaimer: This article was issued by Mathieu Ganado, Junior Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt .The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri Investment Services Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.