How to model real estate investment returns

How to model real estate investment returns

Here I take a look how I set up my real estate investments to Adaquant Asset Allocation Suite.

The estimated return and volatility in the Adaquant estimates file is for unleveraged real estate investments and for price appreciation only.

What does this mean in practice? A good rule of thumb is that on average, the prices of residential real estate increase long-term together with the inflation. However, this is not the whole return that the real estate investor gets. In case of buying own home, there may be benefits of owning the property versus having to rent a similar property (i.e. all costs of owning the property are less than the estimated rent for the property). In case the property is bought and rented, the benefit is the collected rent minus all costs.

Real estate investments are usually leveraged. This means that the investor only needs to pay certain amount of the buy price, the equity, and get a mortgage to finance the rest of the investment. Leverage increases both the return and volatility of the investment.

The estimated return and volatility of the real estate investments are property specific. Therefore one needs to have some way to estimate the returns, hopefully already good time before the investment is made. I myself use an Excel file to gather all information on income and costs of the real estate investment to estimate the returns and volatility of the investment. You can download the Excel template I use from here: real_estate_return_calculation.xls.

You should amend the template in order to corporate all relevant information of your specific real estate investment. After all information is put to the template, it tells you the expected return (Cell B49) and your leverage (Cell B50). This expected return, in the example case 6.41% per annum, contains returns from both price appreciation and income minus costs. You should use this expected return as the estimated return in the Suite. The estimated volatility is the leverage * unleveraged volatility, in the example case 2.33 * 2.8% = 6.5% per annum.

If you have multiple real estate investments, you should calculate the equity weighted average return and leverage of your investments and use those to set the estimated return and volatility in the Suite.

By |2018-08-01T09:40:50+00:00February 14th, 2018|