Real Estate Entrepreneurship

Real estate entrepreneurship can be very profitable, but it also involves many risks. In developing countries, real estate development and real estate transactions are highly regulated and very involving; these factors have led to the evolution of a very sophisticated and dynamic industry sector. The high cost of most real estate transactions has led to the creation of various forms of financial support and investment through a range of public and private means.

Keywords Corporate Venturing; Entrepreneur; Entrepreneurship; Investment; Leverage; Real Estate; Real Estate Entrepreneurship; Real Estate Investment Trust (REIT); Strategic Renewal; UPREIT

Entrepreneurship > Real Estate Entrepreneurship

Overview

Entrepreneurship is a factor of production, risk-taking, and innovation. In macro terms, the term "entrepreneurship" is synonymous with the advancement of an economy, and in micro terms, it refers to the process by which an individual or organization pioneers, innovates, and takes risks for growth and development. Although there is no universally accepted definition of entrepreneurship, it is widely accepted that entrepreneurship encompasses acts of organizational creation, renewal, or innovation that occur within or outside an existing organization with the hope of making a profit (Sharma and Chrisman, 1999; Stanford Online, n.d.).

There are two types of corporate entrepreneurship: strategic renewal and corporate venturing. Strategic renewal refers to the corporate entrepreneurial efforts that result in significant changes to an organization's preexisting business or corporate-level strategy or structure. Corporate venturing, on the other hand, refers to corporate entrepreneurial efforts that lead to the creation of totally new business organizations within preexisting corporate organizations (Sharma and Chrisman, 1999).

Entrepreneurs are individuals or groups of individuals acting independently or as part of a corporate system who create new organizations or instigate renewal or innovation within an existing organization (Sharma and Chrisman, 1999). Entrepreneurs carry out new business permutations out of a quest for growth through innovation and increase in profit.

In most societies, rich or poor, a significant fraction of the total wealth is in the form of land and buildings. Dealing in real estate can be very profitable due to factors such as the rising demand for property, which is a result of worldwide population expansion, growth in specialty real estate, and property appreciation. Buying property can be a wise strategy for entrepreneurs who have money to invest and are looking to diversify. Interestingly, the largest number of millionaires in the period after the Second World War made their money from real estate development (Hayes and Harlan, 1968).

Real estate can be defined as land, together with land improvements. Land improvements refer to anything permanently fixed to a piece of land, as well as items attached to structures on the land, including buildings, fences, and things attached to buildings, such as plumbing, heating, and light fixtures. Real estate is also known as "realty" or "real property" and excludes personal property such as furniture and draperies, which are not fixed to land or land improvements.

In the United States and in many developed countries, the sale and lease of real estate are major economic activities and are heavily regulated by laws to ensure that property sellers are licensed, and home buyers are protected. Legislation also regulates property development in general, taking into consideration issues such as health, safety, and zoning.

The two major types of real estate entrepreneurship are commercial and residential real estate entrepreneurship. Commercial real estate entrepreneurship involves the sale and lease of property for business purposes. Residential real estate entrepreneurship involves the sale and rental of land and houses to individuals and families for daily living.

Other types of real estate include Internet real estate and luxury real estate. The term "Internet real estate" has been used to describe the use of the Internet to promote, advertise, and view commercial and residential real estate for lease or purchase; this term has also been used to describe revenue-generating online properties such as domain names or websites.

"Luxury real estate" describes land and land improvements in prime locations, often with special views or amenities such as proximity to golf courses, school districts, and the downtown district. Along with higher prices, luxury real estate entails greater responsibility for those who handle transactions than ordinary real estate.

The real estate sector is composed of many distinct fields of specialization, and this has given rise to several categories of entrepreneurs. These include appraisers, who offer professional valuation services; brokers, who assist buyers and sellers in transactions; developers, who improve land for use by adding or replacing buildings; property managers, who manage properties for their owners; real estate marketers, who manage the sales side of the property business; and relocation service providers. Some architects also double as real estate developers and undertake their own projects. Within each field, an individual or business may specialize in a particular type of real estate, such as residential, commercial, or even industrial property. In addition, almost all construction businesses have a connection to real estate.

A real estate developer, or property developer, is one who makes improvements of some kind to real property, thereby increasing its value. The developer may be an individual but is more often a partnership, limited liability company, or corporation. There are two major categories of real estate development activity: land development and building development (also known as project development).

