The Law of Gravity in Real Estate Investment

A tip for real estate investors everywhere.

I call it: The Law of Gravity – namely, that investment returns tend to revert to their long term average over time.

Real estate is a non-productive asset – and thus its value is largely a function of the economic and social activity that surrounds it.

In the long term, returns from commercial property will be driven mainly by GDP growth (circa 3.5%), population growth (circa 2.0%) and inflation (circa 2.5%).

So, in Australia at least, commercial property that has not been substantially improved should – in the long term and on average – generate an unlevered return of circa 8.0% pa.

So what?

Well, if you are looking to acquire a particular commercial property, it pays for you to research when and for how much the current owner bought it for, the net income derived over the holding period, and thus the approximate unlevered return for the vendor.

According to the Law of Gravity: If the vendor has made 12% pa unlevered returns over say 8 years, odds are the next 8 years will average 4% pa, so that the average of 8% pa continues to hold true.

So the next time you are acquiring a property, ask yourself: is the vendor getting rich selling this to me? If so, think twice before you buy.