Real estate has become a popular and well-proven class of investment, particularly for those who value a diversified portfolio. Like the stock market, real estate has a very long track record of increasing in value over time. The differences between real estate investments and stocks or bonds are plentiful, as are debates about whether real estate is a better quality of investment or not. And as with any investment, it is important to understand your own particular situation and goals before deciding what’s best for you. Here are some pros and cons to consider if you’re interested in entering into the world of real estate.
Here at Bogart Wealth, we understand that diversifying your assets has real value. For almost any client we’re likely to find ways to achieve some level of diversification. Because real estate investments have a relatively low performance correlation with common asset classes such as stocks and bonds, they present an attractive means to achieve diversification without sacrificing the potential for growth or security.
Real Estate is Tangible
Whether you’re flipping a single family home, buying an office building or investing in a Real Estate Investment Trust (REIT), the underlying asset is a piece of property that holds intrinsic value. In an uncertain world, there is a comfort in knowing that no matter what happens, your property will hold value. Also, you have some control over value. You can choose to maintain, upgrade or improve a property. It’s more than a legal agreement, a trend or a purely economic instrument. It’s made of brick and mortar and is a part of the landscape.
High Investment Returns
There is some debate on whether real estate provides a better return than the stock market. Since 1928, the Dow Jones Industrial Average (DJIA) has yielded inflation-adjusted annual appreciation of 1.6%. That’s actually stronger than some estimates of real estate returns over the same period. But real estate data back in the first half of last century is incomplete – and our economy has evolved since then. More recent decades have seen returns in the 10%-20% range for real estate, a trend which, despite a major correction, is still continuing.
High Yield, Low Risk
Most real estate investments provide an income every month. While residential rental properties are returning 1%-4% of the purchase price on average (depending, of course, on the local market), commercial properties are averaging 6%-12%. In today’s market, many investors are finding that rents are rising at historically high rates, pushing incomes even higher than those averages, particularly in stronger markets. Compared to many other investments, these returns are strong, and lower risk.
No Strings Attached
If you want to access your 401(k) or a Roth IRA you either have to wait until retirement or pay a significant penalty. Some investments, such as life insurance, lock you in for years before yielding maximum returns. If you want a quality investment you can liquidate, at any time, and for any reason, real estate carries none of those requirements. You can just sell it. Of course, selling has a cost, and is hardly instantaneous. See “cons” below.
Hedge on Inflation
When inflation increases, so do real estate resale values and rents. While there are many other factors at play during inflationary periods, real estate has proven to be an effective hedge. While inflation should raise rental incomes, it won’t affect your mortgage payment, if you have one. Some investors use real estate as a means to earn a profit when they believe inflation will rise.
Slow, Costly Transactions
Real estate is not a liquid asset. Sure, you can decide to sell at any time and for any reason. But the process of doing so is much more difficult and expensive than withdrawing your cash from the bank. You will likely need to hire professional help to prepare for and execute the sale, and may need to invest some cash into the property to get the best price. And this doesn’t usually happen overnight. Anyone who’s ever sold a home knows that the process can take months.
Every real estate investment requires some level of upkeep and many require management. In most cases, investors choose to outsource this as a service – which costs money. Larger, more complex properties and portfolios require significant management, handling day-to-day upkeep and maintenance, tenant billing, marketing, rent collection, janitorial services, etc.
Real estate is cyclical, both for the leasing market, which involves occupancy and rental income, and the investment market, which involves property availability and purchase prices. Supply and demand varies in both the leasing and investment markets, causing a different – but related – cycle in each. When demand for leasing space increases, supply goes down and drives up rents. Rents drop as supply comes up to meet demand (or demand drops for other reasons). When investment capital is available, prices rise, driving more supply of properties. This in turn puts downward pressure on pricing.
All of this creates an inevitable question about timing, both on the buy side and the sell side of property investment. Likewise, income rates and relative costs will vary, too, as the market works through its cycles.
If someone slips on an icy sidewalk, or leaves a bathroom sink overflowing, the liability will ultimately lie with the property owner. If you own commercial properties, these risks increase with the larger number of people visiting and working there. While it is a benefit to own real property, the flip side is that you also own the risk associated with it.