Strategic considerations for real estate investment

From freehold to sub-tenant

The typical investment cycle: with typical real estate projects, the goal is to obtain a return from some form of working with a piece of land. In the simplest case, this can be a piece of forest. You wait until trees have grown enough in 50 years to clear them, cut them into planks and build houses from them. Or it could be a piece of land created by constructing a high-rise building on top of a motorway; then the individual apartments are rented out or sold. From the perspective of a professional Monopoly player, this is the typical cycle of purchase, development, construction and sale, although in practice, this cycle is far more complex.

In real life, the purchase is preceded by a long search for a suitable property, securing its purchase through options, a comprehensive due diligence process, market monitoring and raising the necessary funds for both the purchase and the construction. The development itself is also carried out with a high degree of division of labour. In addition to numerous experts from the GGI network, such as lawyers specialising in real estate and public law, the developer employs specialists in tax and legal matters for financing issues and questions of capital market law; furthermore, architects, often lobbyists (especially when it comes to rezoning) and a team to support and organise investors, construction companies and brokers. At the end of the day, it is the coordination of this very differentiated cycle and the many, many players that one has to keep an eye on, that distinguishes the successful from less successful real estate investors. Whereas 10- 15 years ago, it was relatively easy to get hold of land anywhere in the world, this market has now turned around completely. At least before 2008 and also in the period up to 2010, it was a buyers’ market. Buyers with some liquidity and good bank contacts could easily buy real estate. Today an investor needs much, much more liquidity at the beginning of a project due to immensely increased equity requirements.

The inflation issue

Land as a commodity is becoming exponentially scarcer for two reasons: between 2010 and 2020, the world population increased from 6.9 to 7.8 billion (click here for source). At the same time, efforts are being made worldwide to counteract exponential land sealing, which has resulted in less and less cultivable land for more and more people.

Land, especially cultivable land, can thus be seen as a finite resource. It can be compared with other finite resources such as gold, rare earths or fossil raw materials.

If we now consider the aforementioned cycle in a very simplified way – purchase, development, sale, proceeds – it quickly becomes apparent that these proceeds will only become a true profit if the investor succeeds in making a covering purchase from that profit in the DACH region. A real estate developer’s typical project profit ranges between eight and twelve percent. Every strategic investor will therefore have to consider whether this profit might not completely be eaten up by price increases in this segment within a typical development period of two to five years. Indeed, housing inflation is significantly higher than consumer price inflation. In the years 2010 to 2020, it amounted to around 7% p.a. in Austria, compared to 2% p.a. for consumer prices.

In the next part of this series of articles, we will analyse why this problem in and of itself can also be a tremendous opportunity.

---

Photo: Jürgen Fälchle - stock.adobe.com