Land developers typically acquire natural or unimproved land and improve it with utility connections, roads, earth grading, agreements, contracts, and entitlements (the right to develop land with government approval). Once these improvements have been made to the raw land, it is typically subdivided and sold piece-by-piece at a profit to building developers or individuals.

Building developers, on the other hand, usually acquire raw land, improved land, or redevelopable property to construct building projects. The buildings are then sold entirely or partly to others or retained as assets to produce cash flow via rents and other means. Some building developers have their own internal departments for designing and constructing buildings; this is more common among smaller developers. Others subcontract these parts of the work to third parties; this is typical of larger developers.

The real estate development process, though varying from project to project, roughly comprises the following phases: market research, site selection and feasibility analysis, due diligence and preliminary pro forma, property acquisition, project design and refined pro forma, obtaining of entitlements, financing and final pro forma, construction, leasing or sales, and operation (in cases where the project is retained as an asset).

The degree of hands-on involvement in real estate varies. Some entrepreneurs pay rental agents to fill vacancies and handle maintenance issues on their behalf. The rise of companies like Airbnb created an entirely new sector in real estate that saw companies act as online brokers for clients’ properties, charging a commission for their services (Investopedia, 2023). Others, who might enjoy the hands-on aspect of being a landlord, prefer to have more personal control of their investments. However, no matter the method or style of a real estate entrepreneur, they must consider and put into practice the entrepreneurial elements of organizational creation, renewal, and innovation to cope with challenges such as acquisitions and mergers, new competition, and emerging trends in technology, among others.

Real estate is, by its nature, an expensive non-liquid asset. Expense is high, a sale is difficult, and the return on investment is delayed. As such, compensation for entrepreneurial efforts in real estate is tied to uncertainty and profits. Risk and choice are key aspects of real estate entrepreneurship; the entrepreneur must understand risk, how to measure it, and how to weigh its consequences ("Real Estate Managers as Entrepreneurs," 1999). They also must understand the modern real estate market in which they hope to participate.

Buyers incur many additional costs over and above the sale price of a property. These costs usually include the cost of property surveys, appraisals, title searches, brokers' fees, and administrative and processing charges. In developed countries, most individuals, businesses, and small company buyers take out mortgage loans as capital to purchase and improve land and buildings. Real estate developers have to take care of the additional costs of any improvements (known as "hard costs") and the fees of various consultants (known as "soft costs") by themselves.

Further Insights

Steiner (2003) describes seven corporate identities among small real estate business companies. These are:

• Gamblers—This group of small businesses considers real estate to be a capital investment activity.
• Investors—This group of small businesses also considers real estate to be a capital investment activity.
• Service Managers—This group views real estate business as facilities management, an activity similar to other service industries, such as the hotel or restaurant business.
• The Family—This group focuses on managing the real estate's heritage.
• Serial Entrepreneurs— hese companies implement entrepreneurial ideas in the real estate business.
• Fast Growers—his group creates short-term success in projects that are later bought up.
• The Edge City Identities—This group also creates short-term success in projects that are later bought up.

Although the Serial Entrepreneurs are the group that manifests the most entrepreneurship qualities, all the other groups stand to benefit from entrepreneurship practice, be it in the form of strategic renewal or corporate venturing. Entrepreneurial companies are those who are most likely to gain an edge over the competition.

The entrepreneurial nature of those who deal in real estate is evident in diverse ways. For instance, using innovation and creative management, real estate entrepreneurs are developing alternative revenue sources from their properties through various means, including:

• Temporary seasonal or specialized tenants, carts, kiosks, and vacant spaces within shopping malls;
• Leasing incubator space and parking lot space for such uses as special events and seasonal sales activities;
• Innovative advertising, such as the leasing of advertising space on the side of a building or on a rooftop;
• Adding value to residential properties through technology: for instance, offering tenants high-speed Internet access, cable television, utility signups, bottled water, banking, concierge, and other services;
• The management of specialty niche property, such as office-to-residential conversions;
• The management of parking facilities, like structured parking garages that are adjacent to an office or residential property, special event parking, and church parking facilities that are underused on weekdays;
• Medical buildings, church facilities and campuses, marinas, and self-storage facilities ("Real estate Managers as Entrepreneurs," 1999);
• Purchasing a property with the sole intent of listing it on a website like Airbnb or Vrbo.

