What are the three most important factors when investing in real estate? Take an informal poll and you’ll hear one answer over and over again—location, location, location.
But ask what’s the most important factor when investing in tech, energy, or any other sector and either they won’t know or they won’t agree. It’s only in real estate that we agree on the most important factor.
Would you buy real estate without considering its location? Of course not. When you bought your house, you cared about the street, the neighborhood—and of course the city! Location is the first and most important factor that you consider.
You might be wondering why we’d bother writing about a factor so well known. Here’s why: tens of billions of dollars are invested in real estate funds that ignore location. Your money might even be in such a fund.
If you wouldn’t invest in real estate without considering location, your fund shouldn’t either.
Did anyone you polled mention market cap as the most important factor when investing in real estate? Location, property type, and leverage, sure. But never market cap. Yet that’s how 99 percent of real estate ETFs are weighted.
Investors typically buy cap-weighted funds to obtain diversified exposure to a market or sector, and they’re sometimes a very efficient solution. We’re not always opposed to cap weighted, but we are when it doesn’t work. As we’ll see, real estate is such a case.
Cap-Weighted Geographic Diversification
There’s a second factor that must be included in an analysis of location: property type. We want our office holdings to be diversified by location, as well as our apartment, retail and industrial portfolios; it’s a separate exercise for each property type.
As an example, we’ll parse the Vanguard Real Estate ETF (VNQ), the largest real estate ETF with roughly $33 billion of assets.