Every real estate investment’s performance is composed of a mix of equity-like and debt-like behaviors. From a character Asset Management standpoint, investment funding is composed of both private and public equity. It is the correlation of the debt and equity elements to the funding source that enables us to define the four dominant 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 character with short-term leases is pushed almost thoroughly by equity forces. The building’s value from an equity tranche perspective is a function of supply and need for space in a given market, at a given time. In-fact, the debt-to-equity composition for a character 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 character takes on a greater part of equity-like behavior and less of a part of debt-like behavior; and at the end of the triple-net lease, the character value is only affected by equity forces.
Commercial mortgages are utilized in character Asset Management to carve out the debt-like behavior from the character 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 character investment funding is composed of both private and public equity, investors typically define these debt and equity tranches with four dominant real estate investment structures:
* Private Commercial Real Estate Equity – held as individual assets
* Public Real Estate Equity – structured as character 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 shared set of influences in addition as to rare influences specific to each individual structure. It is the examination of debt and equity elements of each structure that enables character 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 elements for several different character investment objectives.