Entrepreneurship is also evident in the financing choices and activities of the real estate entrepreneur. There are many ways to finance a real estate entrepreneurship project, and most of the financing arrangements fall under one of the following broad categories:

• Private investors (pension funds, insurance funds, wealthy individuals, joint ventures, and so on);
• Public investors (REITs, share offerings, public-private partnerships, and so on);
• Private debt (individual loans, bank mortgages, construction loans, and so on);
• Public debt (redevelopment loans, and so on);
• Private grants (non-profit target grants, and so on);
• Public grants (anti-blight subsidies, affordable housing credits, tax incentives, historic preservation grants, and so on);
• Equity financing (use of cash flows from other projects owned by the developer);
• Subordination (establishment of priority of one claim or debt over another).

Because the amounts of money involved in real estate dealings are usually very large, many entrepreneurs—individually and in group—use other people's money to invest in real estate investing. Most real estate development projects are financed with a large amount of debt leverage or leverage financing. Leverage is the use of credit or borrowed funds to improve one's purchasing power and increase the rate of profitability of an investment. With leverage, the investor pays only a small percentage of the purchase price in cash, with the balance supplemented by borrowed funds, to generate a greater rate of return than would be produced by paying primarily cash for the investment.

The leveraged investor builds up equity or ownership in the investment by making payments on the amount of principal borrowed from a third person. It is possible to create added value and obtain additional loan proceeds, some of which may be tax-exempt. By applying more debt to a property, when it sells, the gain is less, and the taxable amount is less due to the payoff of the loan (Haginas, 2006). As with most deals involving money, there are risks involved with financing, such as being over-leveraged.

The literature on real estate investment often features Real Estate Investment Trusts (REITs). A REIT is a company that purchases and manages real estate or real estate loans using money invested by its shareholders. It is an investment trust that owns and manages a pool of commercial properties, mortgages, and other real estate assets; shares can be bought and sold on the stock market.

The REIT concept was launched in 1960 with the aim of helping small investors overcome potential liquidity problems when putting money into commercial real estate properties. The emergence of these trusts was encouraged by making them free from income taxation at the enterprise level. Many modern commercial property markets are dominated by REITs, which have evolved into more aggressive entrepreneurial organizations.

REITs are traded on the stock market. Although they have at times outperformed company stocks and are much more liquid than private real estate, they do not use as much leverage. Managers of REITs generally put more money down when buying property, so they do not give investors as much return for their money.

UPREIT, which became popular in the 1990s, is a variation of REIT which captured the attention of many real estate owners. An UPREIT is a REIT formed by combining properties from existing limited partnerships. The original partners exchange properties held by the partnerships for an interest or operating units in a new transitional operating partnership. After a period, usually one year, the holder of the operating units may convert them to REIT shares and sell the REIT shares on the open market. The value of the operating units at the time of redemption will depend on the market value of the related REIT shares at that time, not the value at the time the original exchange was completed. UPREITs were heavily marketed as an appealing way out for owners seeking a transition from private ownership operation (Malkin, 1998).

REITs, including UPREITS, do have several disadvantages, including the facts that trading private ownership for REIT equity results in a loss of the ongoing enterprise; the REIT is subject to income tax upon income from non-rental sources; and UPREIT operating units acquired through tax-free exchanges cannot be sold until converted to REIT shares, a taxable event, and marketable securities held in an estate are taxed at full market value for estate tax purposes (Malkin, 1998). Real estate entrepreneurs should bear in mind that there is a wide range of other opportunities available to them to profit from their own accomplishments.

A private transaction can achieve the same tax objectives as swapping into an UPREIT while allowing the entrepreneur to maintain or even improve on the ownership framework upon which he or she built a successful business in the first place. To be specific, swapping assets into a private entity may provide an entrepreneur with various liquidity options negotiated on a case-by-case basis, as well as a role in the ongoing management and direction of the property involved in the swap (Malkin, 1998).

A private transaction that allows pooling with a larger privately held collection of assets has long-term value benefits as well. It allows for equity interest in a broader portfolio that offers heightened geographic and product-type diversity and makes funds available for upgrades and competitive improvements while the entrepreneur still maintains control of the property brought into the deal. In addition, it allows the exchanging of interests for a piece of a larger pool, which is a valuable estate planning tool.

