Every real estate investment’s performance is composed of a mix of equity-like and debt-like behaviors. From a Property Asset Management standpoint, investment funding is composed of both private and public equity. It is the correlation of the debt and equity components to the funding source that enables us to define the four primary real estate investment structures.
Consider the case of a private real estate equity asset leased to a single credit tenant with a long-term triple-net lease. The payments on the lease resemble the fixed payments associated with a bond, not with equity. In-fact the value of the triple-net leased asset fluctuates in step with the same factors that influence the value of a bond or a mortgage, such as interest rate movements, inflation, and the credit worthiness of the tenant.
At the other extreme, an equity position in an empty, speculative multi-tenant property with short-term leases is driven almost entirely by equity forces. The building’s value from an equity tranche perspective is a function of supply and demand for space in a given market, at a given time. In-fact, the debt-to-equity composition for a property investment can change with time.
By way of illustration, take the triple-net lease in the first example. As the lease ages and approaches its expiration date, the property takes on a greater component of equity-like behavior and less of a component of debt-like behavior; and at the end of the triple-net lease, the property value is only affected by equity forces.
Commercial mortgages are utilized in Property Asset Management to carve out the debt-like behavior from the property investment. For example, the commercial mortgage-backed securities market carves up the cash flows from pools of mortgages to produce bond-like characteristics in the top-level tranches and more equity like cash-flow characteristics in subordinate layers. As property investment funding is composed of both private and public equity, investors typically define these debt and equity tranches with four primary real estate investment structures:
- Private Commercial Real Estate Equity – held as individual assets
- Public Real Estate Equity – structured as Property Funds or Real Estate Investment Trust
- Private Commercial Real Estate Debt – held as loans or commercial mortgages held in funds
- Public Commercial Real Estate Debt – structured as Commercial Mortgage-Backed Securities
These investment structures react to a common set of influences as well as to unique influences specific to each individual structure. It is the analysis of debt and equity components of each structure that enables property asset managers and their agents to effectively structure the portfolio to meet specific investment goals. In the next two articles, we discuss the debt and equity components for several different property investment objectives.