Real estate investing is risky, but risky investments can lead to greater profits, especially if risk can be minimized through hard work and due diligence before investing. Real estate entrepreneurs must have good skills in persuading, selling, marketing, focusing, listening, and visualizing. They should also be prepared to design and realize their projects as business experiments and test them in the market (Psilander, 2004).

Successful real estate entrepreneurs can become extremely wealthy due to the large sums of money being transacted and the value of the assets they control. Increased value in real estate has typically exceeded the rate of inflation. However, because of the illiquidity of their assets, real estate entrepreneurs often lack the cash needed for daily operational use. This is a situation that they must try to guard against, for the inability to remain cash solvent is the primary cause of business failure for real estate developers.

Massive changes to real estate entrepreneurship occurred in the twenty-first century with the rise of websites such as Airbnb and Vrbo. These sites brought local real estate into a global market. However, instead of only dealing in existing ownership of properties, many entrepreneurs began purchasing properties with the sole intent of listing them on these sites. This greatly affected the real estate industry in many places. Further, with the addition of websites like Zillow which allow people to purchase real estate without the need for middlemen, real estate entrepreneurship and ownership has drastically changed (Mitchell, 2017).

Terms & Concepts

Commercial Real Estate Entrepreneurship: The sale and lease of property for business purposes.

Corporate Venturing: Corporate entrepreneurial efforts that lead to the creation of new business organizations within preexisting organizations.

Entrepreneur: An individual, acting independently or as part of a corporate system, who creates new organizations or instigates renewal or innovation within an existing organization.

Entrepreneurship: In macro terms, this term is synonymous with the advancement of an economy, and in a micro sense, it refers to the process by which an individual or organization pioneers, innovates, and takes risks for growth and development. Entrepreneurship encompasses acts of organizational creation, renewal, or innovation that occur within or outside an existing organization.

Internet Real Estate: The use of the Internet to promote, advertise, and view commercial and residential real estate for lease or purchase. This term has also been used to describe revenue-generating online properties such as domain names or websites.

Leverage: The use of credit or borrowed funds to improve one's purchasing power and increase the rate of profitability on an investment.

Luxury Real Estate: Land and land improvements in prime locations, often with special views or amenities, such as proximity to golf courses, school districts, and the downtown district.

Mortgage: A bank loan to purchase real estate, for which the property itself constitutes collateral.

Real Estate: Also known as "realty" and "real property," real estate comprises land and land improvements permanently fixed to the land, including buildings, fences, and things attached to buildings. Real estate excludes personal property.

Real Estate Investment Trust (REIT): A company that purchases and manages real estate or real estate loans using money invested by its shareholders. It is an investment trust that owns and manages a pool of commercial properties, mortgages, and other real estate assets; shares can be bought and sold on the stock market.

Residential Real Estate Entrepreneurship: The sale and rental of land and houses to individuals and families for daily living.

Strategic Renewal: Corporate entrepreneurial efforts that result in significant changes to an organization's preexisting business or corporate-level strategy or structure.

UPREIT: A variation of the Real Estate Investment Trust (REIT) concept. An UPREIT is a REIT formed by combining properties from existing limited partnerships. The original partners exchange properties held by the partnerships for an interest or operating units in a new transitional operating partnership.

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Suggested Reading

Downs, A. (2004). REITs evolve into entrepreneurs. Retail Traffic, 33, 60–62. Retrieved April 26, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=12493474&site=ehost-live

Dunlap, N. A. (2012). Why invest in commercial real estate? Journal of Property Management, 77, 26. Retrieved November 20, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=71493842

Friedman, J. P., Harris, J. C., & Bruce Lindeman, J. (2004). Dictionary of real estate terms (6th ed.). New York: Barron's Educational Series, Inc.

Kaplan, I. C. (2011). Real estate finance challenges in the wake of the recession: The case for private equity funds. Real Estate Finance, 28, 3–6. Retrieved November 20, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=61442918

Psilander, K. (2002). Development som innovation [Real estate development as innovation]. Essay 16. Stockholm: Department of Infrastructure, KTH.

Urban Land Institute. (2006). Emerging trends in real estate 2007. Washington DC: Urban Land Institute.